Peeling away financial reporting issues one layer at a time

Move Over Kickstarter, Here Comes Crowdfunding

Yesterday was a big day for the capital markets.  For the first time, startups can raise (relatively small amounts of) capital from the public without registering with the SEC and by offering its securities over the internet.  It’s called “crowdfunding.”

Some people think that crowdfunding is a good thing while others think it’s too dangerous, even when subject to the fairly strict SEC regulations that have just now become effective.  The naysayers believe that only sketchy companies that can’t raise money via the “private placement” structures already in place will go the crowdfunding route.

But proponents stress that the safeguards, which the SEC has taken three years to develop, will help; and that relatively modest crowdfunding transaction costs will be affordable to a new segment of issuers.  It is also the first type of offering that levels the playing field between the sharks and small investors who want to expand their portfolios to include a few highly speculative tadpoles that could grow into the next Facebook or  As such, it expands the supply of capital.

To the extent that SEC-regulated crowdfunding is at least a worthwhile experiment, I side with its proponents.  And as a small business owner myself, I appreciate the added flexibility from being being able to dictate the terms of investment arrangements, as opposed to being dictated to by venture capitalists.

But, however you see crowdfunding, I am also thinking that you might like to have a capsule summary of the rules that comprise new Regulation Crowdfunding.

OverviewIn April 2012, Title III of the JOBS Act amended the Securities Act of 1933 (See Section 4(a)(6)) to create an exemption from the registration requirements of the Act for qualifying “crowdfunding” transactions, a relatively new and evolving method of using the Internet and social media to raise capital to support a wide range of ideas and ventures. The intent is that crowdfunding will involve small individual contributions from a large number of investors. Individuals interested in the crowdfunding campaign — members of the “crowd” — may share information about the business and the offering with each other online, and they would use the information that everyone can see on the internet to decide whether to invest.  Hence, a novel new protection for mom and pop investors is the collective “wisdom of the crowd.”

The JOBS Act also provided that crowdfunding transactions would have to wait until the SEC finalized the rules to specify precisely how issuers could rely on the exemption provided.  On October 30, 2015, the SEC issued the final rules, collectively known as Regulation Crowdfunding, that became effective on May 16th.

Limitations—Rule 100(a) limits the amount of crowdfunding offerings by an issuer to a piddling $1 million in securities during any 12-month period.  Perhaps more important, no single investor can contribute more than $2,000 or 5% of its net worth unless its net worth is greater than $100,000 — in which case the limit is generally at the 10% level.

Disclosure Requirements—Crowdfunding issuers provide very limited required disclosures relative to other types of offerings.  They make all of their disclosures (as set forth in Rule 201) via new Form C.  Much of these disclosures are in XML format only, including key financial figures from the financial statements.

I would imagine that my readers are pretty interested in the financial statement requirements.  They are generally scaled to the offering size — with certain accommodations for first-time issuers and exceptions if audited financial statements are already available.  Offerings for less than $100,000 need only disclose a few key lines from tax returns plus unaudited annual (i.e., no “stub periods”) GAAP financial statements that are “certified” by the issuer’s CEO.

Offerings greater than $100,000 and less than $500,000 require independently reviewed (per AICPA standards) annual financial statements, and larger offerings require audits; however, first-time issuers need only obtain review reports.

For all issuers, only annual financial statements are required, but the balance sheet can be no more than 120 days old.  Rule 202 requires an annual report no later than 120 days after fiscal year-end.

Intermediary—A key aspect of Reg Crowdfunding is that an online offering, including information updates, is conducted paperlessly via only one SEC-registered intermediary’s internet platform (called a “funding portal”).  The intent of limiting an offering to only one funding portal is that there is a single official forum for an exchange of information among potential investors (the “crowd”), who would also be notified of updated information from the issuer via email.

A funding portal is distinguishable from a broker-dealer in that it is prohibited from: offering investment advice or recommendations; soliciting purchases, sales or offers to buy the securities displayed on its platform; compensating others for making solicitations; and handing investor funds or securities.

* * * * * *

I hope this helps.  IMHO, Crowdfunding will be one of the more interesting capital market developments to watch over the next few years.


  1. Reply Steven Zeiler May 17, 2016

    Accounting standards for crowdfunding is great and will make the capital markets more efficient and effective, but I’m curious to know what happens when a business does not comply with the rules, such as only using one funding portal.

    Are there criminal penalties for breaking the SEC rules?

    • Reply Tom Selling May 17, 2016

      Regulation Crowdfunding contains safeguards to reduce the risk of fraud and disqualification provisions (see sections 301 and 503). As to actual violations, that’s covered by the Securities Act: Section 11 for civil liability and Section 17 for criminal liability.

  2. Reply Eva June 25, 2016

    Great article. I see two sides of the issue: on one side startups have great opportunity to raise money without giving away shares of the business. However on the other hand most startup will fail and the investors will simply lose money.

  3. Reply South Texas Vocational Technical Institite June 28, 2016

    It is a good thing that crowdfunding is now legally available. I think kickstarter will still be the brand of crowdfunding.

  4. Reply David M. Freedman August 4, 2016

    Two observations about the Title III (Reg CF) crowdfunding market, 10 weeks into the launch of this new asset class:
    1. Of the 50-or-so Title III offerings originating on nine different funding portals, more than half require minimum investments of $100 or less. This is a radical departure from traditional angel investing, where minimums are typically tens of thousands. One result of this is that angel investing becomes very socially motivated — who is going to conduct thorough due diligence for a $100 or even a $1,000 investment?
    2. The dominant securities in Title III offerings are common stock and SAFEs (simple agreement for future equity). The theme: keep it simple.

  5. Reply Paul September 28, 2016

    Great article! Crowdfunding is definitely one of the most advanced fundraising methods comparing to the traditional methods. I think making it legal can effectively help the economy grow especially we are on the down slope right now. In 2015, it was estimated over USD$34 billion were raised worldwide. It is definitely something that the SEC should keep their eye open on as the trend is growing larger and larger every year. Many people are familiar with crowdfunding for non-profit organizations, but crowdfunding affects for profit companies as well. There are two types of crowdfunding: rewards crowdfunding and equity crowdfunding. The difference between the two is that rewards crowdfunding does not involve any shares or equity sacrificing whereas equity crowdfunding does involve bankers to invest in those organizations with equity involved.
    Here are some pros and cons regarding to crowdfunding for startups:
    – Excellent Transparency: Online crowdfunding makes it very easy for law enforcement agencies to keep track of the cash flow, which also makes it difficult for money laundering.
    – Convenient: Comparing to traditional funding methods, online crowdfunding now can attract “investors” around the globe with no limitation. There are a lot more investors involved than to the traditional methods.
    – Rapid growing funding: One can anticipate a rapid growing funding if the information is available and accessible by any investors worldwide.
    – Don’t have to give up business equities: This is probably the number one advantage of crowdfunding because asking banks and shark tanks will involve a lot of negotiation on equity and loyalties and etc.
    – Might fail publicly
    – Might not attract any investors at all
    – Might have to spend a lot of time for marketing campaigns
    Could you provide a little more info on anti-money laundering on crowdfunding regarding to fraud prevention? In addition to what David said, what actions will SEC take to prevent AML on crowdfunding if there is a large number of transactions that are small amounts?

Leave a Comment