In the midst of my recent series of blogs about preparing to sell your company (two blogs posted, two more planned), the Securities and Exchange Commission released a number of revised regulations in late 2020. Many of these changes are significant for early stage companies intending to raise capital, so I thought that they are worth attention.
The new rules make many significant changes, yet they have received little attention to date in the business and legal press. Perhaps one reason is timing. The new rules were announced on Monday November 4th, which I’m told by my inside sources was the day before some sort of election in the US!
Despite the lack of attention, these new rules are important. Although there are other changes, in my view the most significant changes relate to crowdfunding (Regulation CF). This is not a complete list, but some of the changes to Regulation CF are:
- Raising the limit on the funds that can be raised under Regulation CF over a 12-month period from $1.07 million to $5 million;
- Removing the investment limits for accredited investors;
- Allowing non-accredited investors to rely on the greater of their income or net worth in calculating their investment limit and remove the $107,000 cap on an individual’s crowdfunding investments during a 12-month period; and
- Facilitating the use of special purpose vehicles (SPVs) for investment in a Regulation CF offering.
The use of Regulation CF to date has been non-overwhelming, to put it mildly, with issuers raising $108 million from May 2016 through December 2018. The limited use of this private offering exemption is likely part of the motivation for the SEC to modify some of the rules; the revised rules are clearly an acknowledgement by the SEC that the original rules were overly restrictive.
Will the new rules significantly increase the use of Regulation CF? My view is that the revised rules will result in only a modest bump in CF offerings because:
- the offering statement requirements are unchanged;
- the requirements for post-issuance reporting remain in place with only minor changes;
- the continued requirement is that the offering be conducted only through a qualified portal, with the attendant fees;
- while SPV’s are now legally permissible, potential later investors may still avoid a company with a large number of existing investors even if those investors invested by means of an SPV; and
- Regulation CF offerings are still subject to a variety of regulations of state securities commissions, since the limitation of state regulations under NSMIA (National Securities Markets Improvement Act) only applies to Rule 506 offerings (Regulation D).
Prediction is always difficult (especially when it comes to the future, as the saying goes), so we will have to stay tuned to see how the start-up and investment communities react to these changes.
