BUSINESS MANAGEMENT
Funding Small Businesses and Startups Under Regulation Crowdfunding BY DR. CARLA CABARLE, DBA, MS, CPA, STOCKTON UNIVERSITY
According to the latest SEC Staff Report to the Commissioner ( June 2019), there have been more than 1,300 regulation crowdfunding (Reg. CF) offerings made between the regulation’s inception in May 2016 and Dec. 31, 2018. Approximately half of the offerings were successful — small businesses and startups raised an average of $208,400, and the total raised during this time was over $108 million. Since then, Reg. CF offers continue to be an appealing capital raising option for entrepreneurs. Furthermore, regulators continue to enhance the rules, with the latest amendment made in November 2020 to encourage businesses and investors to participate. BENEFITS FOR SMALL BUSINESSES Certain features of Reg. CF appeal to small businesses. Because Reg. CF is an unregistered securities option, it circumvents some of the stringent and costly rules applicable to IPO issuers. For instance, Reg. CF offers are not limited only to accredited investors, and they are not required to include audited financial statements or Sarbanes-Oxley Act (SOX) compliance in the filing. Similar to nonexempt registrants, Reg. CF issuers must include the equivalent of a management discussion and analysis (MD&A) in the filing documents, but the discussion points are much less prescriptive and comprehensive. Furthermore, an intermediary is used to solicit and manage the offer and issuance, as well as provide educational
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materials to investors and enforce investment limitations applicable to unaccredited investors. The intermediary is typically an SEC-registered online funding portal that specializes in capital formation (although registered broker-dealers are permitted), and the fees charged by portals are fairly low (typically 4 to 6 percent of the issuance). Two popular online funding portals are WEFunder (wefunder.com) and StartEngine (startengine.com). HOW IT WORKS Accredited investors are encouraged to invest in Reg. CF by way of no investment limitation. Regulators and stakeholders believe that if accredited investors invest, unaccredited investors will be encouraged to also invest. As an investor-protection measure, the regulation limits investment amounts for unaccredited investors. The offer is assigned a tier based on its size, and the tier determines the level of assurance required. The dollar amount used to determine the size of the offer, or tier, is the current offer’s stated maximum (oversubscription) plus amounts raised from other Reg. CF offers in the previous 12 months. Therefore, no initial Reg. CF offerings are required to include audited financial statements, even at the maximum offer allowed, which is currently $5 million. It should be noted that if the issuer already has audited financial statements, they must be included at any tier. Tier 3 offers ($535,000 to $5 million) are required to include management certification and independent CPA-reviewed financials, and any subsequent offerings must include audited financials. Tier 2 offers ($250,000 to $535,000) must include management certification and independent CPAreviewed financials, and Tier 1 offers ($1 to $250,000) are required to include only a management certification but not reviewed financials. Issuers can choose to provide a higher level of assurance than the tier requires.
The management discussion section of the filing must address the issuer’s financial condition, including material trends, uncertainties, historical data, liquidity and capital resources. It also must include the business plan and a discussion of the planned purpose and intended use of the proceeds at both the minimum offer amount (target) and the maximum (oversubscription). Additional required disclosures include the current number of employees; a discussion of the material risk factors of the investment, including relatedparty transactions; current ownership and capital structure; and material indebtedness. During the offer period, the issuer must inform the public of its progress towards its funding goal, and, if the offer is funded, the issuer must provide annual updates to investors. Companies that do not comply with the annual reporting requirements are prohibited from offering Reg. CF securities in the future. Reg. CF can be a win-win for both small business and investors because buyers can easily find and invest in startups and small businesses at a low cost, and a company can gauge public interest in its stock through a crowdfunding campaign without committing to accounting changes and internal control policies that would be required for an IPO. This saves the issuer time and money and allows them to broaden their reach to a wider pool of investors. Dr. Carla Cabarle, DBA, MS, CPA, is an assistant professor of business studies and accounting at Stockton University. She is a member of the NJCPA Cannabis, Emerging Technologies and Emerging Leaders interest groups and can be reached at carla. cabarle@stockton.edu.
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