By: Robin Sosnow, Esq. and Veronica Dunlop, J.D.
Many small businesses around the country are facing unprecedented economic hardship and require urgent capital due to the effects of Covid-19. Based on feedback from the Small Business Capital Formation Advisory Committee, the Securities and Exchange Commission (“SEC”) devised a set of Temporary Rules to provide the opportunity for immediate access to capital to such businesses. The Temporary Rules are designed to expedite Regulation Crowdfunding (“Reg CF”) offerings, through the lifting of certain requirements and restrictions found in the Reg CF rules, for the benefit of established small businesses affected by Covid-19. It was implemented on May 4, 2020 and will be applicable until August 31, 2020; however, the SEC has stated that it will continue to monitor the situation and may extend the relief period or consider other measures, as necessary
Eligibility and Requirements for utilizing the Temporary Rules
Only U.S. companies are eligible to take advantage of the Temporary Rules (as is the case for Reg CF itself), and the issuer must be organized with existing operations at least six months prior to the commencement of the offering. Because there are a wide variety of businesses that rely on Reg CF, the SEC recognized that the activities that constitute “operations” will vary and provided specific guidance.
“Examples of issuers who would be considered to have operations include but are not limited to those that: have assets, revenue, operating expenses (such as rent, salaries, or utilities), or interest expense; have paid taxes or incurred business debt; or have previously filed a Form C for a Regulation Crowdfunding offering.” (Temporary Final Rule, n.9).
Additionally, if the issuer previously sold securities under Reg CF, it must have complied with the disclosure requirements in section 4A(b) of the Securities Act of 1933, as amended. However, filing delinquencies can be cured. An issuer must meet the eligibility criteria at the time it initiates an offering in reliance on the Temporary Rules. Therefore, an issuer that was delinquent in its filing obligations that becomes current prior to initiating a new offering would be eligible to rely on the temporary rules. Similarly, applicable intermediaries must have a “reasonable basis” for believing that the issuer complied with section 4A(b). However, this can be satisfied by a representation from the issuer.
Lastly, there are specific disclosure requirements which are listed with the relevant section of the Temporary Rules and further elaborated below, as well as a general disclosure requirement. The offering must prominently state that it is expedited due to Covid-19 and pursuant to the Temporary Rules. It is important to seek legal counsel to ensure accurate disclosure, as Rule 10b-5 applies to Reg CF and gives investors a private right of action.
The Temporary Rules provide four main areas of relief, some of which require specific disclosure by the issuer.
Temporary Rule 201(z)(2) allows issuers to file a Form C without the financial statements usually required by rule 201(t) and commence its offering through the intermediary’s platform. However, such financial statements are required to be included in an amendment to the Form C and provided to investors and the intermediary before the intermediary may accept any investment commitments in the offering. It is important to note that an issuer relying on this temporary rule must prominently disclose that: (1) the omitted financial information is not otherwise available and will be provided by an amendment to the offering materials; (2) the investor should review the complete set of offering materials, including previously omitted financial information, prior to making an investment decision; and (3) no investment commitments will be accepted until after such financial information has been provided.
Temporary Rule 201(z)(3) suspends the need financial statements that are reviewed by an independent accountant normally required by Rule 201(t)(2). This applies to an eligible issuer in an offering (or offerings) that, together with all other amounts sold in Reg CF offerings within the preceding 12-month period, have in the aggregate a target offering amount between $107,000 and $250,000. Such an issuer may provide financial statements of the issuer and certain information from the issuer’s Federal income tax returns, both certified by the principal executive officer, again without having to incur the cost and expense of undertaking a financial review. Unlike rule 201(z)(2), an issuer relying on 201(z)(3) will be deemed to have provided the financial information required by Rule 201(t). This temporary relief only applies if reviewed or audited financial statements of the issuer are not otherwise available. An issuer relying on this temporary rule must prominently disclose that financial information certified by the principal executive officer of the issuer has been provided instead of financial statements reviewed by an independent public accountant.
Temporary Rules 304(e) and 201(z)(1)(iv)are designed toprovide relief for businesses with urgent funding needs, by: (i) shortening the period in which an investor may cancel an investment commitment to 48 hours from the time of his or her investment; and (ii) permitting issuers to close the offering on a date earlier than the offering deadline disclosed in the its Form C. To further elaborate, investors may now cancel an investment commitment for any reason within 48 hours from the time of the investment; however, after this 48-hour period lapses, the investment commitment is considered binding and may only be cancelled if there is a material change to the offering, pursuant to Rule 304(c). With respect to the early closing, once the issuer has received binding investment commitments equal to or in excess of the target offering amount, the intermediary must provide notice that the target offering amount has been met, and the issuer may then close the offering. The intermediary, however, does not have to provide five business days’ notice of the earlier closing deadline, as would normally be required under Rule 304(b).
Finally, the issuer must provide a prominent description of the process to complete the transaction or cancel an investment commitment, including a statement that: (1) investors may cancel an investment commitment for any reason within 48 hours from the time of their investment commitment (or such later period as the issuer may designate); (2) the intermediary will notify investors when the target offering amount has been met; (3) the issuer may close the offering at any time once it has aggregate binding investment commitments that equal or exceed the target offering amount (absent a material change); and (4) if an investor does not cancel an investment commitment within 48 hours of the commitment, the funds will be released to the issuer upon closing of the offering and the investor will receive securities in exchange for the investment.
Temporary Rule 303(g)suspends the 303(a)(2) requirement that information be made publicly available on the intermediary’s platform for a minimum of 21 days before any securities are sold in the offering. Instead, under the temporary rule, the issuer must make the required issuer information publicly available on the intermediary’s platform before any securities are sold in the offering. The intermediary may accept investment commitments beginning when such information is made available, so long as the issuer has provided the financial information required by Rule 201(t). Similarly, funding portals are not required to comply with the 21-day requirement in Rule 303(e)(3)(i) when directing a transmission of funds after a sale has occurred and the cancellation period has expired.
Is Raising Capital under the Temporary Regulation Crowdfunding Rules Right for My Business?
Whereas many of the Small Business Administration (SBA) funding programs, including those established under the CARES Act to address the COVID-19 pandemic, are mutually exclusive, equity crowdfunding provides an altogether alternative pathway to financing your business, regardless of its size, employee headcount or industry. Further, it can be utilized in addition to federal funding during this trying time. If your business has had at least 6 months of operations or has already conducted a Reg CF offering in the past, your business is likely eligible and even well suited to efficiently utilize the aforementioned relief available under the Temporary Rules. Moreover, businesses that are seeking no more than $250,000 in funding, subject to the caveats described in Temporary Rule 201(z)(3), need not undertake the time and expense of a financial review.
To learn more about your small business funding options contact us today for a complimentary business consultation.