COVID-19 Capital Needs Addressed by Temporary Relaxation of Title III Crowdfunding Rules
May 18, 2020
Title III crowdfunding may be an attractive capital raising alternative during the current Coronavirus pandemic because it allows companies to use the internet to solicit potential investors and not be restricted to accredited investors. But some of the requirements under Regulation Crowdfunding may diminish its utility for issuers with urgent capital needs as a result of COVID-19. Recognizing this, the Securities and Exchange Commission on May 4 stepped up and issued temporary final rules relaxing certain timing and financial information requirements for offerings initiated under Regulation Crowdfunding between May 4 and August 31. The temporary rules allow issuers that meet certain eligibility criteria to assess interest in a Regulation CF offering before having to prepare full offering materials, and then once launched, to close the offering and have access to funds sooner than would be possible without the temporary relief. The temporary rules also provide an exemption from certain financial statement review requirements for issuers targeting $250,000 or less within a 12-month period in reliance on Regulation CF.
To be eligible for the relaxed temporary rules, an issuer must have been organized and have had operations for no less than six months prior to the commencement of the offering. The SEC believes this eligibility requirement is appropriate because the temporary relief is intended primarily to assist existing companies that require additional funds because of adverse effects caused by the closures and safety measures designed to slow the spread of COVID-19, not newly formed companies. In addition, a company would be ineligible if it previously conducted a Regulation CF offering but failed to comply with its requirements.
Omission of Financial Statements from Initial Form C Filing
An issuer seeking to conduct a Regulation CF offering to address urgent funding needs triggered by COVID-19 may not have current financial statements available, or may have difficulty securing reviewed or audited financials due to the crisis. Therefore, under existing Regulation CF rules that require reviewed or audited financials, such an issuer may find it difficult to launch a timely offering. The issuer may also be more reluctant to incur the cost of reviewed or audited financials during the pandemic without some indication the offering has a chance of succeeding.
The temporary relief will allow issuers to go live with offering information on a funding portal prior to posting financial statements. Specifically, the temporary rules allow eligible issuers to omit required financials in the initial Form C filed with the SEC, to the extent such financials are not otherwise available, and commence its offering on the funding platform. The financials must then be included in an amendment to the Form C and provided to investors and the portal before the portal accepts any investment commitments. This will allow issuers to test the waters and gauge investor interest in an offering before going through the effort and expense of preparing financials.
Increase in Dollar Threshold Triggering Reviewed Financials
Under existing rules, an issuer targeting more than $107,000 but not more than $250,000 in a 12-month period must provide financial statements that are reviewed by an independent public accountant. The SEC recognizes that obtaining reviewed financial statements could pose serious challenges to an issuer with immediate capital needs due to COVID-19. By allowing issuers to gain more timely access to capital, the temporary rules are expected to benefit eligible issuers affected by COVID-19 that may be facing unexpected delays in securing financing due to a temporary inability to retain an independent accountant.
Accordingly, the temporary rule allows eligible issuers in offerings of up to $250,000 (rather than $107,000) to provide financial statements that are only certified by the principal executive officer, assuming reviewed or audited financials are not otherwise then available.
Suspension of 21-Day Requirement
Current rules provide that information in an offering statement must be publicly available for at least 21 days before securities may be sold, although the funding portal may accept investment commitments during that time. In light of the need for expedited access to capital among small business issuers affected by COVID-19, the temporary rules replace the 21-day rule with a requirement that the intermediary make the mandated issuer information publicly available on its funding platform before securities are sold in the offering. Accordingly, an issuer may close a raise during the temporary rule offering period as soon as it’s raised the target offering amount, even if the offering hasn’t been live for 21 days, as long as the closing occurs at least 48 hours after the last investment commitment and the funding portal notifies investors of the early closing.
Relaxation of Cancellation Process
Regulation CF investors normally have an unconditional right to cancel an investment commitment for any reason until 48 hours prior to the deadline identified in the offering materials. If an issuer reaches its target offering amount before the stated deadline, it may close the offering only if: (i) the offering remains open for a minimum of 21 days; (ii) the intermediary provides notice about the new offering deadline at least five business days before the new deadline; (iii) investors are given the opportunity to cancel their commitment until 48 hours prior to the new deadline; and (iv) at the time of the new deadline, the issuer continues to meet or exceed the target offering amount. Although these rules are intended for investor protection, the SEC acknowledges they may also diminish the utility of Regulation CF for issuers with urgent capital needs as a result of COVID-19.
To provide relief to issuers with urgent funding needs, the temporary rules provide that any investor seeking to cancel a commitment must do so within 48 hours of making the commitment, unless there’s a material change to the terms of the offering or to the information provided by the issuer. In addition, once an issuer has received binding commitments (i.e., commitments for which the 48-hour general cancellation period has run) that equal the target offering amount, the issuer may close the offering on a date earlier than the deadline identified in its offering materials. In order to do so, the issuer must comply with additional disclosure requirements and the intermediary must provide notice that the target offering amount has been met, but is not required to provide the five business days’ notice of the earlier closing deadline, as would normally be required.
As mentioned above, the temporary relaxed rules apply only to offerings initiated under Regulation CF between May 4 and August 31, 2020.