Kirill Shilov

@kirillshilov

What a Startup Needs to Know if their going to sell securities in the US?

November 8th 2018

The goal of this article is to give a brief overview of the rules that are issued by the SEC (Securities and Exchange Commission). This is an attempt of the author to go in-depth and have an updated guide about the rules for selling securities in the US. All materials in this article are for informational purposes only. None of the material presented here should be interpreted as investment advice.

The main revolution in crowdfunding happened back in 2012 when US President Barack Obama signed the JOBS Act (Jumpstart Our Business Startups), which gave people more freedom to raise capital for “emerging growth companies” (with annual gross revenues of less than $1 bln). Starting from that time, the SEC created and updated the rules that allow people to raise funds.

Regulation D

The first thing that we need to start with is Regulation D. This has exemptions that control three rules (504, 506(b), and 506(c)). Rule 505 was repealed on October 26, 2016.

Regulation D is the most common method that startups use to raise money from investors without being required to register with the SEC.

The major things that are interesting for us here is that startups can now raise an unlimited amount of funds from accredited and non-accredited investors (more details below). And they can even advertise campaigns in the media.

To see if your company qualifies, you need to first check this link: https://www.sec.gov/smallbusiness/exemptofferings

Rule 504:

  • Amount: Up to $5 million (in a 12-month period)
  • Allowed Investors: accredited investors only
  • Public Advertising: Not allowed
  • Reselling securities: Investors can’t resell securities for at least a year unless the issuer registers the resale transaction with the Commission
  • Documents: Need to fill out Form D

Rule 506(b): (Private placements)

  • Amount: Unlimited
  • Allowed Investors: Unlimited number of accredited investors, up to 35 non-accredited, “sophisticated” investors. (“Sophisticated” investors mean that they need to have special knowledge. Issuers don’t need to take additional steps to verify that an investor is accredited)
  • Public Advertising: Not allowed
  • Reselling securities: Investors can’t resell restricted securities for at least a year unless the issuer registers the resale transaction with the SEC
  • Documents: Need to fill out Form D

Rule 506(c):

  • Amount: Unlimited
  • Allowed Investors: Unlimited number of accredited investors (Issuer must verify that investors are accredited, typically by using a third party such as verifyinvestor.com)
  • Public Advertising: Allowed
  • Reselling securities: Investors can’t resell restricted securities for at least a year unless the issuer registers the resale transaction with the SEC
  • Documents: Need to fill out Form D

As we can see, the most important things here are the amount raised, the allowed type of investors, and public advertising.

Regulation Crowdfunding (Reg CF)

This became possible after the JOBS Act was signed. This means that now any company can raise money online from any type of investor (accredited or non-accredited). Now, in 2018 Q4, you can even participate by using crypto, like BTC or ETH — isn’t that revolutionary? But, of course, there are some rules and limitations that are far from what we’ve seen with ICOs and their utility tokens… Let’s check out what they are.

Reg CF:

  • Amount: $1,070,000 (in a 12-month period)
  • Allowed Investors: Unlimited number of accredited and non-accredited investors.( BUT there is a limit to how much investors can invest (more about that below)
  • Public Advertising: Allowed
  • Reselling securities: Investors can’t resell restricted securities for at least a year unless the issuer registers the resale transaction with the SEC
  • Documents: Need to fill out Form C

There are some important things that you need to understand.

Investment limitations:

First of all, it’s the limitation that each investor can invest (it depends on your annual income and net worth). There is also a limitation to the maximum amount of securities that you can sell to one investor (it shouldn’t be more than $107,000). Here is the table that further explains these limitations:

https://www.sec.gov/info/smallbus/secg/rccomplianceguide-051316.htm#3

Requirement for registered Intermediary:

The second most important thing is that all of your investments should go through “an SEC-registered intermediary, either a broker-dealer or a funding portal.” Here is a link where you can find such an intermediary: https://www.finra.org/about/funding-portals-we-regulate

Here is a list of some portals:

All of your money will be escrowed on such a platform until the crowdfunding process is finished. And in most cases, the intermediary will get its commision.

The good news is that you can now use crypto to invest in those campaigns. Here is an in-depth description of such a campaign that is going on right now.

Regulation A+

The SEC amended Regulation A, an exemption from securities registration, as ​part of implementing the JOBS Act. These amendments were called Regulation A+. You can learn more by reading this document: https://www.sec.gov/files/Knyazeva_RegulationA%20.pdf

One of the most controversial and important provisions of the new Reg A rules is the federal preemption of the state review of these offerings, which is under state rules known as the “Blue Sky” laws.

Previously, each company had to individually register their Reg A offerings in every state where their securities were offered. This administrative burden was, in addition to requiring registration with the SEC, resulted in very few Reg A offerings ever being made. Now, under Tier 2 of Reg A, only the SEC review is required, significantly reducing the administrative burden for businesses.

Here we will explain the main points regarding Reg A+. New regulations give companies the ability to raise up to $50 million from accredited and non-accredited investors. Reg A+ is split in two parts: Tier I (up to $20 million) and Tier II (up to $50 million)

Tier I:

  • Amount: Up to $20 million (In a 12-month period)
  • Allowed Investors: Unlimited number of accredited and non-accredited investors (No limit on investments)
  • Public Advertising: Allowed
  • Reselling securities: Not restricted. Can resell immediately
  • Documents: File a disclosure document with the SEC and get approval

Tier II:

  • Amount: Up to $50 million (In a 12-month period)
  • Allowed Investors: Unlimited number of accredited and non-accredited investors (For non-accredited investors there is a maximum of 10% of their annual income/net worth per year, depending on which is greater.)
  • Public Advertising: Allowed
  • Reselling securities: Not restricted. Can resell immediately
  • Documents: Upfront audit (US-GAAP level audit that goes back two years — for newer companies, the audit is for the period of the their existence). File a disclosure document with the SEC and get approval

One of the most important things to take note of here is that it will take much more work and money to prepare your company for Reg A+ requirements. Your company will have to work with independent accountants to prepare audited financial statements, and companies raising less than $20 million will have a choice between Tier 1 and Tier 2.

Thanks to the Howtotoken Agency experts for the information and comments provided for this topic.
If you are financial expert and found some mistakes in this article, simply comment below and I’ll update the article.

About the author:

Kirill Shilov — Founder of Geekforge.io and Howtotoken.com. Interviewing the top 10,000 worldwide experts who reveal the biggest issues on the way to technological singularity. Join my #10kqachallenge: GeekForge Formula.

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