SECTION 4(A)6 OF THE SECURITIES ACT

Section 4(a)(6) of the Securities Act of 1933, as amended (the “Securities Act” is also known as Regulation CF. These rules have made it easier for companies to raise money from a wider range of investors than ever before. Traditional crowdfunding models may or may not involve the offer and sale of a security, but if so, the issuer must comply with federal and state securities laws, which we discuss in this section. Like offerings under Tier 2 of Regulation A and Rule 506(c), one notable benefit of Regulation CF is that state blue-sky laws are preempted.

Regulation CF provides an exemption from the registration requirements of the Securities Act for certain crowdfunding transactions. To qualify for this exemption, the transactions must meet specific requirements, including limits on the dollar amount of the securities that may be sold by an issuer and the dollar amount that may be invested by an individual in a 12-month period. It also must be conducted through a registered intermediary that complies with specified requirements. These intermediaries are called “funding portals.” Title III also provides limitations on who may rely on the exemption and establishes specific liability provisions for material misstatements or omissions in connection with Section 4(a)(6)-exempt transactions.

REGULATION CROWDFUNDING OR REGULATION CF

In this blog post, we will explain a second type of crowdfunding offering: Regulation Crowdfunding, also called Regulation CF. As you read along, think about how to solve these problems:

• You don’t have the money to fund all fees and costs of a Form S-1 or Regulation A offering.
• You want a real-world test of whether you can raise money in your Form S-1 or Regulation A offering, not a testing the waters transaction where you cannot actually take investors’ money, but a live offering that will bring in some cash.

A properly structured Regulation CF offering can solve both problems. Ask your securities professional advisers for more information about this possibility.

SUMMARY OF REGULATION CF’s REQUIREMENTS

Regulation CF’s requirements are summarized in the chart below:

Maximum Offering Period	12 Months
Maximum Amount of Offering	$1.07 million
General Solicitation & Advertising	Permitted with limits on advertising after the Form C is filed with the SEC
Company Requirements	Excludes non-US, blank-check, reporting, and investment companies.
Disqualification of Covered persons	Yes
Blue Sky Preemption	Yes
Investment Limitations	Investment limitations based on annual income and net worth
Investor Qualification Requirements	Yes
Manner of Sale Requirements	Offers and sales may only take place through registered crowdfunding portals.
SEC Filing Requirements	Yes
Resale Restrictions	Yes

 OFFERING AMOUNTS AND THE OFFERING TERM

Regulation CF limits to $5 million the aggregate amount that may be sold to all investors by the issuer in a 12-month period in reliance on the exemption. The intent of providing the exemption under Regulation CF was to provide an additional mechanism for capital raising for startup and small businesses and not to affect the amount an issuer could raise outside of that exemption. Thus, only the capital raised in reliance on the exemption provided by Regulation CF should be counted toward the limit. The opposite approach—requiring aggregation of amounts raised in any exempt transaction—would be inconsistent with the goal of alleviating the funding gap for startups and small businesses because, by electing crowdfunding, such issuers would be placing a cap on the amount of capital they could raise.

In determining the amount that may be sold in reliance on Section 4(a)(6), an issuer should aggregate amounts it has sold (including amounts sold by entities controlled by, or under common control with, the issuer as well as any amounts sold by any predecessor of the issuer) in reliance on Regulation CF during the 12-month period preceding the expected date of sale and the amount the issuer intends to raise in reliance on the exemption. An issuer should not include amounts sold in other exempt offerings during the preceding 12-month period.

An offering made in reliance on Regulation CF would not be integrated, or combined, with another exempt offering made by the issuer, provided that each offering complies with the requirements of the applicable exemption that is being relied upon for the particular offering. For example, an issuer conducting a concurrent exempt offering for which general solicitation is not permitted will need to be satisfied that purchasers in that offering were not solicited by means of the offering made in reliance on Section 4(a)(6).

In another example, an issuer conducting a concurrent exempt offering for which general solicitation is permitted, for example, under Securities Act Rule 506(c), could not include in any such general solicitation an advertisement of the terms of an offering made in reliance on Regulation CF unless that advertisement otherwise complied with Section 4(a)(6). As such, a concurrent offering would be bound by the more restrictive solicitation requirements of Regulation Crowdfunding, unless the issuer can conclude that the purchasers in the Regulation CF offering were not solicited by means of the offering made in reliance on Rule 506(c).

The amount of securities sold in reliance on Regulation CF by entities controlled by or under common control with the issuer must be aggregated with the amount to be sold by the issuer in the current offering to determine the aggregate amount sold in reliance on Regulation CF during the preceding 12-month period. For a concurrent offering under Rule 506(b), an issuer will have to conclude that purchasers in the Rule 506(b) offering were not solicited by means of the offering made in reliance on Section 4(a)(6). For example, the issuer may have had a preexisting substantive relationship with such purchasers. Otherwise, the solicitation conducted in connection with the crowdfunding offering may preclude reliance on Rule 506(b).

For purposes of determining whether an entity is “controlled by or under common control with” the issuer, an issuer will be required to consider whether it possesses, directly or indirectly, the power to direct or cause the direction of the management and policies of the entity, whether through the ownership of voting securities, by contract or otherwise, consistent with the definition of “control” in Securities Act Rule 405.

The amount of securities sold in reliance on Regulation CF also includes securities sold by any predecessor of the issuer in reliance on Regulation CF during the preceding 12-month period. We believe this approach is necessary to prevent an issuer from exceeding the $1 million limit by reorganizing into a new entity that would otherwise not be limited by previous sales made by its predecessor.

ISSUER ELIGIBILITY TO USE REGULATION CF

Securities Act Section 4A(f) excludes certain categories of issuers from eligibility to rely on Regulation CF. Excluded issuers are as follows:

• companies that are not organized under the laws of a state or territory of the United States or the District of Columbia,
• companies that are subject to Exchange Act reporting requirements,
• certain investment companies,
• companies that are subject to disqualified as a result of certain “covered persons” under the rule,
• companies that have failed to comply with the annual reporting requirements under Regulation Crowdfunding during the two years immediately preceding the filing of the offering statement, and
• companies that have no specific business plan or have indicated their business plan is to engage in a merger or acquisition with an unidentified company or companies.

INVESTMENT LIMITS IN REGULATION CF OFFERINGS

The investment limit reflects the aggregate amount an investor may invest in all offerings under Regulation CF in a 12-month period across all issuers. An investor will be limited to investing:

• the greater of $2,000 or 5 percent of the lesser of the investor’s annual income or net worth if either annual income or net worth is less than $100,000; or
• 10 percent of the lesser of the investor’s annual income or net worth, not to exceed an amount sold of $100,000 if both annual income and net worth are $100,000 or more.

Under this approach, an investor with annual income of $50,000 a year and $105,000 in net worth is subject to an investment limit of $2,500. The startups and small businesses that rely on the crowdfunding exemption are likely to experience a higher failure rate than more seasoned companies. Applying the lower limit ($2,000 or 5 percent rather than 10 percent) for investors whose annual income or net worth is below $100,000 and applying that formula to the lesser of annual income or net worth will potentially limit investment losses in crowdfunding offerings for investors who may be less able to bear the risk of loss. The SEC is concerned about the number of households where there is a sizable gap between net worth and annual income, and the ability of these households to withstand the risk of loss.

The chart below summarizes the income and net worth limitations imposed by Regulation CF. Note that spouses can calculate their net worth or annual income jointly. When such a joint calculation is used, the aggregate investment of the spouses may not exceed the limit that would apply to an individual investor at that income and net worth level.

Investor Annual Income	Investor Net Worth	Calculation	Investment Cap
$150,000	$80,000	Greater of $2,200 or 5% of $80,000 ($4,000)	$4,000
$150,000	$107,000	10% of $107,000 ($10,700)	$10,700
$200,000	$900,000	10% of $200,000 ($20,000)	$20,000
$1,200,000	$2,000,000	10% of $1,200,000 ($120,000), subject to $107,000 cap	$107,000

USE OF INTERMEDIARIES AND CROWDFUNDING PORTALS IN REGULATION CF OFFERINGS

One requirement of Regulation CF is that the issuer cannot conduct the offering itself. The offering must only be conducted through a crowdfunding intermediary commonly referred to as a “funding portal.”  Crowdfunding intermediaries must be registered with the SEC as a broker-dealer or as a funding portal and become a member of FINRA.  An issuer is required to use only one intermediary to conduct an offering in reliance on Section 4(a)(6). The SEC has stated that it believes this helps foster the creation of a “crowd” and better serves the purpose of the statute.

The SEC also believes that for a crowd to effectively share information, having one meeting place is most beneficial for them to obtain and share information, thus avoiding dilution of the “crowd.” Limiting a crowdfunding transaction to a single intermediary’s online platform also helps to minimize the risk that issuers would circumvent the requirements of Regulation Crowdfunding.

Crowdfunding transactions made in reliance on Regulation CF and activities associated with these transactions occur over the internet or another similar electronic medium that is accessible to the public. Such an “online-only” requirement enables the public to access offering information and share information publicly in a way that allows members of the crowd to share their views on whether to participate in the offering and fund the business or idea. Transactions must be conducted exclusively through the intermediary’s platform. This helps ensure transparency, provides for ready availability of information in one place to all investors, and promotes greater uniformity in the distribution of information among investors.

Funding portals are not permitted to physically meet with investors to solicit investments and offerings on its platform, or host launch parties. Intermediaries may engage in back-office and other administrative functions other than on their platforms.

A “platform” is defined as “a program or application accessible via the internet or other similar electronic communication medium through which a registered broker or a registered funding portal acts as an intermediary in a transaction involving the offer or sale of securities in reliance on Regulation CF of the Securities Act.

Under Rule 503(c) of Regulation CF, a person who is subject to statutory disqualification is prohibited from acting as, or being associated with, an intermediary in a crowdfunding transaction unless permitted by an SEC rule or order.

Regulation CF establishes disclosures that an issuer offering or selling securities in reliance on Regulation CF must file with the SEC and provide that filing to investors and the relevant broker or funding portal. These disclosures must be provided to the SEC on Form C.

ISSUER DISCLOSURE REQUIREMENTS ON FORM C

Regulation CF establishes disclosures that an issuer offering or selling securities must provide to the SEC on Form C through EDGAR and to investors through the broker-dealer or funding portal participating in the offering.

Information about the Issuer and the Offering

On the Form C, an issuer is required to disclose information about its president, vice president, secretary, treasurer or principal financial officer, comptroller or principal accounting officer, and any person routinely performing similar functions. If it does not have officers serving in each of these roles, the disclosure is required only to the extent it has individuals serving in these capacities or performing similar functions.

The required information includes all positions and offices held with the issuer, the period in which such persons served in the position or office, and their prior business experience. The required disclosure about the business experience of the directors and officers (and any persons occupying a similar status or performing a similar function) must cover the past three years, which is shorter than the five-year period that applies to issuers conducting registered offerings or exempt offerings pursuant to Regulation A.

Disclosure of an issuer’s website is required, as the SEC believes that every issuer will have a website or be able to create one at a minimal cost.

Instead of requiring issuers to disclose the name of each 20 percent beneficial owner as of the most recent practicable date calculated on the basis of voting power, such disclosure is required as of the most recent practicable date but no earlier than 120 days prior to the date the offering statement or report is filed.

Description of the Business

Rule 201(d) requires the issuer to disclose information about its business and anticipated business plan. The rule does not specify the disclosures that an issuer must include in the description of the business and the business plan or provide a non-exclusive list of the types of information an issuer should disclose. As such, the issuer should provide true and complete information about its business to enable investors to make an informed investment decision.

Use of Proceeds

Rule 201(i) requires an issuer to provide a reasonably detailed description of the purpose of the offering, so that investors understand how the offering proceeds will be spent.

The SEC provides several examples of the disclosures issuers should consider making about the uses of the offering proceeds. For example, an issuer may plan to use the proceeds of an offering to acquire assets or businesses, compensate an intermediary or its own employees, or repurchase outstanding securities of the issuer. In providing its description, an issuer should consider the appropriate level of detail to provide investors about the assets or businesses it anticipates acquiring, based on its particular facts and circumstances, so that the investors could make informed decisions.

If the proceeds will be used to compensate existing employees or to hire new employees, the issuer should consider disclosing whether the proceeds will be used for salaries or bonuses and how many employees it plans to hire, as applicable.

If the issuer will repurchase outstanding issuer securities, it should consider disclosing its plans, terms, and purpose for repurchasing the securities.

An issuer also should consider disclosing how long the proceeds will satisfy the operational needs of the business. If it does not have definitive plans for the proceeds but instead has identified a range of possible uses, then it should identify and describe each probable use and the factors it may consider in allocating proceeds among the potential uses.

If an issuer indicates that it will accept proceeds in excess of the target offering amount, it must provide a reasonably detailed description of the purpose, method for allocating over subscriptions, and intended use of any excess proceeds with similar specificity.

Target Offering Amount and Deadline

Investors in a Regulation CF offering must receive clear disclosure about their right to cancel, the circumstances under which an issuer may close an offering early, and the need to reconfirm the investment commitment under certain circumstances, as they will be more aware of their rights to rescind an investment commitment.

If an issuer sets a target offering amount of $80,000 but is willing to accept up to $650,000, it will be required to disclose both the $80,000 target offering amount and the $650,000 maximum offering amount that it will accept.  In an instance where an issuer reaches the target offering amount of $80,000 prior to the deadline identified in its offering materials, it may close the offering early if it provides at least five business days’ notice about the new offering deadline. Closing the offering early would not require reconfirmation of the investment commitment; however, issuers need to consider whether any material change occurred that would require a reconfirmation from investors. The issuer is required to disclose, at the commencement of the offering, how shares in oversubscribed offerings will be allocated.

Offering Price

Investors will benefit from clear disclosure about the terms of the securities being offered and about each other class of security of the issuer. Regulation CF requires disclosure of the number of securities being offered and those outstanding, whether such securities have voting rights, any limitations on such voting rights, and a description of the restrictions on the transfer of securities.

Although Regulation CF does not specifically call for all aspects of this disclosure, it is necessary to provide investors with a more complete picture of the issuer’s capital structure than would be obtained solely pursuant to the statutory requirements. This should help investors better evaluate the terms of the offer before making an investment decision.

Additional Disclosure Requirements

No matter what, the issuer must disclose any material information, whether specifically listed in the regulation or not. Material information must be provided as needed in order to render the statements made, in light of the circumstances under which they were made, not misleading. What’s material?  Just think, if you were an investor in a company and you found out management knew something it didn’t tell you such as the loss of material customers that would render its financial statements inaccurate or incomplete, which if you had known would have made you run for the hills. That would make it material information

Disclosure of the compensation to be paid to the crowdfunding portal is required and maybe made as a dollar amount, a percentage of the offering amount, or a good faith estimate if the exact amount is not known at the time of the filing.

To avoid duplicative disclosure, an issuer will not be required to repeat what is already provided elsewhere in its disclosure, including the financial statements. Issuers may cross-reference within the offering statement or report, including to the location of the information in the financial statements.

Basic disclosure requirements in a Regulation CF offering include the following:

Identity of the Intermediary. The issuer must identify the intermediary through which the offering is being conducted by name, SEC file number, and Central Registration Depository (CRD) number. This may help investors obtain background information on the intermediary through filings made by him with the SEC, as well as through the FINRA’s BrokerCheck system for broker-dealers.  Registered funding portals may be searched for by name at EDGAR.

Compensation Paid to the Intermediary. An issuer is required to disclose the amount of compensation paid to the intermediary for conducting the offering, including the amount of any referral or other fees associated with the offering, to permit investors and regulators to determine how much of the proceeds of the offering is used to compensate the intermediary. All compensation paid, or to be paid, is required. If the exact amount is not available at the time of filing, issuers are permitted to provide a good faith estimate.

In addition, issuers are required to disclose any other interest held by the intermediary, or any arrangement for the intermediary to acquire such an interest. That is not against the rules if disclosed.

Legends. An issuer is required to include in the offering statement specified statements sometimes referred to as “legends” about the risks of investing in the crowdfunding offering. This requirement is intended to help investors understand the general risks of investing.

Legends in each issuer’s offering statement, regardless of any general warnings available on an intermediary’s platform, provide additional investor protection with minimal costs. For example, the requirement that an issuer include in the offering statement certain legends about the required ongoing reports will help investors understand an issuer’s ongoing reporting obligations and how they will be able to access those reports.

Current Number of Employees. Disclosure of the issuer’s current number of employees is required.

Risk Factors. Disclosure of the material factors that make an investment in the issuer speculative or risky is important to help investors understand the risks of investing in a specific issuer’s offering. Risk factor disclosure should be tailored to the issuer’s business, and the offering and should not repeat the factors addressed in the required legends.

Indebtedness. Issuers must provide a description of the material terms of any indebtedness of the issuer, including, among other items, the amount, interest rate, and maturity date of the indebtedness. Disclosure of names of specific creditors is required only to the extent the creditor’s identity is a material aspect of the indebtedness.

Prior Exempt Offerings. Issuers must provide disclosure about the exempt offerings that they conducted within the past three years. For each exempt offering within the past three years, issuers must describe the date of the offering, the offering exemption relied upon, the type of securities offered, and the amount of securities sold and the use of proceeds.

Related-Party Transactions. Related-party transactions create potential conflicts of interest that may result in actions that benefit the related parties at the expense of the issuer or the investors. Thus, related-party transactions disclosure is required in order to assist investors in obtaining a more complete picture of the financial relationships between certain related parties and the issuer and provide additional insight as to potential uses of the issuer’s resources, including the proceeds of the offering. An issuer is required to disclose transactions with any person who is, as of the most recent practicable date but no earlier than 120 days prior to the date the offering statement or report is filed, the beneficial owner of 20 percent or more of the issuer’s outstanding voting equity securities.

In addition, issuers are required to disclose only related-party transactions that, in the aggregate, are in excess of five percent of the aggregate amount of capital raised by the issuer during the preceding 12-month period, inclusive of the amount the issuer seeks to raise in the current offering under Section 4(a)(6). Any series of similar transactions, arrangements, or relationships should be aggregated for purposes of determining whether related-party transactions should be disclosed.

For example, an issuer seeking to raise $1 million will be required to disclose related-party transactions that, in the aggregate, are in excess of $50,000, which is the same dollar threshold required in Form 1-A for offerings of any size made pursuant to Tier 1 of Regulation A, and an issuer that raises $250,000 will be required to disclose such transactions in excess of $12,500.

There is a definition for “member of the family” in the related-party transactions context that is consistent with the definition of “member of the family of the purchaser or the equivalent” in the resale restrictions context. A “member of the family” is defined as a “child, stepchild, grandchild, parent, stepparent, grandparent, spouse or spousal equivalent, sibling, mother-in-law, father-in-law, son-in-law, daughter-in-law, brother-in-law, or sister-in-law, [including] adoptive relationships” of any of the persons identified.

Other Disclosures Required by Regulation CF

There are three other issuer disclosures required by Regulation CF:

• An issuer must disclose on its website the location where investors will be able to find its annual report and the date by which such report will be available on its website.
• The disclosure must include any material information necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading. This provision should help ensure that investors have all the material information they need on which to base their investment decisions.
• The issuer must disclose whether it or any of its predecessors previously failed to comply with the ongoing reporting requirements of Regulation Crowdfunding.

Financial Disclosures

Section 4A(b)(1)(D) requires “a description of the financial condition of the issuer.” It also establishes a framework of tiered financial disclosure requirements based on aggregate target offering amounts of the offering and all other offerings made in reliance on Regulation CF within the preceding 12-month period.

Financial Condition Discussion

Regulation Crowdfunding requires an issuer to provide a narrative discussion of its financial condition. The description must include a discussion of liquidity, capital resources, and historical results of operations. Issuers are also required to include a discussion of each period for which financial statements are provided and a discussion of any material changes or trends known to management in the financial condition and results of operations of the issuer subsequent to the period for which financial statements are provided.

An issuer will need to consider whether more recent financial information is necessary to assure that the disclosure in the offering document is not misleading.

The discussion required is designed to inform investors about the financial condition and results of operations of the issuer by providing management’s perspective on the issuer’s operations and financial results, including information about liquidity and capital resources and any known trends or uncertainties that could materially affect the issuer’s results. Because issuers seeking to engage in crowdfunding transactions will likely be smaller, less complex, and at an earlier stage of development than issuers conducting registered offerings or Exchange Act reporting companies, the discussion generally will not need to be as lengthy or detailed as the management’s discussion and analysis of financial condition and results of operations of those issuers.

The discussion should address the issuer’s historical results of operations in addition to its liquidity and capital resources. If an issuer does not have a prior operating history, the discussion should focus on financial milestones and operational, liquidity, and other challenges. If an issuer has a prior operating history, the discussion should focus on whether historical earnings and cash flows are representative of what investors should expect in the future.

An issuer’s discussion of its financial condition should consider the proceeds of the offering and any other sources of capital. Issuers also should discuss how the proceeds from the offering will affect their liquidity, whether these funds and any other additional funds are necessary to the viability of the business and how quickly the issuer anticipates using its available cash. In addition, issuers should describe the other available sources of capital to the business, such as lines of credit or required contributions by principal shareholders.

Issuers are required to present the required disclosures, including any other information that is material to an investor, in a clear and understandable manner.

Disclosures of Amounts of Securities Offered and Sold Pursuant to Regulation CF

The adopted requirements are based on the amount offered and sold within the past 12 months as follows:

• For issuers offering $100,000 (subject to inflation adjustments, currently $107,000) or less: disclosure of the amount of total income, taxable income, and total tax as reflected in the issuer’s federal income tax returns certified by the principal executive officer to reflect accurately the information in the issuer’s federal income tax returns (in lieu of filing a copy of the tax returns), and financial statements certified by the principal executive officer to be true and complete in all material respects.

• If, however, financial statements of the issuer are available that have either been reviewed or audited by an independent public accountant, the issuer must provide those financial statements instead and need not include the information reported on the federal income tax returns or the certification of the principal executive officer.

• For issuers offering more than $500,000 but not more than $1.07 million of securities in reliance on Regulation Crowdfunding for the first time: financial statements reviewed by a public accountant that is independent of the issuer. If, however, financial statements are available that have been audited by an independent public accountant, the issuer must provide those financial statements instead and need not include the reviewed financial statements.
• For issuers that have previously sold securities in reliance on Regulation Crowdfunding: Financial statements audited by an independent public accountant are required.

Financial Statement Requirements

All issuers must file with the SEC and provide to investors and the relevant intermediary a complete set of their financial statements, which includes balance sheets, statements of comprehensive income, statements of cash flows, statements of changes in stockholders’ equity, and notes to the financial statements.

In order to avoid potential confusion as to the presentation of financial statements, and consistent with Tier 1 offerings under Regulation A, financial statements that are not audited must be certified by the issuer’s principal executive officer.