Special Projects Segment: The Proposed Crowdfunding Rules for Non-Accredited Investors and the Potential Associated Costs for Small Issuers

We are discussing possible rulemaking for equity crowdfunding under the JOBS Act.

One of the overall issues with the Proposed Crowdfunding Rules before the Securities and Exchange Commission (“SEC”) is the potential cost to those small issuers who might seek to take advantage of raising money through this type of offering. In particular, the proposed financial statement disclosures required pursuant to § 227.201(t) may cause such an offering to be cost prohibitive to many small issuers.

Under § 227.201(t), if the issuer’s aggregated offerings pursuant to § 4(a)(6) of the Securities Act of 1933 during the preceding 12 month period: (i) are less than or equal to $100,000, then the issuer’s principal executive officer must certify that the financial statements are true and complete in all material respects; (ii) exceed $100,000 but are $500,000 or less, then the issuer’s financial statements must be reviewed by an independent public accountant; and (iii) exceed $500,000, then the issuer’s financial statements must be audited by an independent public accountant. Under all three scenarios, the issuer must provide four financial statements: balance sheet, income statement, statement of cash flows, and statement of changes in stockholder’s equity. The issuer must provide those financial statements for the two most recent fiscal years or since the issuer’s inception. Additionally, the financial statements must include related footnotes and be prepared in accordance with Generally Accepted Accounting Principles (“GAAP”).

For an issuer that plans to raise $100,000 or less, the requirement that the principal executive officer certifies the financial statements as true and correct does not create an added expense. However, once an issuer decides to raise more than $100,000, additional costs are imminent. According to a 2014 survey by the Financial Executives Research Foundation, the average audit cost for a private company was $174,858 in 2013, an increase of 3.7% from 2012. Crowdfund, CPA, a company that specializes in helping issuers find a CPA firm that specializes in crowdfunding offerings and can provide the required “review” or “audit” service, estimates that a large public accounting firm charges a minimum of $15,000 for an audit, but the audit fee range for a mid-sized company is $50,000-$150,000. Crowfund, CPA, also estimates that the minimum cost for a financial statement review is $5,000.

While it is difficult to pinpoint the actual cost of a financial statement review or audit because each issuer, its business, and financial condition is unique, what is abundantly clear is that requiring an issuer to undertake a review or an audit under the Proposed Crowdfunding Rules could be quite cost prohibitive. Requiring a small issuer to spend a minimum of $5,000 for a financial statement review before it can seek to raise a minimum of $100,001 and up to a maximum of $500,000 is a significant upfront investment. Even more concerning is the potential up front cost of an audit for an issuer seeking to raise more than $500,000. These potential costs may well prevent many small issuers from taking advantage of the crowdfunding rules – rules that were proposed to grant such issuers easier access to the capital markets.