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MANAGEMENT ACCOUNTING / FINANCIAL PLANNING

New opportunities for CPAs in proposed crowdfunding rules

 

By Ken Tysiac
October 23, 2013

Rules on crowdfunding proposed by the SEC on Wednesday would create opportunities for startups and small, private businesses to raise cash through internet-aided sales of securities—and would create opportunities for work by CPAs.

The SEC commissioners voted 5–0 to propose the rules that are designed to comply with a provision of the Jumpstart Our Business Startups (JOBS) Act of 2012, P.L. 112-106, whose purpose is to create easier access to capital for small businesses.

Crowdfunding gives companies the ability to raise funds by attracting relatively small amounts of money from large numbers of people, and often takes place over the internet. In coming up with the rules, the SEC attempted to create protections for investors while enabling businesses to use crowdfunding effectively.

Raising money through crowdfunding already occurs in artistic endeavors, for example, where small contributions or donations are rewarded with a token of value related to the project. The contributions may be rewarded with tickets to a film, identification in the film’s credits, or prepurchase of a finished product such as a music CD. A number of websites such as kickstarter.com exist to fund such projects. Not-for-profits also engage in crowdfunding to generate donations.

The crowdfunding the SEC proposal addresses would create a framework for allowing startups and small businesses to raise capital through securities offerings using the internet. The JOBS Act permits internet-based platforms to facilitate the offer and sale of securities without having to register with the SEC as brokers.

The proposed rules would:

  • Exclude certain companies from participating in crowdfunding. Non-U.S. companies, companies that already report to the SEC, and certain investment companies would be among those excluded.
  • Limit the amount that a business can raise through crowdfunding to $1 million in a 12-month period.
  • Limit how much an individual can invest in crowdfunding, based on the individual’s annual income or net worth. The limit would be the greater of $2,000 or 5% of annual income or net worth if the annual income or net worth of the investor is less than $100,000. Investors with an annual income or net worth of $100,000 or more could invest 10% of their annual income or net worth, with the investment not to exceed $100,000. Securities purchased in a crowdfunding transaction could not be resold for a period of one year.Require that crowdfunding investments take place through SEC-registered intermediaries, which can be broker-dealers or new entities called “funding portals” that facilitate the offer and sale of securities. Intermediaries would be required to provide investors with educational material about risks, the issuer, and the offering.
  • Require certain disclosures that the issuers would file with the SEC and disclose to the intermediary and investors. These would include information about officers, directors, and certain owners of the issuer; a description of the issuer’s business; a description of the terms of the offering, such as the use of proceeds and the price to the public of the securities being offered; and certain related-party transactions.
  • Require issuers to provide financial statements prepared in accordance with U.S. GAAP.

Opportunities for auditors

Auditing or review of the financial statements may be necessary, depending on the amount of the crowdfunding offering. A tiered system in the proposal would require:

  • Certification of the financial statements by the principal executive officer for offerings of $100,000 or less. These issuers would also be required to provide the SEC with income tax returns for the most recently completed fiscal year.
  • A review of the financial statements by an independent accountant for offerings of more than $100,000 but not more than $500,000.
  • An audit of the financial statements by an independent auditor for offerings of more than $500,000.

“We want this market to thrive in a safe manner for investors,” SEC Chairman Mary Jo White said at the open meeting where the commission considered the proposals.

Public comment on the rules is invited by within 90 days after the proposal is published in the Federal Register and can be made through the SEC’s website.

If the rules are approved, crowdfunding would provide CPAs with chances to provide numerous services to their clients, including education about the process, controller services, corporate advisory services, wealth management, and investor advice. Small business CFOs, meanwhile, would be able to tap into a new potential source of funds.

Invest cautiously

But the restrictive nature of the statute and the proposed rules could limit its usefulness, according to S. Lee Terry Jr., a corporate securities lawyer with Davis Graham & Stubbs in Denver who has served as an SEC staff attorney.

Terry said it probably will be easier for many small businesses to raise capital through rules that allow private securities offerings to more wealthy investors—and advertising of these offerings.

“Getting bigger chunks is a lot easier than getting tens of thousands of people to give you $10,” he said.

The cost of getting audited financial statements for offerings of more than $500,000 also may deter companies from using the crowdfunding route, Terry said. And some auditors may be reluctant to conduct such audits.

He said some auditors who aren’t used to auditing public offerings may recoil at the idea of providing attestation on financial statements that will be circulated to large numbers of people. The potential for litigation from less sophisticated investors who lose their money may be a concern for auditors, Terry said.

“Auditing small company startups involves a lot of guesswork and relies heavily on estimates and attestation from management,” he said.

The proposal was greeted enthusiastically by David Marlett, CPA, the founder, executive director, and chairman of the board of the National Crowdfunding Association, a trade group dedicated to promoting crowdfunding.

He predicted that when the rules are finalized, crowdfunding will have a huge impact in some sectors such as the film industry. But he said a framework for low-cost audits would be helpful for some businesses that are doing crowdfunding. Filmmakers who want to raise funds but whose financial statements wouldn’t show much more than the existence of a script would need a low-cost audit to raise capital through crowdfunding, Marlett said.

In addition, Marlett said, it will be important for CPAs to educate their clients on both the opportunities and pitfalls of crowdfunding investments.

“Most small business investments lose money,” he said. “… And when you open it up to the crowd, there is a need for an educational process as to the investment and what they’re doing, which includes the nature of the downside and the nature of the risk.”

CPAs who advise on personal financial matters should tell clients to proceed with extreme caution with respect to crowdfunding offerings, according to Theodore J. Sarenski, CPA/PFS, CEO of Blue Ocean Strategic Capital in Syracuse, N.Y.

Sarenski said CPAs should caution clients that crowdfunding offerings are like penny stocks. Occasionally an investor might hit a home run with such an offering, but the majority of them are going to be unsuccessful, he said.

Clients should be told to investigate such offerings very carefully, Sarenski said.

“You want to talk to your CPA about, what should I be looking for in the financials, what should I be looking for in the business plan?” he said.

Ken Tysiac (ktysiac@aicpa.org) is a JofA senior editor.

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