Great question! This relates to CfPA's policy platform. Here is our view on the topic.

Reform of Requirements for Financial Reporting

The requirement to provide an independent review or audit is nonsensical for a business with no operating history – we support tailoring the financial reporting requirements so that reviews and audits are only required for businesses with at least six months of operating history. Similarly, the requirement of GAAP financials should be waived for early-stage and smaller businesses (including crowdfunding vehicles they use for their raises). This applies to post-raise reporting as well. For those issuers that choose to provide a higher level of reporting, this can be prominently disclosed so that potential investors know that they are receiving a more fully vetted financial report. Note that the Small Business Administration does not require GAAP-compliant financials for its borrowers.

Background

This policy position includes two components – removing the requirement that financial statements be reviewed or audited when such review or audit does not provide value to investors, and allowing certain issuers to use non-GAAP financials to comply with the disclosure requirements of Rule 201(t) of Regulation Crowdfunding. Currently, all issuers undertaking an offering under Regulation Crowdfunding are required to provide GAAP compliant financial statements and, depending on the amount of funding being sought, have those financial statements reviewed or audited by an independent CPA. While uniformity in financial reporting is important for functioning public markets, many companies undertaking offerings under Regulation Crowdfunding are not, and will never be, part of broader public markets. In fact, the provisions under the JOBS Act leading to Regulation Crowdfunding were enacted “to help provide startups and small businesses with capital by making relatively low dollar offerings of securities, featuring relatively low dollar investment by the “crowd,” less costly.” However, these financial statement requirements effectively eliminate the availability of Regulation Crowdfunding for many companies that this exemption is intended to benefit due to the onerous costs associated with obtaining professionally prepared financial statements.

For companies formed six months or less prior to an offering, funding from an offering under Regulation Crowdfunding may be their first foray into capital raising beyond what has been contributed by the founders. These very early stage startups almost by definition have limited capital resources and limited historical financial activity. Still, they are being required to spend thousands of dollars to prepare financial statements that do not provide any information that aids an investor in making an informed investment decision, given the company’s limited operating history.

So when presented with the opportunity to raise funds from friends, family, and fans that would be interested in investing through an offering under Regulation Crowdfunding, these companies instead turn to small business lenders that may utilize near usurious interest rates because the initial expense to convert their financials from cash basis to GAAP compliant is too great of a barrier. 

Requested Change

We request that the SEC amend Rule 201(t) of Regulation Crowdfunding to include a waiver of the financial statement requirements for issuers (and any predecessor) that have been in operation for less than six months, and the absence of financial statements does not materially impact an investor’s ability to make an informed investment decision. Further, we request that Rule 201(t) also be amended to allow for accounting standards other than GAAP which are consistent with the industry and operations of the issuer.

Statutory Authority

Section 4A(b)(1)(D) of the Securities Act does not expressly state that financial statements are required to be prepared in accordance with GAAP. This leaves open the opportunity to remove the requirement of GAAP compliant financial statements subject to the conditions expressed above. This is also consistent with the statutory authority that the SEC is granted with respect to the financial statement requirements under Section 4A(b)(1)(D).

The SEC is also granted broad authority under Section 4A(b)(5) to implement such other requirements as the SEC determines to be in the public interest. This provides certain authority to create limited categories for which the requirement to provide financial statements may be waived that are consistent with the protection of investors as well. It should be noted however that the statute does currently require reviews and audits for raises above certain thresholds so changing these provisions could require a statutory amendment.

@Benji Jones @Devin Thorpe