Understanding Reg CF: “Financial Condition of the Issuer”

In a rather innocuous requirement, the SEC requires that a company offering securities under Regulation Crowdfunding “describe [its] financial condition…” However, the short directive masks a rather tall order for companies. The discussion of the financial condition of the company will be one of the most analyzed parts of the Form C, both by prospective investors and by regulators. It is here that we are likely to see companies omitting material information in an effort to present an optimistic picture of the company, whether or not the intent was pernicious.

The SEC does provide some guidance to companies making this disclosure. However, that guidance is missing some key dos and don’ts. The guidance may also be misunderstood by inexperienced entrepreneurs who would benefit the most from Regulation Crowdfunding.

For instance, are you disclosing revenue when discussing the results of operations? Don’t exclude the costs of goods/services sold and the selling expenses that got you to those revenue figures. Maybe your revenues were up, but your costs to get there exceeded the gains in revenue. Omitting that information could be considered a materially misleading statement or omission. Top line financial information on its own is always suspect. Complete disclosure that is required for Form C will need to reflect the entirety of the financial condition of the company.

The guidance goes on to instruct companies to detail whether historical results and cash flows are representative of what investors can expect in the future. Here, the SEC is looking for details regarding one-time capitalization costs, write-offs, cash influxes from prior financing activities. The SEC is not looking for predictions about the future based on your expected market size and potential increases in sales. However, the SEC is looking for information about planned activities, like increasing expenses on sales efforts, that could impact future revenues and costs.

Small companies trying to complete and file the Form C alone might be deceived by the relative simplicity of the Form C compared to what each question is actually meant to elicit. And it is possible that incomplete disclosure may open up that company to liability.

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