The Corporate Transparency Act

Beginning on January 1, 2024, new and existing companies, with some exceptions, must disclose their owners to the US Department of the Treasury Financial Crimes Enforcement Network (“FinCEN”). This is big news in the legal world, not just for Crowdfunding but for everyone.

The following summary was prepared by Chimuanya Osuoha. If you’re a client of our firm you’ve probably dealt with Chimuanya and know her to be an extremely capable young lawyer.

The Corporate Transparency Act 

General Rule

Beginning January 1, 2024, all entities that are either formed or registered to do business in the United States by filing documents with a secretary of state or a similar office under the law of a State or Indian Tribe (a “Reporting Company”) are subject to the Corporate Transparency Act (the “CTA”). Reporting Companies will be required to file a report with FinCEN including information about its “Beneficial Owners” and “Company Applicants.”

Any changes to the information, including ownership, must be reported within 30 days.

NOTE:  For the time being, the information provided to FinCEN will not be public. I say “For the time being” for two reasons. One, once the information exists there will probably be pressure to make it public. Two, some states are already headed in that direction. For example, the New York legislature has passed something call the New York LLC Transparency Act, requiring public disclosure of the owners of limited liability companies.


Twenty-three kinds of entities are exempt from the CTA. They include (i) “large operating companies,” defined as a company with more than 20 full-time employees, that has filed income tax returns demonstrating more than $5,000,000 in gross receipts or sales and has an operating presence at a physical office within the United States; (ii) companies required to report under section 12 of the Exchange Act; (iii) investment advisers; (iv) public accounting firms registered under Sarbanes-Oxley;  and (v) tax-exempt entities,.

Click here for a list of the 23 exemptions.

Beneficial Owners

A Beneficial Owner is any individual who, directly or indirectly, (i) exercises substantial control over the entity (e.g., LLC Manager, Corporate Officer, etc.) or (ii) owns or controls twenty-five (25%) percent or more of the ownership interests in a Reporting Company. 

An individual exercises substantial control over a Reporting Company if he or she (i) is a senior officer; (ii) has authority to appoint or remove certain officers or a majority of directors of the Reporting Company; (iii) is an important decision-maker; or (iv) has any other form of substantial control over the Reporting Company. That’s very broad!

If the shares or interest of a Reporting Company are held by a trust, the Beneficial Owner of the Reporting Company could be (i) the Grantor or Settlor of the trust who has a right to revoke the trust or withdraw assets, (ii) the Trustee or person holding authority to dispose of trust assets, or (iii) a sole beneficiary who is the recipient of income and principal, or a beneficiary who has the right to demand distribution or withdraw substantially all assets from the trust. 

The definition of Beneficial Owners includes exceptions for minor children,  non-senior employees, and an individual whose only interest in a corporation, LLC, or other similar entity is through a right of inheritance. 

Company Applicant

A Company Applicant is an individual who directly files or is primarily responsible for the filing of the document that creates or registers the company. Each Reporting Company is required to report at least one Company Applicant, and at most two.

Example:  Individual A is creating a new company. Individual A prepares the necessary documents to create the company and files them with the relevant office, either in person or using a self-service online portal. No one else is involved in preparing, directing, or making the filing. Individual A is the Company Applicant and should be included in the report.

Example: Individual A is creating a company. Individual A prepares the necessary documents to create the company and directs individual B to file the documents with the relevant office. Individual B then directly files the documents that create the company. Individual A and B are Company Applicant and both should be included in the report.

The requirement to name Company Applicants applies only to Reporting Companies formed or registered on or after January 1, 2024. 

Information Required 

The Reporting Company must provide the following information about itself:

  1. Legal name, trade name and d/b/a;
  2. Address of principal place of business;
  3. The State, Tribal or foreign jurisdiction of formation or registration of the Reporting Company; and
  4. IRS Tax ID Number

The Reporting Company must provide the following information for each Beneficial Owner and each Company Applicant:

  1. Full Legal Name;
  2. Date of Birth;
  3. Current residential or business street address; and
  4. A Unique identifying number from an acceptable identification document (passport, driver’s license, etc.), or a FinCEN Identifier.

Deadline for Filing

Reporting Companies created or registered to do business on or after January 1, 2024, must file a report with FinCEN within 30 days after receiving notice of the company’s creation or registration. Reporting Companies formed or registered before January 1, 2024, have until January 1, 2025.


For more information, please contact Chimuanya A. Osuoha, Esq. at or call 856-382-8452. We look forward to being of service. 

Artificial Intelligencer and crowdfunding

Artificial Intelligence And Crowdfunding Law

Like everyone else, I was shocked by the launch of ChatGPT. And like everyone else, I believed lawyers would be first on the chopping block. But I now have a far more optimistic view. I think AI will have a far more nuanced and ultimately beneficial effect for lawyers and their clients, including but not limited to Crowdfunding clients.

At first, I thought lawyers (or non-lawyers, gasp!) could type a question into ChatGPT and get a fully-formed legal product, whether a brief, a memo, a contract, or an obnoxious letter. But it turned out that neither ChatGPT nor its imitators is close to that, and I doubt they ever will be. 

Rather than crashing down the walls, AI is entering the legal profession through the front door. Lawyers are not interfacing with AI directly, by typing prompts into ChatGPT. Instead, the AI is being intermediated by existing legal resources. Through subscription, lawyers have access to extremely powerful online resources like the research tools at Westlaw and the high-quality legal forms at Practical Law. These services are themselves incorporating AI into their products, the same way Microsoft is incorporating AI into Office.

Today, for example, I can upload an Asset Purchase Agreement and get back all sorts of comments – what provisions are missing, as compared to a complete Asset Purchase Agreement, what provisions I should consider adding or deleting depending on whether I represent the buyer or seller, what’s “normal” for a given issue, correcting cross-references, letting me know which capitalized terms haven’t been defined, lots of other things. And I know that these comments and suggestions are coming, ultimately, from some of the best M&A lawyers in the country.

The AI is being intermediated by experts, who are using their experience and brains. In this way AI is not so much revolutionary as another step, if a large step, in the continuing evolution of legal resources.

Lawyers are using AI without even knowing it’s AI. And that’s perfectly normal. How many of us, flipping a light switch, think about electrons?

The result should be to make it easier for lawyers to produce a better product. Or to put it differently, to make high-quality legal work cheaper per hour.

I remember when lawyers thought email and fax machines would give them more leisure time and were shocked when they had the opposite effect. Email and fax machines allowed – actually, forced – lawyers to do more work. Rather than send a document overnight (itself an innovation) and wait for a response, the response was immediate.

The same will be true for AI, in my opinion. AI isn’t going to make lawyers redundant. Instead, with AI driving down the cost of a high-quality contract, existing clients will have more of their work done by lawyers, rather than trying to piece something together themselves, and people who have never used a lawyer will be able to afford one. The overall quality of legal work will rise, benefiting everyone.

Ever seen Apple’s original license agreement with Microsoft? The agreement was so awful, it basically allowed Microsoft to steal the GUI and launch Windows. And I am 100% sure the contract was so awful because a business guy at Apple wasn’t allowed to spend money on a lawyer.

You can see how this will translate to Crowdfunding. Upload a Form C and the AI will tell you what’s missing and suggest corrections and replacements. Upload the Y Combinator SAFE and the AI will tell you “Please read Mark Roderick’s blog post explaining why the Y Combinator form has to be changed for Reg CF.” Unfortunately, the Form Cs and other legal documents used for most Reg CF campaigns today are awful, like the Apple license agreement. I think AI will improve the quality of those documents and at the same time make Reg CF more accessible to more people. 

That’s a huge win.

Questions? Let me know.

Why I’m Grateful This Thanksgiving

William Bradford leader of the pilgrims

My 10th-great grandfather was William Bradford, the leader of the Pilgrims. I’m grateful that he and his band of religious refugees made the trip and were saved from starvation by the native population.

I’m grateful for the wisdom of the American people and the resilience of their institutions.

I’m thankful for a culture that rewards risk-taking and innovation and that is slowly, haltingly, inexorably freeing itself of the prejudices of our collective past.

I’m grateful for American entrepreneurs who endlessly question the present and invent the future.

I’m grateful I declined an invitation to sit on OpenAI’s Board.

I’m grateful – I’m not joking – to the SEC for providing oversight for the most complex, dynamic, trusted capital markets in the world.

I’m grateful that FINRA. . . .

I’m grateful to my colleagues at Lex Nova Law for helping to build a flexible, modern law firm.

I’m grateful to live in a diverse, changing, sometimes-chaotic country where it often seems we disagree about everything (we don’t). Like others, I worry that so many Americans have chosen alternative realities and conspiracy theories, but I have faith that these afflictions, like others in our history, will prove temporary.

I’m grateful that even while the voices of hate are the loudest, those who yearn for peace – the majority – refuse to be drowned out.

I’m grateful that people can change their minds.

I’m grateful to participate in the fundamental rethinking of capitalism called Crowdfunding, making capital available where it has never been available before and making great investment opportunities available to more and more Americans.

I’m grateful to everyone in the Crowdfunding ecosystem, especially to Doug Ellenoff and others who worked to make the JOBS Act a reality.

I’m grateful for my clients, a diverse, energetic, endlessly-creative group of entrepreneurs who are making America better and in the process making my life infinitely more rewarding.

While complaining that my health insurance premiums went up again, I’m grateful they have not dropped to zero.

Thanks for reading everyone! I hope you enjoy your Thanksgiving as much as I intend to enjoy mine. As always, contact me if you have any questions.


financial statements in crowdfunding

Whose Financial Statements?

Reg CF requires financial statements. To refresh your memory:

Those thresholds are based on the maximum you’re trying to raise. So if your “target amount” is $600,000 but you’re trying to raise up to $900,000, and this is your second Reg CF offering, you need audited statements. 

Now suppose you conducted your business as a sole proprietorship or an LLC until six months ago, when someone in Silicon Valley told you to convert to a C corporation. Your sole proprietorship or your LLC is a “predecessor” of your C corporation within the meaning of 17 CFR §230.405. Hence, under the Reg CF rules, your financial statements should include the results of the sole proprietorship or LLC. Which makes sense, given the purpose of the disclosure rules.

The same is true if your company intends to acquire another company. If you’re raising money to buy TargetCo Inc. then TargetCo Inc. is a “predecessor” of your company for purposes of Reg CF. Hence, you should include the financial statements of TargetCo Inc. Which also makes sense.

Especially for small companies, financial statements represent one of the biggest impediments to Reg CF. The rules around predecessors make the impediment that much higher.

Questions? Let me know.

Republican Dysfunction Could Benefit Crowdfunding

Republican Dysfunction Could Benefit Crowdfunding — REALLY

During my lifetime we’ve never seen political dysfunction like the dysfunction we’re seeing among House Republicans. Coming just as American leadership could be most helpful, the dysfunction is dangerous, a national embarrassment, all that and much more. Yet it might prove good for Crowdfunding.

An ally of Representative Kevin McCarthy, Representative Patrick T. McHenry of North Carolina was designated “interim Speaker” when McCarthy was dethroned. Nobody knows what “interim Speaker” means or what he or she can do, but now, with Republicans unable to agree on an actual Speaker and no other way out of the cul-de-sac, the idea is circulating to give Rep. McHenry some real power and try to run the place. 

Unprecedented? Sure. But so is the dysfunction among Republicans.

Well, it just so happens that Rep. McHenry was the leading proponent of the JOBS Act, the 2012 law that launched Crowdfunding in all its current forms. Ever since, he has also been a leading proponent of improving the law, making it easier for entrepreneurs to raise capital and for ordinary Americans to participate.

Crowdfunding isn’t exactly high up on the list of priorities for either party. But when you’re Speaker of the House of Representative, or “interim Speaker with special powers,” you get to do stuff. If Rep. McHenry holds his position, I wouldn’t be shocked to see changes to the JOBS Act attached to other legislation, even a bill to help Israel and Ukraine.

To quote someone else, there are two things you never want to see being made:  sausage and law. If the dysfunction among Republicans can help Crowdfunding and the American economy, so be it.

Questions? Let me know.

Securities Exchange Commission

SEC Adopts Final Rules For Private Advisers And Stresses Fiduciary Obligations

Last year the SEC proposed new rules for private fund advisers. After public comment the SEC just adopted final rules.

Some of the new rules apply only to investment advisers required to be registered with the SEC. Others apply to all investment advisers, including so-called “private fund advisers.” I’m going to focus on the latter set of rules.

NOTE:  The new rules apply more broadly than you might think:

EXAMPLE:  Nikki Chilandra forms an LLC of which she is the sole manager, raises money from her private network of investors (no more than 100), and uses the money to buy a limited partnership interest in one real estate deal. The LLC is a private fund, and Nikki is likely a private fund adviser subject to the new rules.

Here’s a chart comparing the proposed rules with the final rules:

TopicProposed RuleFinal Rule
Charging for Services Not PerformedAn adviser can’t charge for services not provided. For example, if an asset is sold, the adviser can’t charge for the advisory fees that would have been due over the next two years.The final rules do not include this explicit provision. But that’s only because, according to the SEC, advisers are already prohibited from charging for services not performed because of their fiduciary obligations.
Charging for Compliance CostsAn adviser can’t charge the fund for expenses incurred in a regulatory examination of the adviser.The adviser may charge for these expenses with majority consent, unless the investigation results in sanctions under the Investment Advisers Act.
Reducing Clawback for TaxesAn advisor can’t reduce her clawback by the amount of any taxes.The adviser may reduce her clawback for taxes if she notifies investors within 45 days after the end of the quarter in which the clawback occurs.
Limiting Adviser LiabilityAn adviser can’t limit her liability for a breach of fiduciary duty, willful misfeasance, bad faith, recklessness, or even negligence.The final rules do not include this explicit provision. But the SEC explains that, in its view, the provision isn’t needed in light of the fiduciary and anti-fraud obligations already imposed on advisers under the Investment Advisers Act which, according to the SEC, may not be waived by contract (e.g., in an LLC Agreement).
Allocation of Fees Among FundsAn adviser can’t allocate fees among funds on a non-pro rata basis.The adviser may allocate fees on a different basis if (i) the allocation is fair and equitable under the circumstances and (ii) before charging or allocating the fees, the adviser notifies investors, explaining why it is fair and equitable.
Borrowing from FundAn adviser can’t borrow money from the fund.The adviser may borrow money with majority consent.
Preferential Treatment for Redemptions and InformationAn adviser can’t give preferential rights to redemption or preferential information rights to some investors if it would have a material negative effect on other investors.Both are allowed if the same rights are given to all investors (which makes the treatment non-preferential).
Preferential Economic TreatmentAn adviser can’t give other preferential economic rights to some investors without full disclosure to all investors.Preferential treatment is allowed with full disclosure (i) before an investor invests, (ii) when the fundraising period has ended, and (iii) annually.

In my opinion, the most important feature of the new rules isn’t the new rules themselves but the SEC’s statements concerning the fiduciary obligations of investment advisers. The SEC believes that all investment advisers have a duty of care and a duty of loyalty that cannot be waived by contract and can be liable for their negligence, no matter what the contract says.

Questions? Let me know.

SPVs in Crowdfunding

SPVs in Crowdfunding

When you’re raising money for a company, it’s tempting to group all your investors in an entity and have that entity, rather than the individual investors, invest in the company. We often refer to an entity like this as a special purpose vehicle, or SPV. 

The Cursed Investment Company Act

Because the SPV is in the business of owning a security – even if it’s only one security – it’s an “investment company” within the meaning of section 3(a)(1)(A) and/or section 3(a)(1)(C) of the Investment Company Act of 1940. That means, among other things, that the SPV can’t use Reg CF or Regulation A to raise capital.

NOTE:  In 17 CFR §270.3a-9, the SEC created a special kind of SPV called a “crowdfunding vehicle” that can be used to raised capital in Reg CF. I’ve written about those here and here and here but am not writing about them today. Today I’m talking about SPVs formed to raise money under an exemption other than Reg CF, e.g., Rule 506(b) or Rule 506(c).

Because of the prohibitive regulatory burden, we don’t want our SPV to be an investment company. Therefore, having concluded that the SPV is an investment company within the meaning of section 3(a)(1) of the ICA, we look for an exemption.

If you’re raising money only from very wealthy people you find an exemption in section 3(c)(7) of the ICA, which allows an unlimited number of investors as long as each owns at least $5 million of investable assets. All the big hedge funds and private equity funds in Manhattan and Merchantville rely on this exemption. 

The Section 3(c)(1) Exception – 100 Security Holders

For the unwashed masses, the most common exemption – actually, the only other viable exemption for SPVs – is section 3(c)(1) of the ICA. The section 3(c)(1) exemption applies if the outstanding securities of the SPV are held by no more than 100 persons. A few points about the 100-investor limit:

  • The limit refers to the total number of security-holders, not the number of investors in a particular offering. If you’ve conducted one offering and admitted 72 investors, you can’t conduct another offering and admit 87 more.
  • “Securities” include equity, debt, and everything in between. An investor holding a promissory note or a SAFE counts.
  • In general, if an entity invests in the SPV the entity counts as only one security-holder, even if the entity itself has multiple owners. But the law will “look through” the entity, treating its owners as owners of the SPV, if either:
    • You formed the entity to get around the 100-security holder limit; or
    • The entity owns 10% or more of the voting power of the SPV and is itself an investment company.
  • Suppose your SPV has 98 security holders and P.J. Jankara is one of them. She dies and leaves her 100 shares of common stock to her five children, 20 shares each. Is your SPV now an investment company? No, the law provides latitude for involuntary transfers like death.
  • As long as you have no more than 100 security holders in one SPV, you’re allowed to have a separate SPV relying on the section 3(c)(7) exemption. In legal jargon, the two SPVs won’t be “integrated.”

Qualifying Venture Capital Funds – 250 Security Holders

The 100 limit is increased to 250 for a “qualifying venture capital fund.” That means a fund satisfying all six of the following conditions:

  1. The fund represents to investors and potential investors that it pursues a venture capital strategy;
  2. Other than short-term holdings, at least 80% of the fund’s assets must consist of equity interests in portfolio companies;
  3. Investors in the fund do not have the right to withdraw or have their interests redeemed;
  4. All investors in the fund must have the right to receive pro rata distributions;
  5. The fund may have no more than $10,000,000 in aggregate capital contributions and uncalled committed capital, indexed for inflation; and
  6. The fund’s borrowing does not exceed 15% of its aggregate capital contributions and uncalled committed capital.

The regulations don’t define the term “venture capital strategy,” but the SEC provided this explanation:

Under the rule, a qualifying fund must represent itself as pursuing a venture capital strategy to its investors and potential investors. Without this element, a fund that did not engage in typical venture capital activities could be treated as a venture capital fund simply because it met the other elements specified in our rule (because for example it only invests in short-term holdings, does not borrow, does not offer investors redemption rights, and is not a registered investment company). We believe that only funds that do not significantly differ from the common understanding of what a venture capital fund is, and that are actually offered to investors as funds that pursue a venture capital strategy, should qualify for the exemption.

Whether or not a fund represents itself as pursuing a venture capital strategy, however, will depend on the particular facts and circumstances. Statements made by a fund to its investors and prospective investors, not just what the fund calls itself, are important to an investor’s understanding of the fund and its investment strategy.

When asked to define pornography, former Supreme Court Justice Potter Stewart famously responded: “I know it when I see it.” (Contrary to some critics, he did NOT continue “. . . .and I see it a lot.”) The definition of “venture capital strategy” is like that.

Now, one of the high-volume Reg CF portals says this about using SPVs for Rule 506(c) offerings:

If you wish to consolidate all the investors into a single SPV or fund, the law places a limit of 249 investors if the offering is under $10M in investments. If the offering has more than $10M in investments, there is a 99 investor limit.

This is 100% wrong. By referring to a $10M limit, the portal clearly believes that an SPV can be a “qualifying venture capital funds.” But an entity formed to “consolidate all the investors into a single SPV” couldn’t be a qualifying venture capital fund because it doesn’t pursue a “venture capital strategy.” In fact, the SPV has no investment strategy at all. Investors themselves make the one and only investment decision at the time they invest. The SPV is simply a conduit between the investors and the team, used to simplify the team’s cap table.

This is the same high-volume Reg CF portal that uses a series LLC as crowdfunding vehicles, despite this

Whether the exception for qualifying venture capital funds is flexible enough for a bona fide venture capital fund is a different story. But unless you live in Manhattan or Merchantville, assume that your SPV can have only 100 security holders.

Questions? Let me know

Escrow account crowdfunding portals

By Itself, An Escrow Account Won’t Stop Sponsors From Stealing Investor Money

As reported everywhere, CrowdStreet investors recently suffered very large losses when a sponsor apparently absconded with their money. It’s a very bad thing, not only for those investors but for the real estate crowdfunding industry. You’d almost think this were crypto! 

In the aftermath, many have called for crowdfunding sites to use escrow accounts. My point today is that escrow accounts by themselves aren’t enough.

CrowdStreet hosts offerings under Rule 506(c), where escrow accounts aren’t required. On the other side of the street, in the Reg CF world, funding portals must use an escrow agent. Rule 303(e) even specifies who can serve as the escrow agent (a broker-dealer, a bank, or a credit union) and directs which instructions the funding portal is required to give to the escrow agent under what circumstances. If and when the issuer reaches its target amount the funding portal must instruct the escrow agent to release the funds to the issuer, while if the investor cancels his, her, or its investment commitment or the offering is terminated, the funding portal must instruct the escrow agent to return the funds to the investor.

Now let’s assume exactly such an arrangement had been in place for the doomed offering on CrowdStreet.

The offering would have stipulated a “target amount” of $63 million, with the money held securely in escrow. With the target amount raised, CrowdStreet would have given the escrow agent instructions to release the money to the sponsor, following the regulations to the letter. And the sponsor would have stolen it.

By itself the escrow account wouldn’t have prevented the theft. Extrapolating to Reg CF, the escrow accounts used by funding portals do not prevent theft. They just make the unscrupulous sponsor wait until reaching the target amount to steal the money.

To prevent the theft you have to layer something on top of the escrow agent. In the CrowdStreet offering you could have prevented the theft by wiring the money not to the sponsor but to the title company conducting the closing, with instructions that it would be used only to acquire the property. In a typical Reg CF offering, where the money is being used by the issuer for marketing or other general business purposes, it’s much harder.

This is another reason why the “bad actor” rules are odd. They catch people who have violated the securities laws but not people who have robbed strangers at gunpoint. 

Questions? Let me know

Reinvigorate American Capitalism Through Crowdfunding

Reinvigorate American Capitalism Through Crowdfunding

In this episode, we dive into the world of crowdfunding and see how it can reinvigorate American Capitalism with our special guest Mark Roderick. Crowdfunding is an exciting and transformative concept that simplifies capital formation through the Internet. Mark, a corporate lawyer with extensive experience in helping entrepreneurs raise capital, shares his insights on how crowdfunding has the potential to revolutionize investment opportunities.

With the internet expanding opportunities in raising capital, similar to how it revolutionized the retail and dating industries, Mark explains how crowdfunding can connect entrepreneurs with investors in unprecedented ways. Specifically, he delves into the Jobs Act of 2012, which created different types of crowdfunding, including the highly successful Rule 506 C that allowed real estate professionals to advertise and raise billions of dollars. With Mark’s guidance, we also explore the three essential documents in real estate deals that are vital for legality and protection against potential challenges. Join us for this enlightening episode as we uncover the power and potential of crowdfunding with the knowledgeable and experienced Mark Roderick.

Key Points from This Episode:

  • Crowdfunding has the potential to revolutionize real estate investment opportunities.
  • The Internet greatly expands opportunities for raising capital and connecting with investors, similar to how it has revolutionized retail and other industries.
  • Mark has extensive experience in helping entrepreneurs and real estate professionals raise capital.
  • Mark is knowledgeable and experienced in navigating the complexities of crowdfunding laws and helping real estate professionals comply with new regulations.
  • The Jobs Act of 2012 created three types of crowdfunding, including the most successful one, which was a change in the previous rule that prohibited the advertising of real estate syndications.
  • Rule 506 C allows for advertising and requires verification of accreditation for investors.
  • This change enabled real estate professionals to raise billions of dollars of capital, making it a spectacularly successful source of funding.
  • As a corporate lawyer, Mark can provide legally sound and easily understandable documents to ensure compliance and avoid legal troubles in the crowdfunding process.
  • While Mark can assist with legal aspects, he is not able to directly help with raising funds. Established real estate crowdfunding sites like RealCrowd or CrowdStreet may be a viable option for experienced individuals to access an existing investor base.
  • For those starting out, crowdfunding requires active digital marketing efforts. Simply creating a website is not enough to attract investors; it is a marketing business that requires proactive efforts to generate interest and secure investments.
  • Three essential documents in real estate deals – the subscription agreement, limited liability company agreement, and the disclosure document (PPM) – play a vital role in keeping the process legal and protecting against potential legal challenges.
  • Crowdfunding thrives in spaces where limited information is available and can make deals more efficient and known to a broader audience.
  • Crowdfunding is not well-suited for fully efficient markets like single-family home mortgage loans or large-scale development projects where most major investors have access to in-depth information about the deal.

About Mark Roderick

Since the JOBS Act of 2012, Mark Roderick has spent all of his time in the Crowdfunding space, and today he is one of the leading Crowdfunding and Fintech lawyers in the United States. He writes a widely-read blog, which offers a wealth of legal and practical information for portals and issuers. He also speaks at Crowdfunding events across the country and represents industry participants across the country and around the world.

Series A Preferred Stock

Owning Securities Won’t Make Your Funding Portal An Investment Company

Funding portals are allowed to receive part of their compensation in securities of the issuer, as long as the securities are of the same class being offered to investors. For example, if an issuer raises $2M selling Series A Preferred Stock and the funding portal charges a 7% commission, it may take all or any part of the $140,000 as Series A Preferred Stock rather than cash.

Before long, the value of these securities might exceed the value of the funding portal’s business. Inquiring minds would wonder whether owning all those securities will turn the funding portal into an “investment company” within the meaning of the Investment Company Act of 1940.

It’s a good question, but fortunately the answer is No. Section 3(c)(2) of the Investment Company Act provides an exception for:

Any person primarily engaged in the business of underwriting and distributing securities issued by other persons, selling securities to customers, acting as broker, and acting as market intermediary, or any one or more of such activities, whose gross income normally is derived principally from such business and related activities.

Funding portals are engaged in the business of distributing securities issued by other persons (issuers) and should therefore fall within that description.

Two related issues.

Effect of Upstream Distribution: The owners of the funding portal would like to protect the pool of securities from the potential liabilities of the funding portal business (e.g., if the portal has been using a series LLC as a crowdfunding vehicle). Their first thought might be to distribute the securities upstream to the parent company and then put them into a new, wholly-owned subsidiary. But be careful. The new subsidiary might cause the parent to be treated as an investment company.

Effect on Option Pool:  Suppose the funding portal continues to own the securities, either directly or in a wholly-owned subsidiary. On one hand, the potential value of the securities would be attractive to employees and others holding options in the funding portal. On the other hand, the fair-market-value rules of section 409A of the tax code would require the funding portal to place a value on the securities frequently and, as the value of the securities climbs in relation to the value of the funding portal’s business, the value of the options would be less and less correlated with the success of the business, defeating the purpose.

Questions? Let me know