Reg CF is off and running, on its way to becoming the way most American companies raise capital. Still, there are three things that would improve the Reg CF market significantly.
Revise Financial Statement Requirements
Financial disclosures are at the heart of American securities laws, I understand. The best way to understand an established company is often to pore over its audited financial statements, footnotes and all.
But that’s just not true of most small companies, whether the micro-brewery on the corner or a new social media platform. For these companies, reviewed or audited statements yield almost no worthwhile information to prospective investors. Yet the cost of the statements and the time needed to create them are significant impediments in Reg CF.
In my opinion, the following financial disclosures would be more than adequate:
- Copies of the issuer’s tax returns for the last two years;
- Interim financial statements (profit and loss and balance sheet) from Quickbooks or other financial software, through the last day of the month before the offering is launched;
- A separate statement of the issuers’ assets and liabilities in Form C;
- An attestation from the Chief Executive Officer;
- A statement in Form C describing where and how the issuer expects to derive revenue during the next 12 months (e.g., subscription fees, advertisements, rents, etc.);
- Reviewed financial statements for offerings in excess of $1,235,000; and
- No requirement for audited statements.
Conversely, I believe annual audited financial statements should be required after a successful raise.
Address Artificially Low Target Amounts
Artificially low target amounts are the worst thing about Reg CF, by a long shot.
In the common approach, a company that needs $750,000 to execute its business plan sets a target amount of $25,000.
The artificially low target works for both the platform and the company. If the company raises, say $38,000, then the platform receives a small commission and advertises a “successful” offering, while the company can at least defray its costs.
But investors have thrown their money away.
Artificially low target amounts are terrible for investors and terrible for the industry, in a vicious cycle. Nobody wants to throw money away, and with so many Reg CF offerings using artificially low target amounts many serious investors will simply stay away from the industry.
Speaking of the Vietnam war, John Kerry asked “Who wants to be the last man to die for a lie?” Here, the question is “Who wants to be the first to invest in a company that needs a lot more?”
The fix is pretty simple. Issuers should be required to disclose what significant business goal can be accomplished if the offering yields only the minimum offering amount or, if no significant business goal can be achieved, should be required to say so.
In the meantime, it’s pretty shocking that while many offerings use an artificially low target amount, very few disclose the enormous additional risk to early investors. That’s a lot of lawsuits waiting to happen.
More Automation for Issuers
Speaking of lawsuits waiting to happen. . .
Most platforms do a pretty good job automating the process with investors. With issuers not so much.
Instead, platforms interact with issuers through people. Theoretically the role of these people is simply to guide the issuer through a semi-automated process. In practice, however, they end up as all-purpose advisors, giving issuers advice about everything from the type of security the issuer should offer to the issuer’s corporate structure to whether an SPV should be used.
As nice and well-meaning as these people may be, they aren’t qualified to give all that advice. Too often they end up giving advice that is either incomplete or wrong, doing a disservice to issuers and creating an enormous potential liability for the platform.
It’s unrealistic to think the platform will staff a team of investment bankers and securities lawyers giving individual advice to each issuer. Instead, in my opinion, the solution is to do a much better job automating the issuer side of the platform. That’s easier said than done, I realize. I hope and expect that the software providers active in Reg CF can provide some industry-wide solutions.
Questions? Let me know.
The requirements for any kind of review or audit below $1M are absolutely without merit and is in no way any kind of assurance or attestation whatsoever. This is where intrastate crowdfunding rules really outshine REG-CF in practical utility! Most intrastate rules allow issuers to raise up to $1M on their own financials (and often without having to be in GAAP format).
Also most new companies have nothing to audit in the first place so why even go through the charade and expense?
Meanwhile exemptions like REG-D 504 and 506C typically do not have ANY requirements on providing financial statements at all.
While REG-CF enjoyed a better status when it temporarily allowed issuers to raise up to $250K on their own financials, it is now hobbled again in terms of “cost of capital” now that its slid back to $125K, and is just going to continue to encourage issuers to play the Form C/A game.
Unfortunately until this artificial limitation is removed or at least adjusted to be inline with intrastate rules, we will continue to see really marginal offerings at the bottom end of the spectrum with low minimums meant to basically cover the costs of even trying to raise and quality deals electing to use other exemptions.
Yep, I agree with you David. It’s a relic from the public company world.
regarding raising small amounts: Yes it is a problem. MediaShares had a client that raised $200k but it was less than the $500k needed to create their first product. We had them return the money to investors. Many companies do need to accept a small amount so they can have the money to market for more investors. Huge problem if they do not get more.
That’s extremely admirable of you and MediaShares.
I do understand that companies use the “minimum” to pay marketing costs. But it goes without saying, I think, that marketing is an issue for the company, not for its early investors. Maybe someone will design a program to provide financing for marketing, with some very large potential return to reward the large risk. And maybe that, in turn, will force funding portals and issuers to structure their offerings differently. The Reg CF market has a long way to go.
An even bigger problem is the fact that the large majority of CF companies have no exit for investors. The “homemade” ATS on some portals are insufficient, and investors seldom have a way to profit from their investment. We helped two recent companies get acquired after their raise, but this is rare, and we’ve seen investors crying the blues two years or more after their investment.
“Liquidity is Everything” — our ATS which is about to go live allows existing investors to place buy/sell bids as well as register for notifications when bids/asks are available. The bulk of our issuers want to have a right of first refusal to buy their securities back.
“The worth of a thing is the price it will bring” and having SOME kind of possible egress is going to dramatically influence who is willing to come into a deal in the first place!
Now, one of the most amusing and frustrating exercises we have had to do is “educate” the staff at FINRA that in short order, securities will be listed on MULTIPLE ATS’s and that NONE of them will actually have control over the securities nor the funds! We have literally been fighting with them for about 20 months trying to get them to stop pretending that FORM ATS is some kind of “application” — and our bank even piled on with their chief counsel calling them “morons” for getting outside of their swim lane. We even had to remind FINRA that Transfer Agents do not report to them.
It’s high time another SRO was formed! One that offered its members:
1. Model documents and checklists
2. Service Level Agreements
FINRA has demonstrated time and again that it is not fit to be a monopoly.
-dvd
I don’t really have sympathy for investors who want to exit a Reg CF issuer after two years. If they needed the money they should have invested in the public markets.
Realistically there just can’t be an active secondary market for a tiny company. The technology doesn’t matter. You could base an ATS on quantum entanglement and it still wouldn’t create nearly enough potential buyers.
Investors should expect to hold these securities for at least five years, maybe more. But here’s the thing: the lack of liquidity is baked into the price! That’s why public companies trade at multiples much higher than private securities.
Nobody should invest in private companies with money they need within five years.
Put your statement at the top of every offering:
“I don’t really have sympathy for investors who want to exit a Reg CF issuer after two years. If they needed the money they should have invested in the public markets. Realistically there just can’t be an active secondary market for a tiny company. ”
Unfortunately, there will not be any more Reg CF offerings and Mark will have to start chasing ambulances instead of doing Reg CF offerings. Ha!
Anyone who invests in a startup expecting liquidity within two years has been sorely misled! Ain’t going to happen.
As a crowdfunding strategy consulting for Reg CF these suggestions are spot-on. Requiring companies to pay the high expenses for a review and audit for companies with little to no financials seems to be an unnecessary expense that provides little important information to the investors to make a more informed investment decision.
Having low minimum investment does damage to both issuers and investors because if you can’t reach a minimum that can make a material impact most of the time you are not going to reach you maximum raise. If the capital being raised can’t be raised from your primary, secondary, and tertiary networks then raising it from investors who have no relationship to the company and its team the money will not be raised. One of the first things I review with my clients is what can you expect to raise from your network and we work from their.
I feel many times it is disingenuous at best and dishonest at worst for platforms to advertise the number of investor emails they has as a reason to chose a particular platform. There are marketing numbers and then there are actual data points of dollars invested from the marketing of the platform to its email list of former investors.
Bill, you are obviously very knowledgeable about the space. Thanks for reading and commenting!