Category: Crowdfunding Portals

Escrow account crowdfunding portals

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

On By crowdfundattnyIn Crowdfunding Portals, Crowdfunding Real Estate, Portals, Real Estate2 Comments

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. 

Series A Preferred Stock

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

On By crowdfundattnyIn Crowdfunding Portals, FINRA, PortalsLeave a comment

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. 

audience asking questions by raising hands

The Series LLC And Crowdfunding Vehicle: A Legal Explanation And A Funding Portal WSP

On By crowdfundattnyIn Crowdfunding Portals, Crowdfunding Vehicles, Series LLC2 Comments

Lots of people have asked for a legal explanation in response to my previous post about crowdfunding vehicles and the series LLC. Plus, many funding portals will want a Written Supervisory Procedure (WSP) addressing the issue.

Here’s the legal reason why a “series” of a limited liability company can’t serve as a crowdfunding vehicle.

Rule 3a-9(b)(1) (17 CFR §270.3a-9(b)(2)) defines “crowdfunding vehicle” as follows:

Crowdfunding vehicle means an issuer formed by or on behalf of a crowdfunding issuer for the purpose of conducting an offering under section 4(a)(6) of the Securities Act as a co-issuer with the crowdfunding issuer, which offering is controlled by the crowdfunding issuer.

You see the reference to the crowdfunding vehicle as an “issuer” and a “co-issuer.”

Now here’s a C&DI (Compliance & Disclosure Interpretation) issued by the SEC in 2009:

Question 104.01

Question: When a statutory trust registers the offer and sale of beneficial units in multiple series, or a limited partnership registers the offer and sale of limited partnership interests in multiple series, on a single registration statement, should each series be treated as a separate registrant?

Answer: No. Even though a series of beneficial units or limited partnership interests may represent interests in a separate or discrete set of assets – and not in the statutory trust or limited partnership as a whole – unless the series is a separate legal entity, it cannot be a co-registrant for Securities Act or Exchange Act purposes.

Note the conclusion:  “. . . .unless the series is a separate legal entity, it cannot be a co-registrant for Securities Act or Exchange Act purposes.”

A “series” of a limited liability company is not a separate legal entity. Under section 218 of the Delaware Limited Liability Company Act and corresponding provisions of the LLC laws of other states, if you keep accurate records then the assets of one series aren’t subject to the liabilities of another series. That makes a series like a separate entity, at least in one respect, but it doesn’t make the series a separate legal entity. A motorcycle is like a car in some respects but it’s not a car.

That’s the beginning and end of the story:  a crowdfunding vehicle must be an “issuer”; a series of a limited liability company can’t be an “issuer” because it’s not a separate legal entity; therefore a series of a limited liability company can’t be a crowdfunding vehicle.

Maybe someone will challenge the application of the C&DI in court. Until that happens the result is pretty clear.

A couple more things.

First, this same C&DI is the basis of many successful offerings under Regulation A. Suppose, for example, that you’d like to use Regulation A to raise money for real estate projects (or racehorses, or vintage cars, or anything else), but you don’t want to spend the time and money to conduct a Regulation A offering for each project. This same C&DI allows sponsors to treat the “parent” limited liability company as the only “issuer” in the Regulation A offering even while allowing investors to choose which project they’d like to invest in and segregating the projects in separate “series” for liability purposes. If each series were a separate issuer that wouldn’t work.

Second, suppose a funding portal creates a new series for each offering and has conducted 25 offerings (that is, 25 series for 25 crowdfunding vehicles), each with a different type of security (one for each offering). Because we know that only the “parent” can be an issuer:

  • They’ve violated Rule 3a-9(a)(3) because the parent has issued more than one class of securities; and
  • They’ve violated Rule 3a-9(a)(6) because there is no one-to-one correspondence between the securities of the parent and the securities of the crowdfunding issuer.

To quote Simon & Garfunkel, any way you look at this you lose.

If you’re a funding portal, you’ll probably be asked by FINRA to add a WSP dealing with crowdfunding vehicles. Here’s an example.

Questions? Let me know. 

The Legal Liability of Funding Portals: Update for TruCrowd Complaint

On By crowdfundattnyIn Crowdfunding, Crowdfunding Liabilities, Crowdfunding Portals2 Comments

A few weeks ago I posted about the potential legal liability of funding portals. Lo and behold, on September 20, 2021 the SEC brought an enforcement action against an issuer and its principals, and also against the funding portal, TruCrowd, Inc., dba Fundanna, and its owner, Vincent Petrescu.

Here’s a link to the Complaint. If you take the Complaint at face value – and readers should bear in mind that there are least two sides to every story – this is a lesson in how a funding portal can get into hot water with a questionable issuer.

The allegations against the issuer and its principals are straightforward:  they failed to disclose the criminal record of one of the principals; they used investor money for personal purposes; they misled investors about a purported real estate project.

More interesting for our purposes are the allegations against the funding portal and its owner. Calling TruCrowd and Mr. Petrescu “gatekeepers,” the SEC alleges, among other things, that:

  • TruCrowd and Mr. Petrescu allowed the offerings to proceed despite multiple warning signs of possible fraud or other harm to investors.
  • Mr. Petrescu participated in drafting the inaccurate Form C and offering statement.
  • TruCrowd and Mr. Petrescu failed to order a “bad actor” check.
  • Mr. Petrescu ignored warning from a securities lawyer.

It’s hard to walk away from a big commission. But this enforcement action illustrates that sometimes you have to.

Crowdfunding web portal

The Legal Liability of A TITLE III Funding Portal

On By crowdfundattnyIn Crowdfunding Portals, Title III, Title III Crowdfunding5 Comments

In this blog post I summarized the potential legal liability of issuers raising capital using Title II Crowdfunding (aka Rule 506(c)), Title III Crowdfunding (aka Reg CF), and Title IV Crowdfunding (aka Regulation A). Here, I’ll summarize the potential legal liability of a registered Title III funding portal.

To start, let’s distinguish between two kinds of liability:  liability to the government (e.g., to the SEC) for breaking rules; and liability to private parties. Most people think about the first kind of liability but often the second is more important. The government doesn’t know about most violations of securities laws and even if it knows must pick and choose which cases to prosecute. Conversely, private parties – issuers and investors – are likely to know about actual or potential violations and there are plenty of plaintiffs’ lawyers willing to take a shot.

Section 4A(c) of the Securities Act

Section 4A(c) of the Securities Act of 1933 makes an “issuer” liable to an investor where:

  • The issuer made an untrue statement of a material fact or omitted to state a material fact required to be stated or necessary in order to make the statements, in the light of the circumstances under which they were made, not misleading;
  • The investor didn’t know of the untruth or omission; and
  • The issuer cannot demonstrate that the issuer did not know, and in the exercise of reasonable care could not have known, of the untruth or omission.

The statute defines “issuer” to include:

  • Any person who is a director or partner of the issuer;
  • The principal executive officer, principal financial officer, and controller or principal accounting officer of the issuer;
  • Any person occupying a similar status or performing a similar function, regardless of title; and
  • Any person who offers or sells the security in the Reg CF offering.

The SEC has declined to say one way or another whether a funding portal is an “issuer” for these purposes. Given the role of funding portals in presenting securities to the public, however, it seems likely except in unusual circumstances.

If a funding portal is an issuer and a Form C contains false statements or omits important information, the funding portal would be liable to private lawsuits from investors unless the funding portal can prove that it didn’t know about the false statements or omissions and couldn’t have learned about them by exercising reasonable care.

The language of section 4A(c) is very similar to the language of section 12(a)(2) of the Securities Act, which applies to public companies. But the playing field is different. The document used in a public filing – a prospectus – is typically subject to layer upon layer of due diligence, not only by the issuer and its lawyers but also by the underwriter and others. In contrast, many of the Form Cs we see on funding portals are prepared by people with little or no experience in securities, typically online. I expect to see lots of litigation under section 4A(c), as courts decide what “reasonable care” means for funding portals.

Private Lawsuits:              Yes

Rule 10b-5

17 C.F.R. §240.10b-5, issued by the SEC under section 10(b) of the Exchange Act, makes it unlawful, in connection with the purchase or sale of any security:

  • To employ any device, scheme, or artifice to defraud,
  • To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
  • To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person.

Liability arises under Rule 10b-5 only with the intent to deceive, known in legal jargon as “scienter.”

The Supreme Court has held that only the person who “makes” a deceptive statement or omission can be liable under the second prong of Rule 10b-5 – not a person who merely disseminates the statement innocently. But that begs the question:  does a funding portal merely disseminate information from issuers, or does it “make” the statements along with the issuer? Given the role of funding portals in Reg CF, very possibly the latter, although that could depend on the facts of a given case.

But that question could be moot. Under recent court decisions, a funding portal that knows about the misleading statements or omissions and allows them on its website anyway could be liable under either the first or third prongs of Rule 10b-5.

Private Lawsuits:              Yes

Section 17(a) of the Securities Act

Section 17(a) of the Securities Act makes it unlawful for any person, including the issuer, in the offer or sale of securities, to:

  • Employ any device, scheme, or artifice to defraud, or
  • Obtain money or property by means of any untrue statement of a material fact or any omission to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading; or
  • Engage in any transaction, practice, or course of business which operates or would operate as a fraud or deceit upon the purchaser.

Even if it is not the issuer, a funding portal participating in a scheme to mislead investor could be subject to section 17(a) of the Act just as it could be liable to investors under Rule 10b-5.

Private Lawsuits:              No

Crowdfunding and FINRA Regulations

A funding portal that violates the regulations issued by the SEC or FINRA could be sanctioned or, in the extreme case, have its registration with the SEC and/or its membership in FINRA suspended, effectively putting it out of business.

An investor who loses money and learns that the funding portal violated SEC regulations will probably claim that the regulatory violation gives rise to a private right of action – that is, that if she was harmed by the regulatory violation then she can sue the funding portal. Although we can never say never, her claim should fail.

Private Lawsuits:              No

State Common Law

A funding portal could be liable to investors under a variety of state “common law” (as opposed to statutory law) theories, including fraud and misrepresentation. In the typical case, the investor would try to show that (i) the issuer did something wrong, and (ii) the funding portal is responsible for it.

Private Lawsuits:              Yes

Liability to Issuers

Funding portals will be sued by issuers. Among the possible claims:

  • The funding portal made promises about the offering that proved false (e.g., “You’re sure to raise at least $2 million!”);
  • The funding portal conducted the offering ineffectively (e.g., failing to notify subscribers by email);
  • The funding portal made factual misrepresentations (e.g., the number of its registered users or the percentage of its successful raises); and
  • Actions by the funding portal caused the issuer to face lawsuits from investors (e.g., the funding listed the issuer’s year-over-year revenue growth as 1,300% rather than 130%).

Private Lawsuits:              Yes

Criminal Rules

If a funding portal really screws up, it could even be subject to Federal and state criminal penalties, including:

  • Criminal penalties for intentionally violating securities laws
  • Criminal penalties for mail fraud
  • Criminal penalties for wire fraud
  • Criminal penalties for violating the Racketeer Influenced and Corrupt Organizations

Liability of People

Entrepreneurs too often believe that operating through a corporation or other legal entity protects them from personal liability. For example, an entrepreneur on her way to a business meeting swerves to run over a gaggle of doctors and jumps from her car, laughing. “You can’t sue me, I operate through a corporation!”

No. She did it, so she’s personally liable, corporation or no corporation. If her employee did it, the story might be different (unless he was drunk when she handed him the keys).

The same is true in securities laws. To the extent you’re personally making decisions for the funding portal, all the potential liability I’ve described applies to you personally as well.

Reducing Your Risk

A funding portal can and should take steps to reduce its legal risk. These include:

  • Strong Contract with Issuers:  Funding portals should have a strong contract with issuers, clearly defining who is responsible for what and disclaiming liability on the funding portal’s part.
  • Training:  A junior employee of a funding portal once told my client to do something that clearly violated the securities laws. Recognizing that funding portals, like other employers, are liable for the acts of their employees, funding portals should have in place a strong training program. Among other things, employees should know about the funding portal’s potential liability and be familiar with its Manual of Policies & Procedures.
  • Due Diligence Processes:  Funding portals should have in place processes and policies for conducting due diligence. How much due diligence is required is an open question, but if a funding portal is sued for failing to discover a misstatement in a Form C, it’s going to be asked about its due diligence policies. The answer can’t be “None.”
  • Insurance:  Like any other business, funding portals should carry insurance. Even a very weak lawsuit can cost hundreds of thousands of dollars to defend.
  • Culture:  The sea at the tip of South America is among the roughest in the world, as two oceans collide. Crowdfunding is like that, sort of. On one hand, Crowdfunding is new and disruptive and attracts people who want to do something. On the other hand, the legal landscape in which Crowdfunding takes place is old and well-worn, developed before many American homes had radio. Leaping into the brave new world of online capital formation, eager to move fast and at least dent things, funding portals must nevertheless create a culture that takes seriously the often-tedious responsibility associated with selling securities.

Beneficiary Designations by Crowdfunding Issuers and Portals

On By crowdfundattnyIn Crowdfunding Portals, Regulation ALeave a comment

Some Crowdfunding portals and issuers allow investors to designate a beneficiary, i.e., a person who will take ownership of the security (the LLC interest, debt instrument, whatever) should the investor die. Just be careful.

Most states (not Texas) allow the owners of securities, including privately-held securities, to designate a beneficiary outside the owner’s will, under a version of the Uniform TOD (Transfer on Death) Security Registration Act (the Delaware version is 12 DE Code §801 et seq). For the investor, the advantage of designating a beneficiary is that the security doesn’t go through the probate process but instead passes directly to the designated beneficiary.

For the Crowdfunding issuer or portal, there is a benefit to making life easier for investors. And it’s pretty straightforward to create a beneficiary designation form on your website.

Nevertheless, adding convenience for investors carries some risks. For example:

  • Suppose an investor wants to designate her cousin Jacob as the beneficiary of her LLC interest. She uses Jacob’s name on the beneficiary designation form but mistakenly uses her husband’s social security number, out of habit. What happens?
  • The investor correctly designates Jacob on the form but later changes her mind and designates her husband as the beneficiary of the LLC interest in her will. Unfortunately for her husband, the beneficiary designation made using your form cannot be undone by the will. Your form didn’t make that clear.
  • The investor properly designates Jacob as the beneficiary of her LLC interest and doesn’t change her mind, but she lives in a community property state and your form didn’t tell her she needed her husband’s consent.
  • The investor properly designates Jacob as the beneficiary of her LLC interest but he dies before she does, and she hasn’t designated a successor beneficiary.
  • Your site crashes and the investor’s beneficiary designation is lost.

What’s your budget for legal fees this year?

Designating a beneficiary on your site isn’t the investor’s only option. She can sign a simple will or codicil (if she already has a will) designating a beneficiary for her LLC interest and any other securities or other property, which probably makes more sense than designating beneficiaries security-by-security. And if her cousin and husband end up arguing over the codicil, you’re not involved.

If you’d like a sample of a Beneficiary Designation Form let me know.

Bumblebee and flowers

SEC Proposes Limited Exemptions For “Finders”

On By crowdfundattnyIn Crowdfunding Portals, Exchange Act, Finders, Regulation A, SEC, SEC Proposals, Tier I Finders, Tier II FindersLeave a comment

In theory, only broker-dealers registered under section 15 of the Exchange Act are allowed to receive compensation for connecting issuers with investors. In practice, the world of private securities includes lots of folks we refer to as “finders.” Like bumblebees, these folks should be unable to fly according to the laws of physics but many plants couldn’t survive without them.

Because of the disconnect between theory and reality, industry participants have been urging the SEC for years to develop exemptions for finders.

The SEC just proposed exemptions that would allow some finders to operate legally, i.e., to receive commissions and other transaction-based compensation from issuers.

The SEC proposes two tiers of Finders 

  • Tier 1 Finders would be limited to providing the contact information of potential investors to an issuer in one offering per 12 months. A Tier I Finder couldn’t even speak with potential investors about the issuer or the offering.
  • Tier II Finders could participate in an unlimited number of offerings and solicit investors on behalf of an issuer, but only to the extent of:
    • Identifying, screening, and contacting potential investors;
    • Distributing offering materials;
    • Discussing the information in the offering materials, as long as the Funder doesn’t provide investment advice or advice about the value of the investment; and
    • Arranging or participating in meetings with the issuer and investor.

A Tier II Finder would be required to disclose her compensation to prospective investors up front – before the solicitation – and obtain the investor’s written consent.

The Limits to the Proposed Finders

  • The Finder must be an individual, not an entity.
  • The Finder must have a written agreement with the issuer.
  • The proposed exemptions apply only to offerings by the issuer, not secondary sales.
  • Public companies (companies required to file reports under section 13 or section 15(d) of the Exchange Act) may not use Finders.
  • The offering must be exempt from registration.
  • The Finder may not engage in general solicitation.
  • All investors must be accredited.
  • The Finder may not be an “associated person” of a broker-dealer.
  • The Find may not be subject to statutory disqualification.

The SEC issued an excellent graphic summarizing the proposed exemptions

Because they are entities, the typical Crowdfunding portal can’t qualify as a Finder under the SEC’s proposals. And because the proposals don’t allow general solicitation, a Finder who is an individual can’t create a website posting individual deals.

But the no-action letters to Funders Club and AngelList that kick-started the Crowdfunding industry (no pun intended) will invite many Tier 2 Finders to take their businesses online. Under the proposals and the no-action letters, it seems that a Tier 2 Finder could legally create a website offering access to terrific-but-unnamed offerings, but give investors access to the offerings only after registering and going through a satisfactory KYC process per the CitizenVC no-action letter.

A Step Forward for Crowdfunding

Many finders and issuers will jump for joy at the new proposals, while others will be disappointed that the SEC drew the line at accredited investors. In a Regulation A offering or a Rule 506(b) offering open to non-accredited investors, the law requires very substantial disclosure, especially in Regulation A. The SEC must believe that non-accredited investors are especially vulnerable to the selling pressure that might be applied by a finder.

Nevertheless, like the SEC’s proposals to expand the definition of accredited investor, the proposals about finders are a step forward.

CAUTION:  As of today these proposals are just proposals, not the law.

Questions? Let me know.

SEC Issues Emergency Rules To Facilitate Title III Crowdfunding During Covid-19 Crisis

On By crowdfundattnyIn COVID-19, Crowdfunding, Crowdfunding Laws, Crowdfunding Portals, Equity Crowdfunding, JOBS Act, Reg CF, Regulation CF, SEC, SEC Proposals, Securities Exchange Commission, Securities Laws, Title III Crowdfunding1 Comment

With credit markets tightened and 30 million Americans newly out of work, the SEC has adopted temporary rules to make Title III Crowdfunding a little easier from now until August 31, 2020.

The temporary rules are available here. They aim to make Title III a little faster and easier in four ways:

#1 – Launch Offering without Financial Statements

An issuer can launch the offering – go live on a funding portal – before its financial statements are available. (But investment commitments aren’t binding until the financial statements have been provided.)

#2 – Lower Standard for Some Financial Statements

An issuer trying to raise between $107,000 and $250,000 in a 12-month period doesn’t have to produce financial statements reviewed by an independent accountant, only financial statements and certain information from its tax return, both certified by the CEO.

#3 – Quicker Closing

An issuer can close the offering as soon as it has raised the target offering amount, even if the offering hasn’t been live for 21 days, as long as the closing occurs at least 48 hours after the last investment commitment and the funding portal notifies investors of the early closing.

#4 – Limit on Investor Cancellations 

Investors can cancel within 48 hours of making a commitment, but can’t cancel after that unless there’s a material change in the offering.

CAVEAT:  These rules are not available if the issuer:

  • Was organized or operating within six months before launching the offering (e., this is not for brand-new companies); or
  • Previously raised money using Title III Crowdfunding but failed to comply with its obligations.

I’m not sure how much difference these rules will make in practice. But that’s not the main point as far as I’m concerned. The main point is that with about a million other things on its plate, the SEC took the time to think about and draft these rules. The SEC must believe that equity Crowdfunding can play an important role in our capital markets.

On that basis, I predict that the proposals the SEC made on March 4th will be adopted soon after the public comment period expires on June 1st. And after that, who knows.

Questions? Let me know.

SEC Proposes Major Upgrades To Crowdfunding Rules

On By crowdfundattnyIn Accredited Investor, Angel Fairs, Crowdfunding, Crowdfunding Articles, Crowdfunding Laws, Crowdfunding Portals, Crowdfunding Real Estate, Demo Days, Equity Crowdfunding, General Solicitation, Integration, JOBS Act, Raising Money, Regulation A, Regulation A Plus, Regulation A Plus Primer, Regulation D offerings, Rule 506, Rule 506(b), Rule 506(c), SAFE, SEC, SEC Proposals, SPV, Title II, Title II Crowdfunding, Title III, Title III Crowdfunding, Title IV of the JOBS Act, Uncategorized2 Comments

The SEC just proposed major changes to every kind of online offering:  Rule 504, Rule 506(b), Rule 506(c), Regulation A, and Regulation CF.

The proposals and the reasoning behind them take up 351 pages. An SEC summary is here, while the full text is here. The proposals are likely to become effective in more or less their existing form after a 60-day comment period.

I’ll touch on only a few highlights:

  • No Limits in Title III for Accredited Investors:  In what I believe is the most significant change, there will no longer be any limits on how much an accredited investor can invest in a Regulation CF offering. This change eliminates the need for side-by-side offerings and allows the funding portal to earn commissions on the accredited investor piece. The proposals also change the investment limits for non-accredited investor from a “lesser of net worth or income” standard to a “greater of net worth or income” standard, but that’s much less significant, in my opinion.
  • Title III Limit Raised to $5M:  Today the limit is $1.07M per year; it will soon be $5M per year, opening the door to larger small companies.

NOTE:  Those two changes, taken together, mean that funding portals can make more money. The impact on the Crowdfunding industry could be profound, leading to greater compliance, sounder business practices, and fewer gimmicks (e.g., $10,000 minimums).

  • No Verification for Subsequent Rule 506(c) Offerings:  In what could have been a very important change but apparently isn’t, if an issuer has verified that Investor Smith is accredited in a Rule 506(c) offering and conducts a second (and third, and so on) Rule 506(c) offering, the issuer does not have to re-verify that Investor Smith is accredited, as long as Investor Smith self-certifies. But apparently the proposal applies only to the same issuer, not to an affiliate of the issuer. Thus, if Investor Smith invested in real estate offering #1, she must still be verified for real estate offering #2, even if the two offerings are by the same sponsor.
  • Regulation A Limit Raised to $75M:  Today the limit is $50M per year; it will soon be $75M per year. The effect of this change will be to make Regulation A more useful for smaller large companies.
  • Allow Testing the Waters for Regulation CF:  Today, a company thinking about Title III can’t advertise the offering until it’s live on a funding portal. Under the new rules, the company will be able to “test the waters” like a Regulation A issuer.

NOTE:  Taken as a whole, the proposals narrow the gap between Rule 506(c) and Title III. Look for (i) Title III funding portals to broaden their marketing efforts to include issuers who were otherwise considering only Rule 506(c), and (ii) websites that were previously focused only on Rule 506(c) to consider becoming funding portals, allowing them to legally receive commissions on transactions up to $5M.

  • Allow SPVs for Regulation CF:  Today, you can’t form a special-purpose-vehicle to invest using Title III. Under the SEC proposals, you can.

NOTE:  Oddly, this means you can use SPVs in a Title III offering, but not in a Title II offering (Rule 506(c)) or Title IV offering (Regulation A) where there are more than 100 investors.

  • Financial Information in Rule 506(b):  The proposal relaxes the information that must be provided to non-accredited investors in a Rule 506(b) offering. Thus, if the offering is for no more than $20M one set of information will be required, while if it is for more than $20 another (more extensive) set of information will be required.
  • No More SAFEs in Regulation CF:  Nope.

NOTE:  The rules says the securities must be “. . . . equity securities, debt securities, or securities convertible or exchangeable to equity interests. . . .” A perceptive readers asks “What about revenue-sharing notes?” Right now I don’t know, but I’m sure this will be asked and addressed during the comment period.

  • Demo Days:  Provided they are conducted by certain groups and in certain ways, so-called “demo days” would not be considered “general solicitation.”
  • Integration Rules:  Securities lawyers worry whether two offerings will be “integrated” and treated as one, thereby spoiling both. The SEC’s proposals relax those rules.

These proposals are great for the Crowdfunding industry and for American capitalism. They’re not about Wall Street. They’re about small companies and ordinary American investors, where jobs and ideas come from.

No, the proposals don’t fix every problem. Compliance for Title III issuers is still way too hard, for example. But the SEC deserves (another) round of applause.

Please reach out if you’d like to discuss.

Simple Wholesaling Podcast: Raising Money Online for Your Deals & More

On By crowdfundattnyIn Accredited Investor, Crowdfunding, Crowdfunding Interview, Crowdfunding Portals, Podcasts, UncategorizedLeave a comment

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Mark Roderick appeared on the Simple Wholesaling Podcast to talk about crowdfunding and the laws and logistics of raising money online.

In this episode, Mark discusses:

  • Mark’s story
  • Raising capital online
  • Businesses that have been very successful
  • How entrepreneurs and the consumers are protected online
  • Portals he recommends
  • Where people should start if they’re interested to try crowdfunding
  • The “don’ts” when trying to raise money on the Internet
  • What accredited investor means
  • The types of returns entrepreneurs pay out to their crowd investors
  • The effects on the stock market when we have many options to invest in different things