COVID-19 DISCLOSURES IN CROWDFUNDING OFFERINGS

The COVID-19 pandemic illustrates why we include a list of “risk factors” when we sell securities. Suppose a company issued stock on January 1, 2020 without disclosing that its major supplier was located in Wuhan, China and that Wuhan was experiencing an outbreak of a new virus. Investors who bought the stock likely would be entitled to their money back and have personal claims against the founders, officers, and directors.

If the company issued stock on October 1, 2019, before the pandemic began, its duty to tell investors about the pandemic would depend on which version of Crowdfunding it used:

  • If it used Title II Crowdfunding (Rule 506(c)) the company would have no duty to tell investors about the pandemic.
  • If it used Title III Crowdfunding (Regulation CF) the company would be required to tell investors about the pandemic in its next annual report.
  • If it used Title IV Crowdfunding (Regulation A) the company would be required to tell investors about the pandemic in its next semiannual or annual report, whichever comes first.

CAUTION:  That assumes the Company was finished selling stock on October 1, 2019. If it was continuing to sell stock when it learned of the pandemic, then the Company would be required to tell new investors. And if a Title III offering hadn’t yet closed, all existing investors would have the right to change their minds.

CAUTION:  A company – even a publicly-reporting company – generally is not required to tell investors about COVID-19 if it is not selling securities currently, because pandemics are not on the list of disclosure items found in Form 1-U (for Regulation A issuers) or Form 8-K (for publicly-reporting companies). But be careful. For example, if a Regulation A issuer redeems stock without disclosing the effect of COVID-19, it could be liable under Rule 10b-5 and otherwise.

Assume that we’re required to tell investors about COVID-19 today, whether because we’re selling stock or are filing an annual or semiannual report. What do we say?

If this were January, we might say something simple:  “Wuhan, China is experiencing an outbreak of a highly-contagious virus, which is disrupting economic activity. If this virus should spread to the United States, as epidemiologists predict, it could have an adverse effect on our business.”

But this isn’t January. We have much more information today and are therefore required to say more. Exactly how much information we share is as much an art as a science. Our goal is always to give investors enough information to make an informed decision without making the disclosure so dense as to be useless.

Here are two examples, one for multi-family housing projects and the other for a technology company.

Multi-Family Housing

With unemployment reaching levels not seen since the Great Depression, by some estimates already 20% and rising, we are already experiencing a number of negative effects from the COVID-19 pandemic:

  • We are experiencing a decrease in the number of phone calls and visits from potential new tenants. Year-to-year compared to 2019, we experienced a decrease in traffic of approximately ____% in March and ____% in April.
  • We are experiencing an increase in rent delinquency. Year-to-year compared to 2019, the rate of delinquencies greater than 30 days rose from ____% to ____% during March and ____% to ____% during April.
  • We are spending more time and resources on collections and marketing.

Although we are working from incomplete information, we expect these trends to continue and perhaps accelerate, depending on the trajectory of the virus and the ability to re-open the economy. Among possible outcomes:

  • Occupancy levels might decrease, although they have not decreased yet as compared to the same periods in 2019.
  • We do not intend to raise rents until the pandemic eases. Depending on circumstances we could be forced to decrease rents.
  • We expect some tenants to re-locate for economic reasons, from Class A projects to Class B projects and from Class B projects to Class C projects. In some cases tenants might leave the market altogether, by moving in with relatives, for example. Because we operate primarily Class B properties, we are uncertain whether the net effect for our properties will be positive or negative.
  • Conversely, we expect that economic uncertainty will cause some families to postpone buying a house and rent instead, increasing the pool of potential tenants.
  • The pandemic has caused significant uncertainly in the value of many assets, including real estate. Until the uncertainty is resolved it might be difficult for us to borrow money or raise capital by selling equity.
  • If occupancy rates and rents decrease while delinquencies increase, we could be unable to meet our obligations as they become due. A reduction in cash flows and/or asset values could also cause us to be in default under the loan covenants under our senior debt. Either scenario could lead to foreclosure and the loss of one or more properties.

At least in the short run we expect the pandemic to cause our revenue to decrease, perhaps significantly. As a result, we are taking steps to conserve cash. Among other things we have decided not to make any cash distributions until the economic outlook stabilizes and have reduced our staff. We have also begun to contact lenders to request a deferral of our mortgage loan obligations.

We do not know how long the pandemic will last or how its effects will ripple through the American economy. In a best-case scenario we would experience a short-term drop in cash flow and a dip in asset values as the economy adjusts to a new reality. In a worst-case scenario, where occupancy and rent levels drop significantly over an extended period of time, we would be unable to make mortgage payments and possibly lose assets, risking or even forfeiting investor equity if asset values drop far enough. Based on the information currently available to us we expect an outcome closer to the former scenario than to the latter and are marshalling all our experience and assets toward that end.

Technology

Our software provides a virtual connection between internet-based office telephone systems and cellular phones, allowing incoming calls to the office number to be re-directed to the cellular phone and outgoing calls made from the cellular phone to appear to the recipient as if they were made from the office number. Will tens of millions of people working remotely due the COVID-19 pandemic, the demand for our software has grown substantially. On January 1, 2020 our software had been installed on ________ cellular devices worldwide. On May 1, 2020 it was installed on ________ devices.

As a result, we expect both our revenue and our net income for 2020 to increase substantially. However, with many workers now returning to their offices on a full-time or part-time basis it is unclear whether the high demand for our software will continue. Consequently, we are unable to provide a reliable forecast for revenue or net income at this time.

With more than ________ new users, even if temporary, we are accelerating developing of our new consumer-based communications tools. We expected to launch these tools in Q1 2021 but are now aiming for Q3 2020.

Even before the pandemic many of our employees worked remotely at least part of the time. Therefore, our operations have not been affected significantly by the pandemic. Tragically, however, David Newsome, the leader of our marketing team, contracted COVID-19 and died on March 27th in Brooklyn, NY. We have not yet found a replacement for David, who was with the company from its founding in 2013.

We were considering purchasing a commercial building in Palo Alto as the headquarters for our engineering team. Given our successful experience working remotely we have decided to put those plans on hold at least for the time being.

SEC ISSUES EMERGENCY RULES TO FACILITATE TITLE III CROWDFUNDING DURING COVID-19 CRISIS

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.

SEC PROPOSES MAJOR UPGRADES TO CROWDFUNDING RULES

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.

The High Return Real Estate Show Podcast: Crowdfunding For Real Estate Investors 

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Jack gets the day off, and Shecky gets to have a one-on-one conversation with Mark Roderick, the leading Crowdfunding and FinTech lawyer in the US.

In this episode, you’ll learn…

  • What is Crowdfunding?
  • The two different kinds of Crowdfunding
  • What and who to look for in a Crowdfunding company.
  • How does Crowdfunding apply to Real Estate Investing?
  • Who are the big players in the Crowdfunding space?
  • The three types of Equity Crowdfunding

This episode is a MUST listen to anyone wanting to understand how technology is changing our investing landscape!

Questions? Let me know.

Married Couples As Accredited Investors

When a married couple invests in an offering under Rule 506(b), Rule 506(c), or Tier 2 of Regulation A, we have to decide whether the couple is “accredited” within the meaning of 17 CFR §501(a). How can we conclude that a married couple is accredited?

A human being can be an accredited investor in only four ways:

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  • Method #1: If her net worth exceeds $1,000,000 (without taking into account her principal residence); or
  • Method #2: If her net worth with her spouse exceeds $1,000,000 (without taking into account their principal residence); or
  • Method #3: Her income exceeded $200,000 in each of the two most recent years and she has a reasonable expectation that her income will exceed $200,000 in the current year;
  • Method #4: Her joint income with her spouse exceeded $300,000 in each of the two most recent years and she has a reasonable expectation that their joint income will exceed $300,000 in the current year.

A few examples:

EXAMPLE 1: Husband’s net worth is $1,050,001 without a principal residence. Wife’s has a negative net worth of $50,000 (credit cards!). Their joint annual income is $150,000. Husband is accredited under Method #1 or Method #2. Wife is accredited under Method #2.

EXAMPLE 2: Husband’s net worth is $1,050,001 without a principal residence. Wife’s has a negative net worth of $500,000 (student loans!). Their joint annual income is $150,000. Husband is accredited under Method #1. Wife is not accredited.

EXAMPLE 3: Husband’s net worth is $850,000 and his income is $25,000. Wife’s has a negative net worth of $500,000 and income of $250,000. Husband is not accredited. Wife is accredited under Method #3.

Now, suppose Husband and Wife want to invest jointly in an offering under Rule 506(c), where all investors must be accredited.

They are allowed to invest jointly in Example 1, because both Husband and Wife are accredited. They are not allowed to invest jointly in Example 2 because Wife is not accredited, and they are not allowed to invest jointly in Example 3 because Husband is not accredited.

The point is that Husband and Wife may invest jointly only where both Husband and Wife are accredited individually. At the beginning, I asked “How can we conclude that a married couple is accredited?” The answer: There is no such thing as a married couple being accredited. Only individuals are accredited.

CAUTION: Suppose you are an issuer conducting a Rule 506(c) offering, relying on verification letters from accountants or other third parties. If a married couple wants to invest jointly, you should not rely on a letter saying the couple is accredited. Instead, the letter should say that Husband and Wife are both accredited individually.

Questions? Let me know.

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

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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

The Exchange with KB: Crowdfunding, Blockchain & Cryptocurrencies

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Mark Roderick appeared on The Exchange with KB podcast with host Kirill Bensonoff, where he discussed Crowdfunding, Blockchain & Cryptocurrencies. In this episode, Kirill and Mark discussed the JOBS Act, Title II Crowdfunding, Accredited Investors, Regulation Crowdfunding, why we need investment regulation, the future of cryptocurrency, Libra and other blockchain tech and cryptocurrency, and legislation regarding blockchain and crypto.

School for Startups Radio: Crowdfunding Update with Mark Roderick

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Mark Roderick appeared on School for Startups Radio with Jim Beach to discuss the current state of crowdfunding and how the industry is progressing. He discusses the booming real estate crowdfunding industry and how the rest of the crowdfunding space measures up.

The Cashflow Hustle Podcast: Crowdfunding Techniques to Level Up Your Business

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Mark Roderick appeared on the Cashflow Hustle Podcast with Justin Grimes, where he discussed Crowdfunding Techniques to Level Up Your Business.

In this Episode, You’ll Learn About:

1. The Crowdfunding and its flavors
2. The deductions in Crowdfunding
3. The role of SEC
4. Blockchain technology in Crowdfunding
5. The Investor portals
6. Tokenized security in Crowdfunding

Questions? Let me know.

Facebook’s Cryptocurrency

Facebook just announced a Facebook cryptocurrency called Libra.

To me, the timing seems poor. Over the last year or so, Facebook has suffered one public relations black eye after another regarding its privacy policies, it compliance with an order of the Federal Trade Commission, its role in disseminating conspiracy theories and election interference, and its dominance in the social media industry. A Facebook cryptocurrency will, by definition, give Facebook even more private information and even more financial power. Already, regulators and members of the public are shouting “No!”

A few thoughts about what this means:

  • Not long ago, some predicted that cryptocurrencies would lead to a better world, a world that would be more free, more decentralized, where consumers could interact with one another without middlemen. Libra, a cryptocurrency created by one of the most powerful companies in the world, seems to promise exactly the opposite.
  • It didn’t take long to get from idealism to disappointment, but the arc itself is typical of technologies, from radio to automobiles to the internet. We expect technologies to save us, then they don’t.
  • Are tokens securities? Does Howey apply? Facebook’s announcement shows that those questions are small potatoes in the scheme of how cryptocurrencies may re-shape the financial world.
  • Undoubtedly, Facebook is in this for the data. Will consumers care? Probably not.
  • Facebook might be first, but how long can it be before Google and Amazon — especially Amazon — issue their own cryptocurrencies?
  • Regardless of political persuasion, governments aren’t going to allow Facebook or anybody else to compete with their national currencies. We are already seeing opposition from Democrats and Republicans alike, and we can expect more.
  • And the next step: How long can it be before the U.S. dollar itself is given the features of a cryptocurrency, in effect competing with Facebook?
  • The price of bitcoin increased on the announcement, but I think that’s exactly wrong. The announcement shows that bitcoin and other cryptocurrencies will be left behind as big companies take over, just as a few big companies now monetize the once-egalitarian internet.
  • In the same way, I expect the announcement to stifle innovation in the cryptocurrency industry generally, just as the existence of Facebook already stifles innovation in social media and Microsoft once stifled innovation in software. Nobody wants to compete with the giant.

As all six readers of this blog know, I’m a believer in Crowdfunding from a capitalist, ideological perspective. I believe in making capital available to entrepreneurs everywhere, no matter where you grew up, no matter who your parents are, and in making great investments available to ordinary Americans, helping to narrow the wealth and income gaps that do so much harm to our society.

Frankly, Facebook and Libra feel like a step in the opposite direction, toward a world where knowledge and wealth and power are more concentrated and ordinary Americans are so many data points to be monetized. I’m certainly interested in hearing a different point of view.

Questions? Let me know.

Mark Roderick is one of the leading Crowdfunding lawyers in the United States. He represents platforms, portals, issuers, and others throughout the industry. For more information on Crowdfunding, including news, updates and links to important information pertaining to the JOBS Act and how Crowdfunding may affect your business, follow Mark’s blog, or his twitter handle: @CrowdfundAttny. He can also be reached at 856.661.2265 or mark.roderick@flastergreenberg.com