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.
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.
The JOBS Act was signed by President Obama on May 5, 2012. Last month, a client of mine, Tapestry Senior Housing, raised about $13.6 million of common equity for a project in Moon Township outside Pittsburgh. Tapestry is an affiliate of Tapestry Companies, LLC, a national firm that operates as an owner, manager and developer of senior and multifamily properties. The Moon Township project involved the adaptive re-use of an existing Embassy Suites hotel.
This was the largest raise in the history of the CrowdStreet platform and, in my opinion, an important milestone for the Crowdfunding industry.
Not long ago, real estate Crowdfunding was limited to single-family fix-and-flips. At the annual meeting of NAIOP in Denver, in October 2014, I moderated a panel on Crowdfunding with Adam Hooper of RealCrowd and Darren Powderly of CrowdStreet, as it so happens. The audience for our panel was the smallest of the conference — but at the same time probably the youngest and most enthusiastic.
The size of the deals grew and high-quality sponsors like Tapestry began to notice. Now, when word gets out that someone has raised $13.6 million of equity, I believe we’re going to see a spike in interest from a broad spectrum of sponsors in every industry sector.
You can’t raise $13.6 million for just any sponsor and any deal, of course. Tom LaSalle, Jack Brandt, and their team at Tapestry have a remarkable track record in the senior housing space, and this was their third deal on CrowdStreet. CrowdStreet itself has a terrific and well-deserved reputation as a premier site. Put a great deal, a great sponsor, and a great site together and you get a terrific result.
But let’s not forget the most important factor of all (besides the lawyer, I mean). In the Moon Township deal, Tapestry and CrowdStreet gave about 280 accredited investors from all over the United States the opportunity to participate in the kind of investment once reserved for the wealthy. That is now, and will continue to be, the most important ingredient for success. When we talk about Crowdfunding as the democratization of capital, that’s what we mean.
Tapestry raised $13.6 million from 280 investors. There are close to 10 million accredited investors in the United States alone. To my mind, that means that the opportunity for growth, even within Rule 506(c), is practically unlimited.
So hats off to Tapestry and CrowdStreet, and on to the next deal.
Interested in equity crowdfunding? What about understanding how to raise money from the crowd? In this podcast, I do a complete brain dump on all of the regulations impacting raising funds online.
You’ll discover how crowdfunding regulations differ, how to do an online securities offering, and what makes a successful campaign.
The goal of this episode is to bring you accurate and quality information so that you can go out there and raise money from the crowd, be it for real estate or a new business venture.
A couple weeks ago, Howard Marks of StartEngine and I presented a webinar about Regulation A. Listeners asked far more questions than we were able to answer in the time given, and I promised to post their questions and answers on the blog. Here goes.
What’s the difference between Regulation A and Regulation A+?
There is no difference. Regulation A has been around for a long time, but was rarely used primarily because issuers could raise only $5 million and were required to register with every state where they offered securities. Title IV of the JOBS Act required the SEC to create a new and improved version of Regulation A, and the new and improved version is sometimes referred to colloquially as Regulation A+. But it’s the same thing legally as Regulation A.
Can I use Regulation A to raise money from non-U.S. investors?
Definitely. Non-U.S. investors may participate in all three flavors of Crowdfunding: Title II, Title III, and Title IV (Regulation A).
But don’t forget, the U.S. isn’t the only country with securities laws. If you raise money from a German citizen, Germany wants you to comply with its laws.
Can non-U.S. companies use Regulation A?
Only companies organized in the U.S. or Canada and having their principal place of business in the U.S. or Canada may use Regulation A.
What about a company with headquarters in the U.S. but manufacturing facilities elsewhere?
That’s fine. What matters is that the issuer’s officers, partners, or managers primarily direct, control and coordinate the issuer’s activities from the U.S (or Canada).
Is Regulation A applicable to use for equity or debt for a real estate development project?
I believe that real estate will play the same dominant role in Regulation A that it plays in Title II. I also believe that real estate development will be more difficult to sell than stable, cash-flowing projects simply because of the different risk profile.
Is there any limit on the amount an accredited investor can invest?
No. An accredited investor may invest an unlimited amount in both Tier 1 and Tier 2 offerings under Regulation A. A non-accredited investor may invest an unlimited amount in Tier 1 offerings, but may invest no more than 10% of her income or 10% of her net worth, whichever is greater, in each Tier 2 offering.
What kinds of securities can be sold using Regulation A?
All kinds: equity, debt, convertible debt, common stock, preferred stock, etc.
But you cannot sell “asset-backed securities” using Regulation A, as that term is defined in SEC Regulation AB. The classic “asset-backed security” is where a hedge fund purchases $1 billion of credit card debt from the credit card issuer, breaks the debt into “tranches” based on credit rating and other factors, and securitizes the tranches to investors. However, the SEC views the term more broadly.
Can I combine a Regulation A offering with other offerings?
In general yes. For example, there’s no problem if an issuer raises money using Rule 506 (Rule 506(b) or Rule 506(c)) while it prepares its Regulation A offering. The legal issues become more cloudy if an issuer wants to combine multiple types of offerings simultaneously. Theoretically just about anything is possible.
Can the same platform list securities under both Regulation A and Title II?
Yes. In fact, the same platform can list securities under all three flavors of Crowdfunding: Title II, Title III, and Title IV. But on that platform, only licensed “Funding Portals” can offer Title III securities.
Does a platform offering securing under Regulation A have to be a broker-dealer?
The simple answer is No. But a platform that crosses the line into acting like a broker-dealer, or is compensated with commissions or other “transaction based compensation,” would have to register as a broker-dealer or become affiliated with a broker-dealer.
Can a non-profit organization use Regulation A?
Regulation A is one exception to the general rule that all offerings of securities must be registered with the SEC under section 5 of the Securities Act of 1933. Non-profit organizations are allowed to sell securities without registration under a different exception. So the answer is that non-profits don’t have to use Regulation A.
With that said, I represent non-profit organizations that have created for-profit subsidiaries that plan to engage in Regulation A offerings. For example, a non-profit in the business of urban development might create a subsidiary to develop an urban in-fill project, raising money partly from grants and partly from Regulation A.
Can I use Regulation A to create a fund?
If by “fund” you mean a pool of assets, like a pool of 30 multi-family apartment communities, then Yes. You can either buy the apartment communities first and then raise the money, or raise the money first and then deploy it in your discretion. If you want to own each apartment community in a separate limited liability company subsidiary, that’s okay also.
If by “fund” you mean a pool of investments, like a pool of 30 minority interests in limited liability companies that themselves own multi-family apartment communities, then No. Your “fund” would be treated as an “investment company” under the Investment Company Act of 1940, and Regulation A may not be used to raise money for investment companies.
Can a fund be established for craft beverages?
Same idea. You could use Regulation A to raise money for a brewery that will develop multiple craft beverages. You cannot use Regulation A to buy minority interests in multiple craft beverage companies.
For a brand new company, can the audited financial statements required by Tier 2 be dated as of the date of formation, and just show zeroes?
Yes, as long as the date of formation is within nine months before the date of filing or qualification and the date of filing or qualification is not more than three months after the entity reached its first annual balance sheet date.
How does the $50 million annual limit apply if I have more than one project?
The $20 million annual limit under Tier 1, and the $50 million limit under Tier 2, are per-issuer limits. A developer with, say, three office building projects, each requiring $50 million of equity, can use Regulation A for all three at the same time.
NOTE: This is different than Title III, where the $1 million annual limit applies to all issuers under common control.
What does “testing the waters” mean?
It means that before your Regulation A offering is approved (“qualified”) by the SEC, and even before you start preparing all the legal documents, you can advertise the offering and accept non-binding commitments from prospective investors. If you don’t find enough interest, you can save yourself the trouble and cost of going through with the offering.
NOTE: Any materials you use for “testing the waters” must be submitted to the SEC, if the offering proceeds.
Where can Regulation A securities be traded?
Theoretically, Regulation A securities could be registered with the SEC under the Exchange Act and traded on a national market. But I’m sure that’s not what the listener meant. Without being registered under the Exchange Act, a Regulation A security may be traded on the over-the-counter market, sponsored by a broker-dealer.
This sounds expensive! Can you give us an estimate?
Since Labor Day, I’ve spoken at half a dozen events: for entrepreneurs, for intellectual property lawyers, for finance professionals, for digital marketing groups. This week I’ll be speaking at one of the premier Crowdfunding events in country, the CFGE Crowdfund Banking and Lending Summit on the 16th and 17th in San Francisco.
The conference features some of the leaders in the industry, including:
Richard Swart, Director of Research for Innovation in Entrepreneur and Social Finance, Colman Fung Institute for Engineering Leadership at UC Berkeley.
Ron Suber, the President of Prosper.
Jason Fritton, the Founder and CEO of Patch of Land.
Tom Lockard, the Vice President for Real Estate Investment and Institutional Sales of Fundrise.
Nikul Patel, the Chief Lending Officer of LendingTree.
Jesse Clem, the Co-Founder of LOQUIDITY, LLC.
Joy Schoffler, the CEO of Leverage PR.
Whether you’re new to Crowdfunding or an industry veteran, I’d strongly suggest you attend. I’m always amazed how much more there is to learn.
To register, click here. Make sure to use my promo code and receive a 25% discount! Promo code: Roderick
And while you’re there, please stop by and say hello. Crowdfunding and skiing – those are my two favorite topics.
On Kickstarter, everyone know you need a good video to attract funding. Why don’t we see more videos in the equity Crowdfunding world?
Take a look at some Kickstarter videos. They’re great! They convey a message. They convey enthusiasm. They convey a will to succeed. They describe the project in the developer’s – sorry, the sponsor’s – voice. They ask for money persuasively.
All of that is relevant to equity Crowdfunding. I think the only reason we don’t see it (yet) is because that’s just not the way we’ve been doing things in finance for the last 30 years. We have a thick Private Placement Memorandum that creates friction in the transaction, but we don’t have a video.
For at least some of its deals, RealtyMogul now has a short introductory video featuring an attractive young representative from Wealth Forge. A good start!
Whenever I speak about Crowdfunding, I suggest that the hard-won lessons of the donation-based world should not be lost on equity-based world. If there’s one lesson from Kickstarter, it’s that videos matter.
NOTE: Any marketing folks see an opportunity here?
