Category: Reg CF

Illustration representing the structure of Regulation Crowdfunding and the difference between using a custodian and a crowdfunding vehicle

Don’t Use Custodians In Crowdfunding

On By crowdfundattnyIn Crowdfunding Custodian, Crowdfunding Vehicles, Reg CF5 Comments
Visual representation of Reg CF structure and custodian risk

There is no compelling reason to use a custodian in Reg CF and a very good reason not to. But some funding portals, like StartEngine, keep doing it. Why?

On its website, StartEngine explains that custodians are used for:

  • Safekeeping of Assets:  Custodians are responsible for holding and protecting securities and other assets. 
  • Settlement of Transactions:  Custodians facilitate the settlement of securities transactions, ensuring that trades are executed correctly and that the ownership of securities is accurately transferred.
  • Income Collection:  Custodians collect income generated by the securities, such as interest and dividends, and ensure that these funds are credited to the correct accounts.
  • Corporate Actions:  Custodians manage corporate actions, ensuring that all changes are accurately recorded and reflected in the investor’s accounts.
  • Reporting and Compliance:  Custodians provide detailed reports on the assets they hold and manage, ensuring transparency and compliance with regulatory requirements. They play a vital role in providing accurate and timely information to both issuers and investors.

For a publicly traded company, those things are true. But for a Reg CF offering, none of them matters very much.

In any case, they can all be handled more effectively by using a crowdfunding vehicle. NewCo, Inc. is raising money using Reg CF. NewCo forms and serves as the manager of NewCo CF LLC. NewCo CF LLC is one entry on the cap table of NewCo, Inc. Investors buy stock in NewCo CF LLC rather than in NewCo, Inc.

Everything – distributions, reporting, etc. – works the same as if investors owned stock in NewCo, Inc. directly, with no custodian needed.

The crowdfunding vehicle is also a more effective solution for the thing that really does matter, protecting the issuer from section 12(g) of the Exchange Act.

As discussed here, section 12(g) provides that if a company has more than $10 million of assets and at least 500 non-accredited shareholders (or 2,000 total), it must file all the reports required of a public company. When a crowdfunding vehicle is used – NewCo CF LLC in the example above – only entity investors, not individuals, are counted toward those limits. Hence, a crowdfunding vehicle all but eliminates the risk of section 12(g).

A custodian might avoid section 12(g) as well, but not necessarily. On one hand, SEC Rule 12g5-1(a)(3) (17 CFR §240.12g5-1(a)(3)) provides that, in general, where stock owned by many investors is held by a custodian, only the custodian will be treated as a shareholder for purposes of the 500 and 2,000 shareholder limits.

On the other hand, Rule 12g5-1(b)(3) provides that where the issuer knows or has reason to know that the custodian was used “primarily” to avoid section 12(g), then the custodian is ignored.

In the world of public companies, nobody thinks custodians are used primarily to avoid section 12(g), inasmuch as public companies are already filing like public companies. But in the world of Reg CF, section 12(g) was a central challenge from the beginning. In fact, the SEC created crowdfunding vehicles to help the Reg CF industry avoid section 12(g). Given that background, there is no chance, in my opinion, that StartEngine chose to use custodians without thinking about section 12(g). That they listed the benefits of custodians without mentioning section 12(g) suggests they were also thinking about Rule 12g5-1(b)(3).

Without seeing the internal discussions and emails, nobody can know whether StartEngine is using custodians primarily to avoid section 12(g). At some point, however, a successful issuer that raised capital using Reg CF and a custodian is going to ask its lawyer, “Do we have to start reporting publicly?” And after listening to the lawyer hesitate and talk about Rule 12g5-1(b)(3), “Why didn’t we use a crowdfunding vehicle instead?”

That’s the question. Why use a custodian in Reg CF?

Questions? Let me know.

Markley S. Roderick
Lex Nova Law
10 East Stow Road, Suite 250, Marlton, NJ 08053
P: 856.382.8402 | E: mroderick@lexnovalaw.com

Who should use a crowdfunding vehicle and why

Who Should Use A Crowdfunding Vehicle And Why

On By crowdfundattnyIn Crowdfunding Vehicles, Entrepreneurs, Exchange Act, Reg CF, SEC4 Comments

Most of the time, the SEC writes rules to clarify technical legal issues. When the SEC allowed crowdfunding vehicles, on the other hand, it was in response to a psychological issue, not a legal issue.

Entrepreneurs tempted to raise capital using Reg CF, thereby bypassing VCs and other professional investors, were told by those same VCs and professional investors that Reg CF would “screw up your cap table.” Even though that wasn’t true, many entrepreneurs believed it was true. The SEC gave us crowdfunding vehicles to solve the psychological problem:  with a crowdfunding vehicle, you can put all your Reg CF investors in one entity with one entry on your cap table. 

In that way, using a crowdfunding vehicle for your Reg CF offering is like using a C corporation rather than an LLC. You the entrepreneur might know it’s unnecessary, but if your prospective investors think it’s necessary, then it’s necessary. As I often say only partly tongue-in-cheek, that’s why they call it capitalism.

In fact, there is one reason for using a crowdfunding vehicle beyond the psychological. That’s because of a quirk in section 12(g) of the Securities Exchange Act of 1934.

Section 12(g) of Exchange Act

Section 12(g) of the Exchange Act provides that any company with at least $10 million of assets and a class of equity securities held by at least 2,000 total investors or 500 non-accredited investors of record must provide all the reporting of a fully public company. You don’t want that burden for your startup.

The good news is that Reg CF investors aren’t counted toward the 2,000/500 limits, provided:

  1. The issuer uses a registered transfer agent to keep track of its securities; and 
  2. The issuer has no more than $25 million of assets. 

Most startups will never have $25 million of assets. Most startups will never have 500 non-accredited investors or 2,000 total investors. Some startups will issue debt securities rather than equity securities. But some startups could find themselves subject to full public reporting under section 12(g). 

For those startups, a crowdfunding vehicle makes sense. That because, through a quirk in the rules, if you use a crowdfunding vehicle then the only investors who count toward the 2,000/500 limits are entities, like LLCs and corporations. Individual investors aren’t counted at all, and the assets of the company don’t matter.

Thus, if you’re a startup that might otherwise trigger section 12(g), a crowdfunding vehicle makes sense.

Requirements for Crowdfunding Vehicles

A crowdfunding vehicle must:

  • Have no other business.
  • Not borrow money.
  • Issue only one class of securities.
  • Maintain a one-to-one relationship between the number, denomination, type, and rights of the issuer’s securities it owns and the number, denomination, type, and rights of the securities it issues.
  • Seek instructions from investors with regard to:
    • Voting the issuer’s securities (if they are voting securities).
    • Participating in tender or exchange offers of the issuer.
  • Provide to each investor the right to direct the crowdfunding vehicle to assert the same legal rights the investor would have if he or she had invested directly in the issuer.

Those are requirements, not suggestions. In a later post I’ll explain what they mean. Here, I’ll just point out that some high-volume portals violate some of the requirements routinely, in my always-humble opinion. 

******

NOTE:  Crowdfunding vehicles work only with Reg CF. If you raise money from 127 accredited investors using Rule 506(c), you can’t put them in a separate entity. But don’t worry, it doesn’t have to screw up your cap table. 

Questions? Let me know.

Markley S. Roderick
Lex Nova Law
10 East Stow Road, Suite 250, Marlton, NJ 08053
P: 856.382.8402 | E: mroderick@lexnovalaw.com

how to get rid of artificially low targets in reg cf

How To Get Rid Of Artificially Low Targets In Regulation Crowdfunding

On By crowdfundattnyIn Crowdfunding Portals, Reg CF, SEC, Securities Exchange CommissionLeave a comment

As I’ve explained several times to both readers, I believe artificially low minimums are a huge impediment to Reg CF. A company needs to raise $750,000, sets its target at $10,000, and raises $17,439.98. Poof, that money disappears. The company offsets some of its expenses and the funding portal claims a successful offering.

In my opinion, very few serious investors will participate in such an offering. And because it’s so common, I believe most serious investors just stay away from the industry.

I’ve never heard anyone defend artificially low minimums. What I have heard from both portal and issuers is they need artificially low minimums for financial reasons. The issuer comes to the portal with no money. Both the issuer and the portal plan to use the first dollars raised to market the offering. If we can raise $10,000 and invest in marketing, maybe we can raise $50,000 more. If we raise $50,000 more and invest in marketing, maybe we can raise the rest. 

As my friend Irwin Stein says, a well-planned, well-funded Reg CF offering should succeed. The challenge is that many issuers come to the table without a marketing plan or budget. The issuer and the funding portal bridge the gap by effectively asking early investors to take a lot more risk without telling them about it or compensating them for it. 

Long ago I learned it’s better to deal with reality. If the reality is that the issuer lacks a marketing plan or budget, then rather than hide the ball from early investors, let’s split the offering into two parts. Let’s have a first offering for $50,000 to pay for marketing, then a second offering for $750,000 (or whatever) with a real target, maybe $550,000. The company is saying, “Ideally we’d like $750,000 but we can still manage to execute a viable business plan with $550,000.” 

Investors in the first offering are taking far more risk than investors in the second and should be compensated accordingly. They might get two or three times the shares per $1.00 invested or might even get a different security altogether.

We might find that the company’s most ardent supporters – friends and family – will fund the first round. We would also find, I expect, that companies seeking to raise money for marketing will explain their marketing plans in detail and want to advertise high-quality marketing firms.

Far too often, well-intentioned people look to the SEC or Congress to improve Crowdfunding, only to see their hopes dashed. For example, many people look to the SEC or Congress to improve liquidity in Crowdfunding. Last Autumn I suggested a way that portals and issuers could ensure liquidity themselves. I have a client doing that right now. 

We can do the same with artificially low minimums. They’re bad for investors and bad for the industry. And we don’t need them.

Questions? Let me know.

Markley S. Roderick
Lex Nova Law
10 East Stow Road, Suite 250, Marlton, NJ 08053
P: 856.382.8402 | E: mroderick@lexnovalaw.com

shark tank for regulation crowdfunding

Shark Tank For Regulation Crowdfunding?

On By crowdfundattnyIn Reg CF, Regulation CF, Rule 2042 Comments

I’ve been asked by more than a handful of entrepreneurs about using Reg CF in a Shark Tank format. The founder appears in a TV studio with experienced investors, who pepper her with questions. If viewers like what they see, they scan a QR code at the bottom left, which takes them through the Reg CF investment process.

Non-accredited investors getting easy access to great startups, agnostic as to geography. Exactly what the JOBS Act wanted. 

I’ve had to tell each of those entrepreneurs No.

Each entrepreneur thought I was the bad guy, but the real bad guy is Rule 204, the Reg CF advertising rule. Rule 204 gives a company raising money two choices for advertising outside the funding portal. One, you can say anything you want as long as you don’t mention any of the six “terms of the offering.” Two, you can mention the terms of the offering but say almost nothing else, just the company’s name, address, phone number, and URL, and a brief description of the business (i.e., a “tombstone” ad).

The six deadly “terms of the offering” are:

  1. How much you’re trying to raise
  1. What kind of securities you’re selling (e.g., stock or SAFE)
  1. The price of the securities
  1. How you plan to use the money
  1. The closing date of your offering
  1. How much you’ve raised to date

Now imagine the founder answering questions in the studio. She can say anything she wants about the product, about herself, her team of advisors, the market, the social benefits of the company, all that stuff. Even with careful scripting, however, it’s unrealistic to think she can answer questions accurately and generate enthusiasm in the audience (which is the point) without mentioning any of those six items. Maybe a founder can do it here and there, but you wouldn’t bet your TV show on it.

The purpose of Rule 204 is to ensure that every Reg CF investor gets the same information as every other investor. The regulations want everything about the company and the offering to be in one place:  the funding portal. They don’t want someone who watches your TV show to know either more or less than someone who doesn’t.

Personally, I think Rule 204 is misguided. If there’s a risk that someone who watches your TV show will know either more or less than someone who doesn’t, you can (i) post a video of the TV show on the funding portal, and (ii) make sure TV viewers invest through the funding portal’s platform, where they can see everything. Eliminating Rule 204 would invigorate the Reg CF market without hurting investors.

Eliminate Rule 204 and stop issuers and portals from using artificially low minimums. That’s my platform for 2026.

In the meantime, I’m afraid a Shark Tank for Reg CF isn’t going to work.

Questions? Let me know.

Markley S. Roderick
Lex Nova Law
10 East Stow Road, Suite 250, Marlton, NJ 08053
P: 856.382.8402 | E: mroderick@lexnovalaw.com


title III crowdfunding outline for portals and issuers

The Crowdfunding Bad Actors Rule: Applying For A Waiver

On By crowdfundattnyIn Applying For A Waiver, Bad Actors Rule, Reg CF, Regulation A, Regulation CFLeave a comment

Reg CF, Rule 506(c), and Regulation A all include what have come to be known as “bad actor” rules, codified in 17 CFR §227.503, 17 CFR §230.506(d), and 17 CFR §230.262. In each case, the rule provides that the company can’t use the exemption in question to raise capital if the company itself or certain people affiliated with the company (directors, officers, etc.) have violated certain securities-related laws.

(The bad actor rules don’t apply to investors!)

In each case, the rule allows a company to apply for a waiver. The waiver provisions are codified in 17 CFR §227.503(b)(2), 17 CFR §230.506(d)(2)(ii), and 17 CFR §230.262(b)(2). Each provides for waiver “Upon a showing of good cause and without prejudice to any other action by the Commission, if the Commission determines that it is not necessary under the circumstances that an exemption be denied.”

The SEC Has Complete Discretion

The SEC has identified some factors it will consider but, in truth, whether it is “necessary under the circumstances that an exemption be denied” is highly ambiguous and therefore highly subjective. As a result, the SEC has enormous discretion whether to grant waivers. Faced with two waiver requests with similar facts, the SEC might reach different conclusions. 

What Factors Matter

With that said, the SEC has identified the following factors, for now:

  • Did the Violation Involve the Sale of Securities?  An individual can become a bad actor without violating securities laws – for example, if a state regulator prohibits her from being associated with savings and loan associations. The SEC might be more inclined to give her a waiver, as compared to a person found guilty of having violated federal securities laws.
  • Did the Violation Involve Bad Intent?  Some violations involve bad intent (in legalese, “scienter”), like the intentional failure to disclose important information to investors. The SEC is less likely to grant waivers in those cases than where the violation was technical and unintentional, like the inadvertent failure to file a report.
  • Who Was Responsible for the Misconduct?  Suppose that while Mr. X was its Managing Partner, Company Y engaged in conduct causing it to become a bad actor, and that Mr. X was responsible. Two years later, Mr. X is no longer with Company Y. The SEC is more likely grant Company Y a waiver than if Mr. X were still at the helm. 
  • Is the Culture of the Company Good or Bad?  Underlining that waiver requests are highly subjective, the SEC believes that, where the bad actor is an entity rather than individual, it should take into account the culture, or “tone at the top,” of the entity. If the C-suite executives are trying to comply, the SEC would be more likely to grant a waiver than if they have obstructed the SEC’s investigations.
  • How Long did the Misconduct Last?  If the misconduct was brief, even an isolated event, the SEC would be more inclined to rule favorably than if it occurred over an extended period.
  • What Remedial Steps Have Been Taken?  The SEC will consider “what remedial measures the party seeking the waiver has taken to address the misconduct, when those remedial measures began, and whether those measures are likely to prevent a recurrence of the misconduct and mitigate the possibility of future violations.” Remedial steps could include (i) improving internal training, (ii) adopting or revising policies and procedures, (iii) improving internal controls, (iv) terminating employees responsible for the misconduct, and (v) completing educational courses. I believe the most effective remedial action, from the SEC’s perspective, would be to hire an outside compliance consultant, take her recommendations seriously, and implement as many as possible. 
  • Will Bad Things Happen if the Waiver is Denied?  The SEC will consider who will be hurt if the waiver is denied, and how badly. For example, suppose Company XYZ has already raised $50 million from 2,700 investors for a real estate development, using Regulation A. It needs to raise $5 million more using Rule 506(b) but has been designated a bad actor. If it is unable to raise the additional capital all the existing investors will lose their money. The SEC would take the potential harm to existing investors into account, along with other factors.

The SEC has also stated that it might develop a longer and more objective list in the future, based on its experience with actual waiver requests.

Waivers Are Not Black and White

The SEC can say No. It can also say Yes, but with conditions. For example, it might require additional disclosure. It might require additional notices to investors. It might limit the scope or term of the offering(s) for which a waiver is requested. In one instance, the SEC granted the waiver provided that (i) the applicant would retain an independent consultant and submit a written report, (ii) the applicant would implement all the consultant’s recommendations or obtain the SEC’s consent to alternatives, and (iii) the initial waiver would last for only 30 months, with the opportunity to request an extension.

You Might Not Need a Waiver

The bad actor rules apply to offerings under Rule 506, Regulation A, and Reg CF (they also apply to offerings under Rule 505, but that’s not Crowdfunding). Rule 506, Regulation A, and Reg CF are exemptions to the general rule, set forth in section 5 of the Securities Act of 1933, that every time you raise money from investors you have to conduct a full-blown IPO. 

But they are not the only exemptions. Section 4(a)(2) of the Securities Act still provides an exemption for “transactions by an issuer not involving any public offering.” In the early days of our securities laws, the ambiguity of the italicized language led to an enormous amount of litigation, which in turn led the SEC to create some of the exemptions, or “safe harbors,” used regularly today.

But the language is still there and, despite the ambiguity, there is no doubt that exempt offerings can be conducted without relying on Rule 506, Regulation A, or Reg CF. Consider Company XYZ above, which needs $5 million to complete its real estate development. If Company XYZ knows (has an existing relationship with) five wealthy investors each willing to write a $1 million check, it can forego the waiver request.

How to Apply 

Written requests for waivers should explain in detail (i) how the person came to be treated as a bad actor, (ii) her background in the securities industry and otherwise, and (iii) the nature of the offering(s) for which the waiver is sought. Is it a single real estate syndication under Rule 506? A large fund raising capital using Regulation A? A private equity fund raising capital from only qualified purchasers, i.e., people with more than $5 million of investable assets?

Most importantly, the request should explain why disqualification is not necessary. A request that amounts to “He’s a really great person and promises to do better this time” will be denied. A request should correlate with the factors identified by the SEC and identify any other objective factors showing that what happened in the past has little or no bearing on the new offerings. 

Waiver requests should be sent to:

Sebastian Gomez Abero, Chief
Office of Small Business Policy
Division of Corporation Finance
U.S. Securities and Exchange Commission
100 F Street, N.E.
Washington, DC 20549-3628

Confidentiality

Requests for waivers become public documents, just like requests for no-action letters. If you want parts of your waiver request to be treated as confidential, you can ask for confidential treatment separately. Be prepared for the SEC to say No, whereupon you will decide whether to withdraw the request.

Questions? Let me know.

Crowdfunding Legal Links

Supreme Court Curbs SEC Enforcement Actions, And That’s Not All

On By crowdfundattnyIn Reg CF, SEC1 Comment

Last week, in a 6-3 opinion, the U.S. Supreme Court held that the SEC must use the regular federal court system, not its internal administrative proceedings, in an antifraud suit against an investment adviser seeking civil damages. The Court ruled that litigating the case through the SEC’s internal proceedings violated the defendants right to a jury trial under the Seventh Amendment of the U.S. Constitution.

The case throws into question all pending SEC administrative proceedings. Like most Supreme Court decisions, the opinion in SEC v. Jarkesy leaves important questions open. What about proceedings that do not involve fraud? What about proceedings where the SEC is not seeking civil penalties? 

SEC v. Jarkesy must be read in conjunction with two other Supreme Court decisions issued last week, Ohio v. EPA and Loper Bright Enterprises v. Raimondo. In the former, the Court held that the EPA had overstepped its bounds in interpreting the Clean Air Act. In the later, the Court overturned a 40-year precedent, the “Chevron Doctrine.” This doctrine, established by the Supreme Court in Chevron U.S.A. v. Natural Resources Defense Council in 1977, held that except in unusual cases, courts should defer to the judgment of administrative agencies in interpreting the laws with the jurisdiction of the agencies.

Many have welcomed the trio of decisions, believing they will free individuals and businesses from the biases of the “administrative state.” I am more skeptical.

Take an example close to my heart. As enacted by Congress, the exemption under section 4(a)(6) of the Securities Act of 1933, aka Reg CF, imposed a limit of $1,000,000, which proved completely inadequate. A couple years ago the SEC increased the limit to $5,000,000. Under Loper Bright Enterprises v. Raimondo, I’m not sure the SEC had the power to increase the limit. If someone challenges the limit, he or she might win.

You show me a regulation you don’t like, I’ll show you others you do like. You show me a decision by an SEC administrative law judge you don’t like, I’ll show you a decision by a federal judge, or by the Supreme Court itself, that you hate. Mr. Jarkesy, the investment adviser accused of fraud, might be happy that the administrative proceedings against him are stopped. Will he be better off in federal court?

As I see it, these cases are about a transfer of power away from the Executive branch to the Supreme Court. Chief Justice John Roberts said as much: “Chevron’s presumption is misguided because agencies have no special competence in resolving statutory ambiguities. Courts do.” 

The Chevron Doctrine was born when the Supreme Court realized in 1977 that courts were not equipped to handle the complexities of modern life and would therefore defer to experts. Since then, modern life has become far more complex. All the same decisions will have to be made. Personally, I see no reason to think the Supreme Court will reach better decisions for the environment or for Reg CF than bureaucrats with subject matter expertise will reach. With bureaucrats we hold an election every four years. With the federal court system, never.

One thing I know for sure, the changes will be great for lawyers. Lawyers benefit from change, and in legal terms the changes the Supreme Court made last week are monumental. The federal courts are about to be flooded with claims from every point on the ideological spectrum. There aren’t nearly enough federal judges to handle all the claims the Supreme Court has just invited, but there are plenty of lawyers!

Questions? Let me know.

How to Write A Biography For A Crowdfunding Disclosure Document

How To Draft A Form C For Regulation Crowdfunding

On By crowdfundattnyIn Crowdfunding Vehicles, Form C, Reg CF, SPVLeave a comment

Form C is the disclosure document used in Reg CF. Because I see so many Form Cs that aren’t done properly, I thought it would be worthwhile to explain how a Form C should be drafted and why too many lawyers go astray.

Rule 201 (17 CFR §227.201) tells us exactly what should be disclosed in a Form C:

  • Rule 201(a) calls for the name, legal status, physical address, and website of the issuer.
  • Rule 201(b) calls for the names and business experience of officers and directors. 
  • Rule 201(c) calls for the name of each person owning 20% or more of the voting stock.
  • All the way through Rule 201(z), which calls for copies of testing the waters materials.

Rule 201 is exhaustive, i.e., there is no disclosure requirement in Reg CF outside Rule 201, other than a short financial summary. 

If you had never prepared a disclosure document, how would you provide the disclosures required by Rule 201? Chances are, you would simply go down the list, from Rule 201(a) to Rule 201(z), and provide answers to all the questions. And that is exactly the right way to do it.

Look at this Form C, for a company called ScienceCast, Inc. Look at the Table of Contents, how it just goes through Rule 201, item-by-item. Look at the body, where each item is labeled with the corresponding rule. Look how the Form C describes the role of the crowdfunding vehicle, or SPV. If you had never prepared a disclosure document and were trying to do things right, I bet this is how you would do it.

Yet look at most of the Form Cs that are filed with the SEC. They don’t follow this format at all or follow it only loosely. In the worst case, of which there are many examples, you can’t even tell it’s a Form C. It looks like a typical Private Placement Memorandum you would see in a Regulation D offering.

And that explains why too many lawyers go off track. A lawyer who has prepared hundreds of Private Placement Memoranda thinks “A Form C is just another type of disclosure document. I’ll start with the form I’m already familiar with rather than create something new from scratch.”

Legal forms can be very useful, but they can also become like an old ship encrusted with barnacles. Over time, lawyers tend to add things to form documents as new cases are decided or new concepts come to mind, but rarely is any of the old stuff scraped away, much less the whole document re-thought.

Using the fresh-out-of-the-box Form C rather than the encrusted Private Placement Memorandum has many benefits:

  • It’s far easier to make sure all the disclosures are there.
  • It’s far easier to check for accuracy.
  • It’s far easier to create an easy-to-understand template.
  • It’s far more efficient, cutting costs.
  • It’s far easier for a lawyer to prepare or review, cutting costs.
  • It’s far easier for the funding portal to explain to the issuer.
  • It avoids all the duplication you see in a typical PPM.
  • It avoids all the state notices and other unnecessary legal boilerplate you see in a typical PPM.
  • It’s far easier for an investor to compare one offering to another.
  • It’s far easier for an investor to read and understand.
  • It uses less energy, reducing the impact of Reg CF on the fragile coral reefs surrounding Australia.

For Reg CF to grow, the industry must standardize. I hope it can at least standardize around a Form C.

Questions? Let me know.

blind pool offerings in crowdfunding

Does Reg CF Allow Blind Pool Offerings?

On By crowdfundattnyIn Reg CF, Regulation CF4 Comments

It’s a trick question.

It’s a trick question because the term “blind pool offering” doesn’t appear in Reg CF. If you try to figure out whether Reg CF allows “blind pool offerings” you’ll drive yourself crazy and/or reach the wrong answer. 

To illustrate the point, suppose NewCo was formed to buy Class B multi-family projects in the southeastern United States but has not yet identified any such properties. If you focus on the term “blind pool offering” you might decide that NewCo can’t use Reg CF. But if you read Reg CF instead, you’ll reach the opposite – and correct – conclusion. 

To see whether NewCo is eligible for Reg CF, we look at the eligibility rules in 17 CFR §227.100(b). NewCo is a Delaware entity, so we’re good under section 100(b)(1). NewCo isn’t subject to the reporting requirements of the Exchange Act, so we’re good under section 100(b)(2). And we keep going through the list until we get to section 100(b)(6), which provides that Reg CF may not be used if the issuer:

Has no specific business plan or has indicated that its business plan is to engage in a merger or acquisition with an unidentified company or companies.

Does that describe NewCo? Well, no. NewCo does have a specific business plan and it’s not about merging with anyone. 

Thus, having gone through the whole list of section 100(b), we conclude that NewCo is eligible to use Reg CF, 100%.

I’ll add two epilogues.

First, Regulation A uses exactly the same language as Reg CF, in 17 CFR §230.251(b)(3). And even a cursory review of the Regulation A offerings reviewed and qualified by the SEC reveals many, many companies like NewCo.

Second, Industry Guide 5, issued by the SEC to provide disclosure guidelines for real estate offerings, specifically contemplates issuers like NewCo. Item 20D provides for certain disclosures in offerings where “a material portion of the maximum net proceeds (allowing for reasonable reserves) is not committed (i.e., subject to a binding purchase agreement) to specific properties. . . .” 

During my first year of law school in 1838, a partnership tax guru named Bill McKee insisted that we read the statute first. It has turned out to be excellent advice.

Questions? Let me know.

financial statements in crowdfunding

Whose Financial Statements?

On By crowdfundattnyIn Filing Financial Statements & Other Reports, Reg CF4 Comments

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.

title III crowdfunding outline for portals and issuers

The Crowdfunding Bad Actor Rules Don’t Apply To Investors

On By crowdfundattnyIn 100 Investor Rule, Accredited Investor, Investor, Investor Disclosures, Reg CF, Regulation A, Rule 506, Title III, Title III Crowdfunding1 Comment

I often see Subscription Agreements asking the investor to promise she’s not a “bad actor.” This is unnecessary. The term “bad actor” comes from three sets of nearly indistinguishable rules:

  • 17 CFR §230.506(d), which applies to Rule 506 offerings;
  • 17 CFR §230.262, which applies to Regulation A offerings; and
  • 17 CFR §227.503, which applies to Reg CF offerings.

In each case, the regulation provides that the issuer can’t use the exemption in question (Rule 506, Regulation A, or Reg CF) if the issuer or certain people affiliated with the issuer have violated certain laws.

Before going further, I note that these aren’t just any laws – they are laws about financial wrongdoing, mostly in the area of securities. Kidnappers are welcome to use Rule 506, for example, while ax murderers may find Regulation A especially useful even while still in prison.

Anyway.

Reg CF’s Rule 503 lists everyone whose bad acts we care about:

  • The issuer;
  • Any predecessor of the issuer;
  • Any affiliated issuer;
  • Any director, officer, general partner or managing member of the issuer;
  • Any beneficial owner of 20 percent or more of the issuer’s outstanding voting equity securities, calculated on the basis of voting power;
  • Any promoter connected with the issuer in any capacity at the time of filing, any offer after filing, or such sale;
  • Any person that has been or will be paid (directly or indirectly) remuneration for solicitation of purchasers in connection with such sale of securities; and
  • Any general partner, director, officer or managing member of any such solicitor.

Nowhere on that list do you see “investor.” The closest we come is “Any beneficial owner of 20 percent or more of the issuer’s outstanding voting equity securities,” but even there the calculation is based on voting power. In a Crowdfunding offering you wouldn’t give an investor 20% of the voting power, for reasons having nothing to do with the bad actor rules. 

So it just doesn’t matter. This is one more thing we can pull out of Subscription Agreements. 

I know some people will say “But we want to know anyway.” To me this is unconvincing. If you don’t ask about kidnapping you don’t need to ask about securities violations.

Questions? Let me know.