Can an LLC Serve as a Crowdfunding Vehicle for a Corporation?

Crowdfunding doesn’t screw up the issuer’s cap table. Nevertheless, because many issuers and investors think it does, the SEC adopted 17 CFR §270.3a-9 earlier this year, providing that a Reg CF issuer may use a “crowdfunding vehicle” to issue securities to investors, thereby adding only one entry to its own cap table.

The use of SPVs to own securities is common in the Title II (Rule 506(c)) world and in the world of securities generally. We form a separate entity, typically a limited liability company, to own securities of the “main” company. Indeed, a variation of the SPV structure is required in securitized real estate financing.

But that’s not what the SEC has in mind with crowdfunding vehicles in Title III. The SEC has in mind an entity that is a mirror image, you might say an alter-ego, of the issuer. For example, the crowdfunding vehicle:

  • Can have no purpose other than owning securities of the issuer;
  • Must have the same fiscal year end as the issuer;
  • May not borrow money;
  • Must be reimbursed for all its expenses only by the issuer; and
  • Must “Maintain a one-to-one relationship between the number, denomination, type and rights of crowdfunding issuer securities it owns and the number, denomination, type and rights of its securities outstanding.”

What does that last requirement mean? To me, it sounds as if the “rights” associates with the issuer’s securities must be the same as the “rights” associated with the crowdfunding vehicle’s securities.

The “rights” associated with securities are defined in part by contract, which we can control, but in part by state law. Corporate laws vary widely from state to state and even within a state the laws of corporations are often very different than the laws of limited liability companies. This is intentional:  limited liability company statutes were written to be different than the corresponding corporate statutes. For example, LLC statutes typically give members of an LLC far greater freedom of contract while corporate laws, for historical reasons, take a more paternalistic view.

When the regulations were proposed, CrowdCheck (Sara Hanks) submitted the comment pointing out that because of the differences in laws among types of entities and states, it would be difficult or impossible for the rights associated with owning an issuer to be identical to the rights associated with owning a crowdfunding vehicle. When the final regulations were issued, the SEC had not changed the language of the regulation and responded to comment as follows:

As one commenter pointed out, because investors are investing in the crowdfunding vehicle, and not directly in the crowdfunding issuer, there may be slight differences in the rights in the crowdfunding vehicle that investors receive. However, we do not believe these slight differences in rights should in any way affect the ability of the crowdfunding vehicle to issue securities with rights that are materially indistinguishable from the rights a direct investor in the crowdfunding issuer would have [bold added].”

The differences in rights described in the CrowdCheck’s comments were not “slight.” To the contrary, the differences in rights between, say, a New Jersey corporation and a Delaware limited liability company would be “material” in any other area of the securities laws. Having filed a registration statement that identified the wrong type of entity and the wrong state, I can imagine a lawyer arguing to the SEC staff “Who cares? Those are only slight differences!”

How should we interpret the SEC’s response? Why didn’t the SEC just change the language of the regulation, rather than pretend the differences in state laws aren’t “material”? Can issuers and funding portals do whatever they want?

There are two issues:

  • The first issue is just cost. Issuers and portals want to automate SPVs, using the same type of entity, the same state, and the same contracts for all of them.
  • The second issue is taxes. If the issuer is a corporation and the crowdfunding vehicle is also a corporation, then dividends paid by the issuer to the crowdfunding vehicle will be subject, in part, to double tax.

The question is more than academic. When investors lose money they’re unhappy and often look for someone to blame. If a Mississippi corporation uses a Delaware limited liability company as a crowdfunding vehicle and an investor loses money, a clever plaintiff’s lawyer (no jokes here) won’t find it hard to argue that the Delaware LLC failed to qualify under 17 CFR §270.3a-9 and that the offering was therefore illegal, giving his client the right to get her money back from the issuer and its principals and possibly from the funding portal and its principals as well.

As readers know, I think the SEC has done a terrific job with Crowdfunding, going out of its way to support the industry time after time. For that matter, the SEC introduced crowdfunding vehicles only because of the mistaken impression that Crowdfunding “screws up your cap table.” As crowdfunding vehicles become more widely-used, however, I think more straightforward guidance is required, if only to dissuade clever plaintiffs’ lawyers. For example, the SEC could say explicitly “Differences in rights arising solely from state laws governing corporations, limited liability companies, limited partnership and other legal entities will not be taken into account for these purposes.”

Until that happens, I would be cautious and bear in mind that issuers don’t really need a crowdfunding vehicle in the first place.

set of medical protective face masks

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 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 Wealthy Wellthy Podcast: What You Don’t Know About Crowdfunding

The Wealthy Wellthy Podcast: What You Don’t Know About Crowdfunding

2019-06-20_10-54-52

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Our guest on this episode of The Wealthy Wellthy Podcast is Mark Roderick, an attorney who devotes most of his time to crowdfunding. Maybe you are like me in thinking that crowdfunding is pretty straightforward and self-explanatory. I mean, if your friend is looking to start a business and you want to support them, you can donate or invest through their crowdfunding page online and that’s that, right?

Every entrepreneur faces the stage in their business where they need to acquire capital, either from acquaintances, networking, angel investors, venture capitalists, or strategic partners. This process is messy and confusing, filled with regulations and stipulations that may make acquiring the capital more trouble than it is worth. This was partially due to the antiquated laws that were created in the aftermath of The Great Depression and were stifling in the modern economic climate. However, in 2012, the Jobs Act made it legal for entrepreneurs to advertise to raise capital. This opened up a whole new world for small business owners and others who were desperate to be able to connect more easily with potential investors as well as investors who were eager to find new opportunities.

During the interview, Mark distinguishes between the 3 kinds of crowdfunding: (1) to accredited investors only, (2) Regulation A to accredited or non accredited investors, and (3) Title 3 – which is the most common. He also talks about the factors that are most important from a legal perspective when you are determining which crowdfunding site to use to raise capital or to invest capital. It was also interesting to hear Mark spell out the 3 reasons why people invest through crowdfunding: (1) they want to support the company, (2) to do social good, and (3) to make money.

Mark even gave me some advice about a real estate deal I am considering and revealed that 90-95% of the capital exchanged through crowdfunding is for real estate transactions. Finally, he busted a couple of myths regarding the amount of risk involved in crowdfunding and whether money raised from others is subject to securities laws.

What We Covered

  • [2:16] – Who is Mark Roderick?
  • [3:28] – Mark describes the fragmented traditional ways of raising capital.
  • [8:58] – Angel investors and how to present your “deck” to them.
  • [11:08] – Working with venture capitalists and strategic partners.
  • [13:31] – A brief history of the laws affecting capital.
  • [22:34] – What does crowdfunding look like for startup entrepreneurs?
  • [27:20] – How to find a regulated site to post your capital request on.
  • [30:58] – Crowdfunding is the intersection of old and new school.
  • [34:57] – Advice to keep in mind when you are using a crowdfunding site.
  • [38:06] – Mark tells us 3 of the crowdfunding sites he works with.
  • [40:08] – When should an entrepreneur hire an attorney during this process?
  • [42:40]– The prevalence of real estate in the crowdfunding world.
  • [53:24] – What message does Mark want to get out there?
  • [56:17] – Mark busts 2 myths about crowdfunding.

Questions? Let me know.

The Per-Investor Limits of Title III Require Concurrent Offerings

Since the JOBS Act was signed by President Obama in 2012, advocates have been urging Congress to increase the overall limit of $1 million (now $1.07 million, after adjustment for inflation) to $5 million. But for many issuers, the overall limit is less important than the per-investor limits.

The maximum an investor can invest in all Title III offerings during any period of 12 months is:

  • If the investor’s annual income or net worth is less than $107,000, she may invest the greater of:
    • $2,200; or
    • 5% of the lesser of her annual income or net worth.
  • If the investor’s annual income and net worth are both at least $107,000, she can invest the lesser of:
    • $107,000; or
    • 10% of the lesser of her annual income or net worth.

These limits apply to everyone, including “accredited investors.” They’re adjusted periodically by the SEC based on inflation.

These limits make Title III much less attractive than it should be relative to Title II. Consider the typical small issuer, NewCo, LLC, deciding whether to use Title II or Title III to raise $1 million or less. On one hand, the CEO of NewCo might like the idea of raising money from non-accredited investors, whether because investors might also become customers (e.g., a restaurant or brewery), because the CEO is ideologically committed to making a good investment available to ordinary people, or otherwise. Yet by using Title III, NewCo is hurting its chances of raising capital.

Suppose a typical accredited investor has income of $300,000 and a net worth of $750,000. During any 12-month period she can invest only $30,000 in all Title III offerings. How much of that will she invest in NewCo? Half? A third? A quarter? In a Title II offering she could invest any amount.

Because of the per-investor limits, a Title III issuer has to attract a lot more investors than a Title II issuer. That drives up investor-acquisition costs and makes Title III more expensive than Title II, even before you get to the disclosures.

The solution, of course, is that Congress should make the Title III rule the same as the Tier 2 rule in Regulation A:  namely, that non-accredited investors are limited, but accredited investors are not. I can’t see any policy argument against that rule.

In the meantime, almost every Title III issuer should conduct a concurrent Title II offering, and every Title III funding portal should build concurrent offerings into its functionality.

Questions? Let me know.

Using Title III Disclosures In Title II Crowdfunding

Title III requires all these disclosures, reported on the new Form C:

  • The name, legal status, physical address, and website of the issuer
  • The names of the directors and officers of the issuer and their employment history over the last three years
  • The name of each person owning 20% or more of the issuer’s stock
  • The issuer’s business and business plans
  • The number of employees of the issuer
  • A statement of risks
  • How much money the issuer is trying to raise
  • How the money will be used
  • The price of the shares or the method for determining the price
  • The capital structure of the issuer, including the rights of all security-holders, restrictions on transfer, and how the securities are being valued
  • A description of the portal’s financial interests
  • A description of the issuer’s liabilities
  • A description of other offerings conducted within the past three years
  • A description of “insider” transactions
  • A discussion of the issuer’s financial conditionimpossible possible
  • Financial statements or their equivalent
  • Any other information necessary in order to make the statements made not misleading

As I write this, a lot of very smart entrepreneurs and software engineers are working to automate these disclosures. They have to:  to make money running a Title III portals, you’re going to have to automate everything that can be automated.

Now look at Title II. As a write this, the disclosures for almost all Title II deals are prepared the old-fashioned way, with a lawyer writing an old-fashioned Private Placement Memorandum. The PPM for Deal 1 on Portal X might or might not include the same information as the PPM for Deal 2 on Portal X, and almost certainly doesn’t include the same information or look the same as the PPM for deals on Portal Y. An investor trying to compare apples to apples would go, well, bananas.

That situation is ripe (sorry) for change and I think it will change as Title III comes online, for three reasons:

  1. As someone argued recently, investors couldn’t care less about the distinction between Title II and Title III. They are going to want to see the same information in the same format.
  2. Using the tools developed for Title III, Title II portals will be able to provide more information than they are currently providing, cheaper and more effectively.
  3. There is no law that dictates what information must be provided in a Title II offering. But we still think about 17 CFR §240.10b-5, which makes it unlawful 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. . . .not misleading. . . .” As the industry develops, it seems at least possible, if not likely, that the disclosures required by Title III could be viewed as the standard for avoiding Rule 10b-5 liability.

Questions? Let me know.

How To Operate A Title II Portal And A Title III Portal On The Same Platform

crainsMost Title II and Title IV portals will also want to operate Title III portals, and vice versa. Can they do it?

The Title III regulations issued by the SEC appear to contemplate that a Title III portal – a “funding portal” – will do more than operate a Title III portal. For example, 17 CFR §227.401 provides that “A funding portal. . . .is exempt from the broker registration requirements of section 15(a)(1) of the Exchange Act in connection with its activities as a funding portal.” If a Title III portal couldn’t do anything else, that extra language at the end wouldn’t be necessary.

The same is true for of the regulations issued by FINRA. FINRA prohibits Funding Portals from making false or exaggerated claims, implying that past performance will recur, claiming that FINRA itself has blessed an offering, or engaging in other misconduct, but a well-behaved Title II or Title IV portal would have no trouble meeting those standards.

What about the platform itself? The Title III regulations (17 CFR §227.300(c)(4)) define “platform” as:

A program or application accessible via the Internet or other similar electronic communication medium through which a registered broker or a registered funding portal acts as an intermediary in a transaction involving the offer or sale of securities in reliance on section 4(a)(6) of the Securities Act.

Nothing there would prohibit Title II, Title III, and title IV securities from appearing on the same website.

The fly in the ointment is 17 CFR §227.300(c)(2)(ii), which provides that a Title III portal may not:

  • Offer investment advice or recommendations; OR
  • Solicit purchases, sales or offers to buy the securities displayed on its platform.

What does that mean, in the context of a portal offering both Title II and Title III securities? What it should mean is that a Title III portal cannot offer investment advice or recommendations concerning Title III securities, and cannot solicit purchases, sales, or offers of Title III securities. The idea of Title III is to protect Title III investors. Why should the SEC care whether the portal is offering investment advice concerning Title II or Title IV securities?

But we can’t be 100% sure that’s what it means. If it means that a Title III portal can’t offer investment advice about any securities and can’t solicit offers to buy any securities, then we need to steer clear.

I’ve spoken informally with the SEC and they’re not sure how to interpret 17 CFR §227.300(c)(2)(ii). They suggested I submit a request for a no-action ruling and I guess I will, unless one of my Crowdfunding colleagues already has.

Pending that guidance, there are several ways to operate a Title II portal, a Title III portal, and a Title IV portal on the same platform:

  • Operate the portals through a single legal entity. Avoid giving investment advice to anybody or soliciting purchases, sales, or offers of any securities.
  • Operate the portals through one legal entity. If you want to offer investment advice and/or actively solicit, do it through or more additional legal entities. For now, limit the investment advice and active solicitation to Title II and Title IV securities.
  • Create a separate legal entity to hold the Title III license. Create an arm’s length license agreement between that entity and the entity that owns the platform (a simple downloadable form is here). List all the deals on the same platform, but make sure that when an investor clicks on a Title III deal the Title III portal handles the investment process.

Finally, FINRA is a wonderful organization, but I’m not necessarily eager to have FINRA looking at everything my clients do. All other things being equal, I might choose option #3 just to keep a degree of separation between the regulated entity and my non-regulated activities. But that’s not necessarily the end of it – FINRA will want to explore the relationship between the funding portal and its affiliates.

Questions? Let me know.

Why Title II Portals Will Also Become Title III Portals, And Vice-Versa

CF Portal Mall

Why has Home Depot made local hardware stores a thing of the past? Partly price, but mainly selection. And I think the same forces will require most Crowdfunding portals to offer investments under Title II, Title III, and Title IV, all at the same time.

Crowdfunding portals are like retail stores that sell securities. They have suppliers, which we call “sponsors” or “portfolio companies,” and they have customers, which we call “investors.” They pick the market they want to serve – hard money loans, for example – then try to stock their shelves with products from the best suppliers to attract the largest number of customers. Think of DSW, but selling securities rather than shoes.

Now consider these situations:

  • You’re a Title II portal and have established a relationship with Sandra Smith, a real estate developer you’ve learned to trust. She informs you she’d like to raise $30 million to build a shopping center in Chicago and needs to attract investors from the local community. You could tell her you only do Title II and send her across the street, but maybe she’ll find a competitor where she can get Title II and Title IV under one roof. So you’d really like to offering Title IV as well, which means attracting non-accredited investors.
  • You’re a Title II portal raising money for biotech. A company approaches you with a new therapy for cystic fibrosis. They have 117,000 Facebook followers and wide support in the cystic fibrosis community, and have already raised $30,000 in a Kickstarter campaign. They want to raise $800,000 for clinical tests, then come back and raise $5 million if the tests are successful. Sure, you could tell them to go somewhere else for the $800,000 raise and come back for the larger (and more profitable) $5 million round, but once they leave they’re probably not coming back.
  • You’re a Title III portal with lots of investors signed up. Turned away by the portal she’s used to working with, Sandra Smith asks for your help in the $30 million Title IV raise. Any reason to turn her down?

Those of us in the industry see Title II, Title III, and Title IV as separate things, but to the suppliers and customers of the industry they’re all the same thing. The differences between Title II and Title IV are nothing compared to the differences between sneakers and 6-inch heels! Yet DSW sells them both and everything in between because in the eyes of customers, they’re all shoes.

It doesn’t matter to suppliers and customers that Title II and Title III require different technology and business models. It doesn’t matter that one is more profitable than the other. Mercedes might lose money selling its lower-end cars but doesn’t mind doing so because customers who buy the lower-end Mercedes today buy the higher-end Mercedes 10 years from now. The Vanguard Group probably loses money on some of its funds but sells them anyway to keep customers in the fold. As the Crowdfunding market develops, I think the same will be true of the interplay with Title II, Title III, and Title IV.

For portals that have achieved success in Title II, it might be unwelcome news that Title II isn’t enough. But on the positive side, Fundrise has managed to leverage its reputation in Title II into a well-received REIT under Title IV. In any case, I think it’s inevitable.

Questions? Let me know.

How to Present Investor Disclosures in Crowdfunding Offerings (And How Not To)

Title II Crowdfunding is often referred to, more or less accurately, as “online private placements.” It’s time the industry turned the online, digital, aspect of the offerings more to its advantage.

Remember when newspapers first came online? Remember how interesting they were visually? I’m being sarcastic. They were nothing more than photographs of the paper version, failing to take advantage of the digital platform and its unique capabilities.

Too many (not all) Crowdfunding portals take the same approach to providing investor disclosures. You click through the process and suddenly see an enormous PDF document that is nothing more or less than a paper private placement memorandum, complete with Schedules and Exhibits. You’reOnline document supposed to scroll down and “sign” at the bottom. On some platforms the investor actually has to click I’m Ready to Invest before he sees the disclosures!

There are at least three things wrong with this approach:

• Investors can’t be happy with it.

• It doesn’t convey information effectively.

• The disclosure might be legally ineffective. I think about a plaintiff’s lawyer cross-examining the portal operator, pointing to a disclosure on page 67 and asking “Did you really expect my client to read all that at the end of the click-through process?”

It doesn’t have to be that way! There are much better ways to provide information online. Take a look at today’s online version of the New York Times or Wall Street Journal to see how far we’ve come.

Crowdfunding portals can do the same thing. The first step is to move the mental image of that paper PPM into Trash or the Recycle Bin (depending on whether you’re Mac or PC) and start from scratch. What are we trying to accomplish here? What are the tools at our disposal? Pose that question to some creative people and you’ll get a whole range of possibilities, all of them better for investor, sponsor, and portal.

Questions? Contact Mark Roderick.

Title II Needs Company

Statue of Lib CF_Purchased

Title II Crowdfunding is great, and it’s booming. For the first time in history entrepreneurs have access to every accredited investor in the world, and every accredited investor in the world has access to deals once reserved for the very wealthy. New Crowdfunding portals – I call them “stores” – are opening all the time, serving more and wider markets. The stores are growing in sophistication and attracting a growing number of customers, i.e., investors. Register with Fundrise and you can invest in 3 World Trade Center!

But as long as Crowdfunding remains limited to Title II, it’s not going to achieve its potential. And that’s not only, not even primarily, because allowing non-accredited investors to participate would deepen the pool of available capital.

It’s not primarily about capital, but about the Crowdfunding ecosystem. Accredited investors represent a small fraction of Americans. Open the ecosystem to another 100 million potential investors and everything changes. Awareness changes. New ideas are borne and flourish. New businesses are created that wouldn’t have been created otherwise. New experts come into the field, new business models are tested. Behavior and expectations change.

I’m sure there are better and more sophisticated ways to describe what happens when more people join an ecosystem. Maybe things like “network effects” and “information feedback loops.”

Whatever it’s called, we need non-accredited investors in the market for Crowdfunding to achieve its potential. To get non-accredited investors into the market we need the SEC to issue final regulations under Title III and Title IV, and for that to happen it looks as if we’re going to need urging from the Legislative branch.

If you have a moment and the inclination, please click on the link below to find the names and email addresses of your Congressman and Senators, and drop them an email. I’ve included a sample form but of course feel free to create your own.

Title II has been lonely for too long!

Find My Congressman and Senators

Sample Email

Questions? Contact Mark Roderick.