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

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

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

#1 – Launch Offering without Financial Statements

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

#2 – Lower Standard for Some Financial Statements

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

#3 – Quicker Closing

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

#4 – Limit on Investor Cancellations 

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

CAVEAT:  These rules are not available if the issuer:

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

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

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

SEC PROPOSES MAJOR UPGRADES TO CROWDFUNDING RULES

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

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

I’ll touch on only a few highlights:

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

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

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

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

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

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

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

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

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

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

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

Please reach out if you’d like to discuss.

New Year and a New Law Firm

For all its warts and disappointments, 2019 was a record-breaking year for the Crowdfunding industry, promising even better things to come.

I wish for everyone — readers, friends, colleagues, clients, even casual hookups — a terrific New Year filled with self-awareness, peace, close, meaningful personal relationships, financial success, and a sense of having made the world better than we found it.

I’ll also take the opportunity to announce that effective tomorrow, January 1st, I and a group of selected lawyers from this firm and others are forming a new law firm, Lex Nova Law LLC.

The new firm will allow me to expand my practice in Crowdfunding, Fintech, and digital assets, with an even greater focus on aligning my legal practice with the way my clients run their businesses. More generally, Lex Nova Law will focus on the needs of entrepreneurs and their businesses, always the engine of the American economy. We will be guided by our motto: character matters.

My contact information:

Mark Roderick
Lex Nova Law LLC
1810 Chapel Avenue West, Suite 200
Cherry Hill, NJ 08002
t:(856) 382-8402
e: mroderick@lexnovalaw.com

Connect with me on LinkedIn
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As always, thank you for reading.

Making Money in Multifamily Real Estate Podcast

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Today’s guest on the Making Money in Multifamily Real Estate Show is Mark Roderick, one of the leading crowdfunding and FinTech lawyers in the United States. He has in depth knowledge of capital raising and securities law and represents many portals and other players in crowdfunding. He has a blog, which provides readers a wealth of knowledge for legal and practical information. He also has a crowdfunding event across the country and represents industry…

Questions? Let me know.

Regulation A: What Country Do You See When You Wake Up?

sara palin

A company may use Regulation A (Tier 1 or Tier 2) only if the company:

  • Is organized in the U.S. or Canada, and
  • Has its principal place of business in the U.S. or Canada.

I’m often asked what it means for a company to have its principal place of business in the U.S. or Canada. The first step is to identify the people who make the important decisions for the company. The next step is to ask what country those people see when they wake up in the morning. If they see the U.S. or Canada, they’re okay. If they see some other country, even a beautiful country like Norway or Italy, they’re not okay, or at least they can’t use Regulation A.

Seeing the U.S. or Canada via Facetime doesn’t count.

A company called Longfin Corp. ignored this rule and suffered the consequences. The people who made the important decisions for the company saw India when they woke up in the morning. The only person who saw the U.S. was a 23-year-old, low-level employee who worked by himself in a WeWork space. In its offering materials the company claimed to be managed in the U.S., but a Federal court found this was untrue and ordered rescission of the offering, $3.5 million in disgorgement, and $3.2 million in penalties.

Harder questions arise if, for example, three of the directors and the CFO see the U.S. when they wake up, but two directors and the CEO see Ireland.

On the plus side, a U.S. mining company with headquarters in Wyoming definitely can use Regulation A even if all its mines are in South America. The “principal place of business” means the location where the company is managed, not where it operates.

Questions? Let me know.

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

2019-10-22_10-03-37CLICK HERE TO LISTEN

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

In this episode, you’ll learn…

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

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

Questions? Let me know.

Podcast: Understanding Crowfunding with Mark Roderick

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CLICK HERE TO LISTEN

Rules are always changing in the crowdfunding space. Make sure that it is the best way for you to raise private capital by understanding the mechanics of this process. In this episode, let one of the leading Crowdfunding and FinTech attorneys, Mark Roderick, get you up to speed with the new laws and technology, and how the internet has disrupted this industry. Mark also talks about three flavors of Equity Crowdfunding and the rules for each type. Get an investor’s point-of-view and determine factors that dictate how much money you need to raise.

Questions? Let me know.

The Biggest Challenge With Title III Crowdfunding

Crowdfunding Image - XXXL - iStock_000037694192XXXLarge

The biggest challenge with Title III Crowdfunding isn’t the $1,070,000 maximum or the per-investor limits. The biggest challenge is how a small company complies with the disclosure requirements on a tight budget.

The disclosures required by Title III — I’m talking specifically about the long list of disclosures required by 17 CFR 227.201 — are fundamentally the same as those required by Title IV (aka Regulation A), which is itself only a slightly scaled-down version of a full-blown public offering.

There are easy questions, like naming the directors and officers, but the most important disclosures make sense only to securities lawyers. Ask the owner of a small business to list the “risks of investing” and you get mostly a blank stare, not the careful list the regulations anticipate. And when you get through everything else, you’re told to disclose “Any material information necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading.”

To a securities lawyer that’s just a restatement of SEC Rule 10b-5. To the founder of a small business it means nothing.

The result is what we see in the Title III market today, a mishmash. Some sites and companies manage to do it well, but many don’t. The widespread failure of compliance has led some to question whether Title III should be expanded before the Title III industry gets its house in order.

How does the industry get its house in order?

Before trying to answer that question, let’s think about how small companies raised money before Title III.

Before Title III, the typical small business was only vaguely aware of securities laws, if at all, and raised money however it could from whomever it could. Without knowing it, the microbrewery raising $250,000 from friends and family was eligible for the Federal exemption under Rule 504 and might have been eligible for state exemptions as well. But it probably wasn’t making the kind of disclosures required by Title III.

The same was true for would-be Silicon Valley unicorns. I’m pretty sure SoftBank didn’t ask Adam Neumann for a list captioned “Risks of Investing.”

The fact is that investing in a small business before 2016, big or small, generally was driven by relationships, not by legal disclosures. Because disclosure is the heart of the U.S. securities laws, it’s no surprise that the SEC turned to disclosure to protect widows and orphans in Title III. But the full-disclosure paradigm is new to this world. Ironically, the typical Title III issuer – even the issuer whose Form C falls short – is making far more disclosures than most small companies made before Title III, and far more than would-be unicorns are making to VCs today.

Does the paradigm used for large companies and institutional investors make sense for tiny companies and non-accredited investors? I’ll leave that for another day.

As an industry, we can take a few steps to improve:

  • Software and Templates – Better software and better templates can help. At the same time, no template or software can produce “Any material information necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading.” I translate that to “What would you tell your grandparents if they were investing?” But still, it’s hard.
  • Standardization – Depending on your point of view, standardization is either the price or the benefit of participating in a mass market. In either case, I’m convinced that Title III can’t function properly without far more standardization:
    • Standardized Corporate Structures – It would be great if every Title III issuer were a Delaware corporation or a Delaware limited liability company, using the same standardized Bylaws or Limited Liability Company Agreement.
    • Standardized Securities – Common stock, a simple preferred stock, a straight term loan, a simple revenue-sharing note, a SAFE, and their tokenized equivalents.
    • Standardized Disclosure Templates – An investor should be able to compare the disclosures between companies and portals apples-to-apples.
    • Standardized Legal Documents – Subscription Agreement, contract between portal and issuer, terms of the SAFE – everything should be standardized. Toward that end, within the next month I’m going to make a set of standardized documents available for issuers and portals.
  • No More $10,000 MinimumsC’mon, man! The Target Amount should reflect the minimum required for a viable business, or to get a necessary patent, or something. The widespread use of artificially-low Target Amounts has damaged the Title III market, driving away serious investors.

As long as I’m at it, I’ll ask just one thing of the SEC. Ideally, figure out a way to eliminate the per-investor limits for accredited investors under Title III, which serve no purpose and are inconsistent with Regulation D. Or, if that’s not possible under the language of the JOBS Act, get to almost the same place by creating a regulatory safe harbor under the Exchange Act, which would allow funding portals to receive commissions from accredited investors in a side-by-side offering.

Everyone benefits, and the Title III market gets healthier.

Questions? Let me know.

IRS Issues New Guidance on Taxation of Cryptocurrencies

MSR Update

The Internal Revenue Service just issued more guidance on the taxation of cryptocurrencies. The guidance comes in the form of Revenue Ruling 2019-24 and a set of FAQs. Officially, the guidance applies only to Federal income taxes. However, states are likely to follow the IRS rules.

Revenue Ruling 2019-24 is about hard forks in a distributed ledger. The IRS concludes that the hard fork is not itself a taxable event – that is, if you hold a cryptocurrency immediately before a hard fork and still hold it immediately after, the hard fork has no tax consequences. On the other hand, if you receive an air drop of the new cryptocurrency following the hard fork, you’re taxed on the value of the air drop.

Otherwise, there are no surprises in the new guidance. Thus:

  • Cryptocurrency is treated for Federal income tax purposes just like any other property, a diamond or a rusty 1964 Chevrolet. Cryptocurrency is not treated like U.S. dollars in any sense.
  • If you receive cryptocurrency in exchange for something else, whether property or services, you’re treated as having received a payment equal to the value of the cryptocurrency at the time you received it. If the bitcoin was worth $3,000 at the time you received it, you received a payment of $3,000 for each bitcoin you received, even if the bitcoin was worth $500 the month before or $10,000 the month afterward.
  • When you dispose of cryptocurrency, you have gain or loss based on the difference between the amount you paid for the cryptocurrency – your tax “basis” – and the amount you received for it, just as if you were selling the 1964 Chevy.
  • In general, you have capital gain or loss from selling cryptocurrency. But if you’re in the business of trading cryptocurrency the cryptocurrency will be treated as “inventory” and you’ll have ordinary income or loss.
  • Cryptocurrency received for services is treated as income for purposes of self-employment taxes as well as for purposes of income taxes.
  • Most people would guess that receiving cryptocurrency is taxable, g., my employer paid me $5,000 of ether, so I’m taxed on $5,000 of income. Less obvious is that you’re subject to tax when you pay someone with cryptocurrency. For example, if you’re the employer and pay your employee $5,000 of ether, you have engaged in a taxable sale of your ether, as if you had sold the ether for $5,000 and then turned around given $5,000 of cash to your employee.
  • If you trade one cryptocurrency for another, it’s a taxable sale. There is no such thing as a tax-free exchange of cryptocurrency, as there is for real estate.
  • If you own a bunch of bitcoin and want to use some to buy a house, you can choose which of your bitcoin to use (presumably the bitcoin with the highest tax basis).
  • If you receive cryptocurrency as a gift, it’s not taxable. Caution: there is no such thing as a business “gift.”
  • You can make a charitable contribution using cryptocurrency. If you’ve held the cryptocurrency for more than a year, your deduction is generally equal to the value of the cryptocurrency. Otherwise, your deduction is the lesser of the value of the cryptocurrency or your tax basis.
  • If you contribute cryptocurrency to an LLC or partnership, it’s not taxable at the time of the contribution. But when the LLC later disposes of the cryptocurrency, you will be taxed on any gain that was “built in” to the cryptocurrency at the time you contributed it.
  • If you own multiple crypto wallets, you can transfer among them without tax consequences.

Questions? Let me know.

REITS vs. Pass Through Entities: Section 199A and Real Estate Crowdfunding

Skyscraper Buildings Made From Dollar Banknotes

The 2017 tax act added §199A to the Internal Revenue Code and, with it, two complementary tax deductions:

  • A deduction of up to 20% of the income from a limited partnership, limited liability company, or other “pass through” entity.
  • A deduction equal to 20% of “qualified REIT dividends.”

Which is better for sponsors and investors?

As described here, the 20% deduction for pass-through entities is enormously complicated. Most important, the deduction can be limited for taxpayers whose personal taxable income exceeds $157,500 ($315,000 for a married couple filing jointly). These limits depend on the W-2 wages paid by the pass-through entity (not much for most real estate syndications) and the cost of the entity’s depreciable property (pretty substantial for most real estate syndications). And, naturally, those limits are themselves subject to special rules and definitions.

In contrast, the 20% deduction for qualified REIT dividends (which includes most dividends from REITs, other than capital gain dividends) is straightforward, with no cutdown for higher-income taxpayers.

Does that mean §199A favors REITs over LLCs and other pass-through entities? Not necessarily.

The key is that most real estate syndications don’t generate taxable income. Typically, the depreciation from the building “shelters” the net cash flow, at least during the early years of the project. The tax-favored nature of real estate is, in fact, part of what makes it such an attractive investment in the first place.

If an investor in an LLC is receiving cash flow from the syndication and paying zero tax, the 20% deduction of §199A is irrelevant. And, for that matter, so is the 20% deduction for REIT dividends. If a REIT isn’t generating taxable income because its cash flow is sheltered by depreciation, then its distribution will probably treated as a non-taxable return of capital rather than a taxable dividend.

As discussed here, the key advantage of a REIT over an LLC or other pass-through entity is that the LLC investor receives a complicated K-1 while a REIT investor receives a simple 1099. The relative simplicity of the 20% deduction for REIT dividends over the 20% deduction for pass-through entities is nice, but wouldn’t tip the balance in favor of a REIT by itself.

Questions? Let me know.