USING A SAFE IN REG CF

The SEC once wanted to prohibit the Simple Agreement for Future Equity, or SAFE, in Reg CF offerings. After a minor uproar the SEC changed its mind, and SAFEs are now used frequently. I think prohibiting SAFEs would be a mistake. Nevertheless, funding portals, issuers, and investors should think twice about using (or buying) a SAFE in a given offering.

Some have argued that SAFEs are too complicated for Reg CF investors. That’s both patronizing and wrong, in my opinion. Between a SAFE on one hand and common stock on the other, the common stock really is the more difficult concept. As long as you tell investors what they’re getting – especially that SAFEs have no “due date” – I think you’re fine.

The reason to think twice is not that SAFEs are complicated but that a SAFE might not be the right tool for the job. You wouldn’t use a hammer to shovel snow, and you shouldn’t use a SAFE in circumstances for which it wasn’t designed.

The SAFE was designed as the first stop on the Silicon Valley assembly line. First comes the SAFE, then the Series A, then the Series B, and eventually the IPO or other exit. Like other parts on the assembly line, the SAFE was designed to minimize friction and increase volume. And it works great for that purpose.

But the Silicon Valley ecosystem is very unusual, not representative of the broader private capital market. These are a few of its critical features:

  • Silicon Valley is an old boys’ network in the sense that it operates largely on trust, not legal documents. Investors don’t sue founders or other investors for fear of being frozen out of future deals, and founders don’t sue anybody for fear their next startup won’t get funded. Theranos and the lawsuits it spawned were the exceptions that prove the rule.
  • The Silicon Valley ecosystem focuses on only one kind of company: the kind that will grow very quickly, gobbling up capital, then be sold.
  • Those adding the SAFE at the front end of the assembly line know the people adding the Series A and Series B toward the back end of the assembly line — in fact, they might be the same people. And using standardized documents like those offered by the National Venture Capital Association ensures most deals will look the same. Thus, while SAFE investors in Silicon Valley don’t know exactly what they’ll end up with, they have a good idea.

The point is that SAFEs don’t exist in a vacuum. They were created to serve a particular purpose in a particular ecosystem. To name just a couple obvious examples, a company that won’t need to raise more money or a company that plans to stay private indefinitely probably wouldn’t be good candidates for a SAFE. If it’s snowing outside, don’t reach for the hammer.

If you do use a SAFE, which one? The Y Combinator forms are the most common starting points, but in a Reg CF offering, you should make at least three changes:

  1. The Y Combinator form provides for conversion of the SAFE only upon a later sale of preferred stock. That makes sense in the Silicon Valley ecosystem because of course the next stop on the assembly line will involve preferred stock. Outside Silicon Valley, the next step could be common stock.
  2. The Y Combinator form provides for conversion of the SAFE no matter how little capital is raised, as long as it’s priced. That makes sense because on the Silicon Valley assembly line of course the next step will involve a substantial amount of capital from sophisticated investors. Outside Silicon Valley you should provide that conversion requires a substantial capital raise to make it more likely that the raise reflects the arm’s-length value of the company.
  3. The Y Combinator form includes a handful of representations by the issuer and two or three by the investor. That makes sense because nobody is relying on representations in Silicon Valley and nobody sues anyone anyway. In Reg CF, the issuer is already making lots of representations —Form C is really a long list of representations — so you don’t need any issuer representations in the SAFE. And dealing with potentially thousands of strangers, the issuer needs all the representations from investors typical in a Subscription Agreement.

The founder of a Reg CF funding portal might have come from the Silicon Valley ecosystem. In fact, her company might have been funded by SAFEs. Still, she should understand where SAFEs are appropriate and where they are not and make sure investors understand as well.

The SEC Can Stop Your Regulation A Offering At Any Time

The SEC has two powerful tools to stop your Regulation A offering anytime.

Rule 258

Rule 258 allows the SEC to immediately suspend an offering if

  • The exemption under Regulation A is not available; or
  • Any of the terms, conditions, or requirements of Regulation A have not been complied with; or
  • The offering statement, any sales or solicitation of interest material, or any report filed pursuant to Rule 257 contains any untrue statement of a material fact or omits to state a material fact necessary to make the statements made, in light of the circumstances under which they are made, not misleading; or
  • The offering involves fraud or other violations of section 17 of the Securities Act of 1933; or
  • Something happened after filing an offering statement that would have made Regulation A unavailable had it occurred before filing; or
  • Anyone specified in Rule 262(a) (the list of potential bad actors) has been indicted for certain crimes; or
  • Proceedings have begun that could cause someone on that list to be a bad actor; or
  • The issuer has failed to cooperate with an investigation.

If the SEC suspends an offering under Rule 258, the issuer can appeal for a hearing – with the SEC – but the suspension remains in effect. In addition, at any time after the hearing, the SEC can make the suspension permanent.

Rule 258 gives the SEC enormous discretion. For example, the SEC may theoretically terminate a Regulation A offering if the issuer fails to file a single report or files late. And while there’s lots of room for good-faith disagreement as to whether an offering statement or advertisement failed to state a material fact, Rule 258 gives the SEC the power to decide.

Don’t worry, you might think, Rule 260 provides that an “insignificant” deviation will not result in the loss of the Regulation A exemption. Think again: Rule 260(c) states, “This provision provides no relief or protection from a proceeding under Rule 258.”

Rule 262(a)(7)

Rule 262(a)(7) is even more dangerous than Rule 258.

Rule 258 allows the SEC to suspend a Regulation A offering if the SEC concludes that something is wrong. Rule 262(a)(7), on the other hand, allows for suspension if the issuer or any of its principals is “the subject of an investigation or proceeding to determine whether a. . . . suspension order should be issued.”

That’s right: Rule 262(a)(7) allows the SEC to suspend an offering merely by investigating whether the offer should be suspended.

Effect on Regulation D

Suppose the SEC suspends a Regulation A offering under either Rule 258 or Rule 262(a)(7). In that case, the issuer is automatically a “bad actor” under Rule 506(d)(1)(vii), meaning it can’t use Regulation D to raise capital, either.

In some ways, it makes sense that the SEC can suspend a Regulation A offering easily because the SEC’s approval was needed in the first place. But not so with Regulation D, and especially not so with a suspension under Rule 262(a)(7). In that case, the issuer is prevented from using Regulation D – an exemption that does not require SEC approval – simply because the SEC is investigating whether it’s done something wrong. That seems. . . .wrong.

Conclusion

As all six readers of this blog know, I think the SEC has done a spectacular job with Crowdfunding. But what the SEC giveth the SEC can taketh away. I hope the SEC will use discretion exercising its substantial power under Rule 258 and Rule 262(a)(7).

Don’t Use a Series LLC as a Crowdfunding Vehicle

At least one high-volume Crowdfunding portal is using a series LLC as a crowdfunding vehicle. It’s a terrible idea.

A “series LLC” is a relatively new concept. Rather than form a new limited liability company for a business, you can form a “series” of an existing limited liability company. Think of the parent LLC as a building and the series as a cubicle in the building. If you do everything right, the assets and liabilities of each series are segregated from the assets and liabilities of every other series.

EXAMPLE:  A company wants to conduct two businesses, one an asbestos business and the other an auto dealership. It creates Series X to conduct the asbestos business and Series Y to conduct the auto business. Under Delaware law, if the company does everything right, maintaining separate books and records, creditors of the asbestos business can’t get at the assets of the auto business and vice versa.

That’s great in theory. But there are two problems.

The first is that while Delaware law is clear, as far as I know the series structure has never been tested in a bankruptcy court. Bankruptcy courts have enormous power to achieve equitable results and often use that power aggressively. Suppose the asbestos company has caused 57 children to develop a rare but deadly form of cancer and the assets of the asbestos company aren’t sufficient to pay the economic damages. Will a bankruptcy court allow the parent company to walk away with the auto business intact? Maybe, maybe not.

The second problem is that some states simply disregard the Delaware law. Arizona is one of them. Its statute provides:

A foreign limited liability company, its members and managers and its foreign series, if any, have no greater rights and privileges than a domestic limited liability company and its members and managers with respect to transactions in this state and relationships with persons in this state that are not managers or members.  A foreign series is liable for the debts, obligations or other liabilities of the designating foreign company and of any other foreign series of that designating foreign company, arising out of transactions in this state or relationships with persons in this state and a designating foreign company is liable for such debts, obligations or other liabilities of each foreign series of that designating foreign company.

That means if the kids got sick is in Arizona, the court is going to ignore the series and take the assets of the auto business, no question.

Now let’s think about a crowdfunding vehicle.

Suppose the funding portal has created crowdfunding vehicles, or SPVs, for three issuers, Company A, Company B, and Company C. It’s created each crowdfunding vehicle as a series of one limited liability company.

Two years from now a bankruptcy court somewhere in the United States declines to respect the separateness of the series structure. Immediately, the crowdfunding vehicle of Company A is subject to all the liabilities of the crowdfunding vehicles of Company B and Company C, and vice versa nine different ways. When the investors in Company B lose all their money because of a lawsuit involving Company C they’re going to sue, and because Company B didn’t even tell investors about that risk, its founders are going to be sued personally – and successfully.

Now let’s say someone from Arizona invests in the crowdfunding vehicle of Company C. Later, it’s revealed that Company C failed to disclose material information in its offering. Under the Arizona law that investor can sue the crowdfunding vehicles of Company A and Company B. The investor wins that lawsuit and now investors in Company A and Company B have claims against their own company and their founders.

It’s a legal disaster.

And for what great benefit did the funding portal take that risk, using a series LLC rather than a separate LLC as the crowdfunding vehicle? To save about $150 in filing fees. Really.

That’s why using a series LLC as a crowdfunding vehicle is such a terrible idea. If a funding portal tells you to use a series LLC as your crowdfunding vehicle remember Nancy Reagan’s famous slogan:  Just Say No! And if you already have a crowdfunding vehicle formed as a series LLC, change it right away.

And for that matter, remember that you don’t need a crowdfunding vehicle in the first place.

Publicly-Traded Partnerships: The Trap for LLCs Traded on ATS

One drawback of private companies is they’re not liquid, meaning you can’t sell your shares easily. That’s why lots of people are spending lots of time and money creating secondary markets for private companies. These secondary markets typically take the form of an “alternative trading system,” or ATS, owned and operated by a broker-dealer. More on secondary markets here.

If you’re raising money for an LLC it’s attractive to have the interests traded on an ATS because you can tell prospective investors they’ll have liquidity, in theory if not in practice. But there’s a drawback, too:  if interests of in the LLC are traded on an ATS then the LLC might be treated as a corporation for tax purposes, not as a partnership, with potentially bad consequences.

If you’re interested in the differences between partnerships and corporations you can read this, but suffice it to say that (i) if you’re an LLC you probably made that choice intentionally, and (ii) a corporation is subject to two levels of tax on exit, significantly reducing the anticipated after-tax return to investors.

Under section 7704 of the Internal Revenue Code, a partnership (including an LLC taxed as a partnership) will be treated as a corporation for tax purposes if either:

  • Interests in the partnership are traded on an established securities market; or
  • Interests in the partnership are readily tradable on a secondary market “or the substantial equivalent thereof.”

The interests in a private LLC typically aren’t going to be traded on NASDAQ or any other established securities market, so we don’t worry about the first rule. But we do worry about the second rule. Interests in a partnership will be deemed readily tradable on a secondary market or the equivalent if:

  • Interests in the partnership are regularly quoted by any person, such as a broker or dealer, making a market in the interests; or
  • Any person regularly makes available to the public (including customers or subscribers) bid or offer quotes with respect to interests in the partnership and stands ready to effect buy or sell transactions at the quoted prices for itself or on behalf of others; or
  • The holder of an interest in the partnership has a readily available, regular, and ongoing opportunity to sell or exchange the interest through a public means of obtaining or providing information of offers to buy, sell, or exchange interests in the partnership; or
  • Prospective buyers and sellers otherwise have the opportunity to buy, sell, or exchange interests in the partnership in a time frame and with regularity and continuity.

Focus on the third bullet point. The whole point of listing LLC interests on an ATS is to give investors a readily available, regular, and ongoing opportunity to sell or exchange the interest. Hence, listing your LLC’s interests on an ATS will automatically turn your partnership into a corporation for tax purposes – unless you satisfy one of the exceptions.

This is the Internal Revenue Code so there are exceptions and exceptions to the exceptions and so on. How else would lobbyists put food on the table?

These are the primary exceptions:

  • Exception for Private Placements:  Your LLC raised capital in a private offering (including Rule 506(c) and Reg CF) and has no more than 100 members.
  • No Actual Trading:  Interests in your LLC are listed on an ATS but no more than 2% of all interests are traded each year.
  • Exception for Passive Income and the Oil & Gas Industry:  At least 90% of your LLC’s income is from interests, dividends, rent, gains from the sale of real estate or capital assets, or the oil & gas business.
  • Qualified Matching Service:  Interests in your LLC are traded only through a “qualified matching service” and no more than 10% of the interests are traded each year. A qualified matching service is where:
    • The service consists of a system that lists bid and/or ask quotes in to match sellers to buyers;
    • Matching occurs either by matching the list of buyers with the list of sellers or through a bid and ask process;
    • The selling partner cannot enter into a binding agreement to sell the interest until the 15th day after the date information regarding the offering of the interest for sale is made available to potential buyers;
    • The closing of the sale does not occur prior to the 45th day after the date information regarding the offering of the interest for sale is made available to potential buyers;
    • The matching service displays only quotes that do not commit any person to buy or sell a partnership interest at the quoted price or quotes that express interest in a partnership interest without an accompanying price and does not display quotes at which any person is committed to buy or sell a partnership interest at the quoted price;
    • The selling partner’s information is removed from the matching service within 120 days after the date information regarding the offering of the interest for sale is made available to potential buyers and, following any removal (other than removal by reason of a sale of any part of such interest) of the selling partner’s information from the matching service, no offer to sell an interest in the partnership is entered into the matching service by the selling partner for at least 60 days.

Many real estate LLCs will satisfy the exception for passive income (real estate rent), although they should be careful with other sources of income, like income from a parking lot or laundry facility. Most LLCs in the oil & gas business will satisfy the same exception because it was written for them. An LLC formed to hold treasury bonds is obviously okay.

But the large majority of LLCs raising money in Crowdfunding conduct other businesses, everything from technology to baby wipes. These companies must weigh the benefit of trading on an ATS – theoretical liquidity – against the cost of being treated as a corporation for tax purposes.

NOTE:  You could list the interests of your LLC on an ATS but limit trading to stay below the allowed annual thresholds. But of course that limits liquidity for your investors, taking some of the air out of your marketing message.

Beneficiary Designations by Crowdfunding Issuers and Portals

Some Crowdfunding portals and issuers allow investors to designate a beneficiary, i.e., a person who will take ownership of the security (the LLC interest, debt instrument, whatever) should the investor die. Just be careful.

Most states (not Texas) allow the owners of securities, including privately-held securities, to designate a beneficiary outside the owner’s will, under a version of the Uniform TOD (Transfer on Death) Security Registration Act (the Delaware version is 12 DE Code §801 et seq). For the investor, the advantage of designating a beneficiary is that the security doesn’t go through the probate process but instead passes directly to the designated beneficiary.

For the Crowdfunding issuer or portal, there is a benefit to making life easier for investors. And it’s pretty straightforward to create a beneficiary designation form on your website.

Nevertheless, adding convenience for investors carries some risks. For example:

  • Suppose an investor wants to designate her cousin Jacob as the beneficiary of her LLC interest. She uses Jacob’s name on the beneficiary designation form but mistakenly uses her husband’s social security number, out of habit. What happens?
  • The investor correctly designates Jacob on the form but later changes her mind and designates her husband as the beneficiary of the LLC interest in her will. Unfortunately for her husband, the beneficiary designation made using your form cannot be undone by the will. Your form didn’t make that clear.
  • The investor properly designates Jacob as the beneficiary of her LLC interest and doesn’t change her mind, but she lives in a community property state and your form didn’t tell her she needed her husband’s consent.
  • The investor properly designates Jacob as the beneficiary of her LLC interest but he dies before she does, and she hasn’t designated a successor beneficiary.
  • Your site crashes and the investor’s beneficiary designation is lost.

What’s your budget for legal fees this year?

Designating a beneficiary on your site isn’t the investor’s only option. She can sign a simple will or codicil (if she already has a will) designating a beneficiary for her LLC interest and any other securities or other property, which probably makes more sense than designating beneficiaries security-by-security. And if her cousin and husband end up arguing over the codicil, you’re not involved.

If you’d like a sample of a Beneficiary Designation Form let me know.

TWO REASONS WHY EVERY TITLE II PORTAL SHOULD ADD A TITLE III PORTAL

If you operate a Title II Crowdfunding platform, whether Rule 506(c) or Rule 506(b), you should add the functionality for Title III. Two reasons:

  • It will be good for you, i.e., you will make more money.
  • It will be good for our country.

Adding Title III Will Be Good for You

Any day now the SEC will announce a bunch of changes to the Title III rules, including these: 

  • Sponsors will be able to raise $5M rather than $1.07M.
  • There will be no limit on the amount an accredited investor can invest.
  • The limits for non-accredited investors will be raised.

Most of the deals on your site are less than $5M. Even though the $5M limit under Title III is per-sponsor rather than per-deal, this means that if your Title III portal were up and running today you could expand your potential audience from about 10 million households to about 120 million households.

There are four benefits to making deals available to non-accredited investors.

The first, immediate benefit is that non-accredited investors do have money. By adding non-accredited investors you make it easier to fill deals.

The second, immediate benefit is that adding non-accredited investors allows you to market to affinity groups. If you’re selling a mixed-use project in Washington, D.C. you can market to the neighbors. If you’re selling a company developing a therapy for cystic fibrosis you can market to everyone whose family has been affected.

The third, immediate benefit is you can start taking commissions. If you’re like most Title II portals you spend time and effort to make sure you’re not a broker-dealer. If you were a Title III portal those issues would disappear.

The fourth benefit is not immediate but is much more important than the first three, in my opinion. It’s about building a brand and a funnel of investors.

If you operate a portal you are selling a product, no different than shoes or automobiles. Just as Mercedes offers the A-Class sedan to bring less-affluent customers into the showroom and the Mercedes family, adding Title III can vastly increase your audience and revenue as some non-accredited investors become accredited and the SEC further relaxes the rules for non-accredited investors.

Alternatively, they could start shopping in somebody else’s Title III showroom.

Adding Title III Will Be Good for the Country

Our country is suffering in many ways. Yes, we’re suffering politically, but in some ways the political suffering is just one manifestation of our deep and deepening income and wealth inequalities. You can find a hundred charts showing the same thing:  the very wealthy are becoming wealthier while everyone else, especially the lower 50%, becomes poorer and more desperate.

When I was a teenager I delivered newspapers in Arlington, Virginia. In my suburban territory I delivered papers to accredited investors, whose houses were a little bigger and drove Cadillacs and Town Cars, and to non-accredited investors, whose houses were a little smaller and drove Chevies and Toyotas. One of my customers was George Shulz, the Secretary of the Treasury, who came to the door in his bathrobe and tipped well.

Tax policies, trade policies, all the instrumentalities of government have been focused over the last 40 years to serve the interests of the well-off. Part of it was cynical politics, part too much faith (which I shared) in the power of markets to lift all boats. Most of the boats in our country remain moored at low tide. Steve Mnuchin and his wife wouldn’t dream of living in that neighborhood today while 98% of Americans couldn’t afford to.

Call me an idealist, but I believe Crowdfunding can at least claw back some of the inequality. The deals on your Title II portal should be available to ordinary Americans. They should participate in those returns. They should regain faith that the capitalist system can work for them. We should all hope that the phrase “institutional quality,” when applied to investments, will lose its meaning.

Crowdfunding isn’t the whole solution, but it’s part of the solution. And you can make it happen.

How many companies have stayed away from Crowdfunding and the capital it can provide based on a fallacy? Way too many,

THE BIG PROBLEM FOR CROWDFUNDING THAT REALLY ISN’T A PROBLEM

Ask 10 entrepreneurs why they haven’t used Crowdfunding. Three will answer they haven’t heard of it while seven will say “Crowdfunding will screw up my cap table.” Once and for all, let’s lay that fallacy to rest.

We’ll start by noting that many companies have raised money from Crowdfunding and gone on to later rounds of funding, including public offerings. That proves that what passes for common knowledge in some circles can’t actually be true. But let’s drill down a bit more.

What is it about Crowdfunding that could screw up a cap table?

It couldn’t be the number of investors. Public companies with hundreds of thousands of shareholders have no problem managing their cap tables or raising more capital when they need it. Beyond that, technology has made keeping track of investors pretty simple. You can send 1099s to 2,000 shareholders as easily as you can send them to 20, while Excel spreadsheets have 1,048,576 rows. Cap table management tools like Carta make the process even easier.

Don’t want to manage the cap table yourself? Fund managers like Assure Fund Management will handle it for you.

If having lots of investors doesn’t screw up a cap table, what does?

The answer is that a cap table is screwed up by the terms of the securities issued to investors. For example:

  • A company issues 52% of its voting stock to early investors.
  • A company issues stock to early investors with an agreement giving the investors veto rights over a sale of the company.
  • A company issues stock giving early investors a “put” after five years.

In those circumstances and many others, the rights given to early investors inhibit or even preclude the company from raising money in the future. Who’s going to invest in a company where the founder no longer has voting control?

But for purposes of this post, the important observation is that none of those examples depends on the number of rows in your Excel spreadsheet or how the money was raised. If the first round of funding came from just 10 friends and family members who together received 52% of the voting stock, that company has a screwed up cap table and will have a hard time raising more money. By contrast, the company that raised money from 1,000 strangers in Title III by issuing non-voting stock does not have a screwed up cap table and can raise money from anyone in the future, no problem.

To avoid screwing up your cap table, don’t worry about the number of investors and certainly don’t avoid Crowdfunding. Instead, focus on what matters:  the kinds of securities you issue and the rights you give investors. 

Where did the fallacy come from? The venture capital and organized angel investor folks, i.e., the same folks who predicted a few billion dollars ago that Rule 506(c) would never work because accredited investors wouldn’t submit to verification. Considering themselves indispensable middlemen, these folks view Crowdfunding as a threat. (I’ve always thought they should use Crowdfunding as a tool instead of fighting the tide, but that’s a different blog post.)

The fallacy has proven very hard to shoot down, perhaps because of the outsized influence venture capital and organized angel investor folks enjoy in the capital formation industry. In fact, it’s proven so hard to shoot down that the soon-to-be-released SEC rules allowing SPVs in Title III were written in response. If we’re smart about the kinds of securities we issue we don’t need an SPV, while if we issue the wrong kind of security then an SPV doesn’t help. The new SEC rules were written solely for the sake of perception, “solving” a problem that didn’t really exist.

Similarly, the perception that Crowdfunding screws up your cap table led one of the largest Title III platforms, WeFunder, to create an even more convoluted “solution.” WeFunder has investors appoint a transfer agent to hold their securities. Under 17 CFR §240.12g5-1, this means that all the securities are “held of record” by one person for purposes of section 12(g) of the Exchange Act. Based on the section 12(g) definition WeFunder then claims that a round of financing on its platform leaves the issuer with “a single entry on your cap table.” That’s a creative claim, given that the term “cap table” has no legal meaning and if an issuer is an LLC and raises money from 600 investors there are going to be 600 K-1s.  But the point is that WeFunder goes to this trouble and the attendant costs over a problem of perception, not reality.

How many companies have stayed away from Crowdfunding and the capital it can provide based on a fallacy? Way too many, that’s for sure.

THE EXPANDED DEFINITION OF ACCREDITED INVESTOR: A (FIRST) STEP IN THE RIGHT DIRECTION

For all the ink spilled wondering and worrying how the SEC might change the definition of accredited investor, yesterday’s announcement seems almost anti-climactic.

Perhaps the main story is what the SEC didn’t do. It didn’t limit the definition of accredited investor in any way. Everyone who was an accredited investor yesterday is an accredited investor today. In that sense the SEC continues to demonstrate its support for the private investment marketplace and give the lie to those who believe otherwise.

On the other hand, the SEC didn’t break much new ground expanding the definition, at least for now.

The principal expansion, as expected, was in adding to the list of accredited investors individuals who hold Series 7, Series 65, or Series 82 licenses. The SEC also added investment advisers registered with the SEC or any state and, more surprisingly, venture capital fund advisers and exempt reporting advisers. I say “more surprisingly” because neither venture capital fund advisers nor exempt reporting advisers are required to pass exams or otherwise demonstrate financial knowledge or sophistication.

The list of accredited investors was also extended to include:

  • Entities, including Indian tribes, governmental bodies, funds, and entities organized under the laws of foreign countries, that (1) own “investments” (as defined in Rule 2a51-1(b) under the Investment Company Act of 1940) in excess of $5 million, and (2) were not formed to invest in the securities offered;
  • Rural business development companies;
  • Family offices with at least $5 million in assets under management and their family clients, as each term is defined under the Investment Advisers Act of 1940; and
  • Knowledgeable employees of a private fund, but only with respect to investments in that fund.

Finally, the SEC clarified that existing provisions of the accredited investor definition that refer to spouses also includes “spousal equivalents,” meaning someone who has gotten under your nerves for at least seven years (actually “a cohabitant occupying a relationship generally equivalent to that of a spouse”).

While a modest first step, these additions are welcome and a harbinger of bigger things to come. The new rule explicitly invites FINRA, other industry self-regulatory authorities, and accredited education institutions to develop “certifications, designations, or credentials” that the SEC would approve for accredited investor qualification. I imagine FINRA and professional organizations will jump at the chance. If this leads to millions or tens of millions of Americans learning about securities and participating in the Crowdfunding market, well, that’s a very good thing for everyone.

The new definition will become effective 60 days after being published in the Federal Register.

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
Follow me on Twitter

As always, thank you for reading.

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.