Tag: crowdsourcing

Free Seminar – Smart Talk: Crowdfunding 101

On By crowdfundattnyIn Crowdfunding, Crowdfunding Speaking Engagements, General Solicitation, JOBS Act, Regulation D offerings, Rule 506, SEC, Securities Exchange Commission, Securities LawsLeave a comment

I have been asked by the University City Science Center in Philadelphia, PA to be the featured speaker on Crowdfunding at the “Smart Talk – Crowdfunding 101” seminar on October 24, 2013.

I will discuss the basic changes to the JOBS Act and what this means for you and your company’s future, including: Rule 506 of Regulation D issued by the Securities & Exchange Commission (SEC); new requirements for establishing that investors are accredited; SEC regulations; mechanics of a Crowdfunded offering; proposed changes to Form D; and the exclusion of “bad actors.”

The seminar will take place on Thursday, October 24, 2013 at the Quorum at the University City Science Center in Philadelphia, PA from 8:30 – 10:00 a.m. This event is free, but space is limited, so you must register to attend. To register, email the University City Science Center to secure a seat. For additional information on the event, click here.

I hope to see you there!

MARK RODERICK

Will The SEC’s 15 Day Notification Rule End Angel Fairs?

On By crowdfundattnyIn Angel Fairs, AngelList, Crowdfunding, FundersClub, General Solicitation, Regulation D offerings, Rule 506, SEC, Securities Exchange CommissionLeave a comment

No, it won’t.

On July 10, 2013 the SEC proposed rules that would, among other things, require a company to notify the SEC at least 15 days before using any “general solicitation” to raise money under the newly-adopted Rule 506(c) of Regulation D, also known as Title II Crowdfunding.

This proposal triggered more anxiety in the investment community than any other. Angel groups in particular were concerned about the possible effect on “angel fairs” and similar networking events, where companies look for investors and publicity by making presentations and handing out literature. If these activities constituted general solicitation, so the thinking went, and a company had not notified the SEC at least 15 days in advance, the company would be violating the law with potentially serious consequences.

Should companies stop presenting at angel fairs? Should attendance at angel fairs be limited? Would the SEC rule bring a wrenching halt to the way startups have raised money for 30 years?

There are two reasons why the concerns in the investment community are probably overblown.

First, “general solicitation” is not a new concept. Regulation D has always prohibited general solicitation. Rule 506 of Regulation D is itself a regulatory implementation of section 4(a)(2) of the Securities Act of 1933, which provides simply that the registration requirements do not apply to “transactions by an issuer not involving any public offering.” It has always been the position of the SEC, reflected in Rule 502(c), that using general solicitation to attract investors crossed the indistinct line from “private offering” to “public offering.”

Thus, every angel fair that has ever been held for the last several decades has been subject to the SEC prohibition on general solicitation. Yet given all that time and all those opportunities, the SEC has never taken the position that what happens at angel fairs constitutes prohibited general solicitation.

Having stood aside and permitted angel fairs for three decades, it seems unlikely that the SEC would take the opposite position today, after Congress announces its support for Crowdfunding by enacting the JOBS Act!

So far, it is safe to say that the SEC has taken the opposite approach, i.e., by making Crowdfunding easier, not more difficult. Consider, for example, the two no-action letters issued by the SEC on March 26, 2013 to FundersClub and AngelList. It seems very possible, even likely, that these letters would not have been issued before enactment of the JOBS Act. The SEC seems to have taken the wishes of Congress to heart and there is no reason to believe it intended to do otherwise with the 15 day proposal.

The other reason the concerns are overblown is that the rule in question is not yet in effect. The public comment period ended on September 23, 2013 and the SEC is considering the many comments made by the investment community. The chances are very high that when the SEC issues the final rule, these comments will be taken into account.

Maybe I’ll be proven wrong. Maybe the SEC will suddenly reverse course after 30 years and issue final rules that blow angel fairs out of the water, throw up unnecessary impediments to Crowdfunding despite the JOBS Act, and make everyone angry. Don’t bet on it.

Questions? Let me know.

A Legal Structure for Crowdfunding

On By crowdfundattnyIn Crowdfunding, Crowdfunding Portals, Entrepreneurs, Financings, Investing, JOBS Act, SEC, Securities Exchange CommissionLeave a comment

It’s official:  Crowdfunding is now in effect and thousands of companies are about to start raising money under the new SEC regulations. If each company offers different deal terms for investors, it’s going to be that much more difficult for investors to make apples-to-apples investment decisions.

Meanwhile, some in the investment community are still concerned that a company raising money through Crowdfunding will be hobbled in raising more money afterward, e.g., from angel groups or venture capital funds.

The sooner the market adopts a standard investment structure, the better for all.

Here is a legal structure that would standardize the Crowdfunding market, satisfy SEC regulations, and ensure that the Crowdfunding round of financing does not preclude later rounds:

  • New Entity:  Form a new entity for the Crowdfunding investors. We’ll call this entity InvestCo, and we’ll call the operating company itself MyCo. InvestCo will be one owner of MyCo, no matter how many investors buy stock in InvestCo.
  • Structure of InvestCo:  InvestCo will be either a limited liability company or a C corporation, based on tax and state-law considerations. InvestCo will be controlled by the same individuals who control MyCo.
  • Percentage Ownership:  Each investor will own a pro rata share of InvestCo based on his or her investment. InvestCo, in turn, will own a percentage of MyCo stipulated by MyCo in the offering materials, based on the amount of money raised and the value of MyCo. Here is a post with suggestions on establishing this ownership percentage.
  • Voting Rights of Investors:  Investors will not be entitled to vote in InvestCo, and InvestCo will not be entitled to vote in MyCo. That is, the investors in a Crowdfunded offering will have no voting rights, except the right to appoint one member to the Board of Directors of MyCo.
  • Preference on Sale or Liquidation:  If MyCo is sold or liquidated, InvestCo will be entitled to receive a return of its investment before any distributions are made to the other owners of MyCo as they exist today. If MyCo raises more money in the future, the rights of InvestCo could be subordinated to the rights of the new investors.
  • Dividend Right:  InvestCo’s stock in MyCo will bear a dividend rate of 5%.
  • Tag-Along Rights: If the founder of MyCo sells some of his or her stock, InvestCo will have the right to participate in the sale.
  • Anti-Dilution Rights:  InvestCo will be entitled to “weighted average” anti-dilution protection.
  • Right to Information:  Investors will have the right to basic information from MyCo, such as annual financial statements. Of course, state law may give them (and any other owners) the right to additional information.

This structure should be acceptable to all of the constituents of the Crowdfunding market:  the entrepreneurs who started MyCo; the broad investing public that will make Crowdfunding a success; the angel groups that help so many startups succeed and currently anchor the early-stage market; and the venture capital funds that provide additional funds for companies that need and deserve them.

Questions? Let me know.

Technology Platform for Crowdfunding

On By crowdfundattnyIn Crowdfunding, Entrepreneurs, Form D, Regulation D offerings, SEC, Technology PlatformsLeave a comment

A company raising money through Crowdfunding will face certain logistical challenges:

  • How to keep track of prospective investors
  • How to automate the due diligence process
  • How to execute documents electronically and securely
  • How to communicate with investors
  • How to securely handle the transfer of funds
  • How to satisfy the new SEC requirements regarding accredited investors
  • How to prepare and file the newly-expanded Form D with the SEC

These challenges have always been present in Regulation D offerings, but with a dozen investors, or two dozen, or three dozen, they were merely a manageable nuisance. In a Crowdfunding offering with 150 investors they could be overwhelming.

SeedInvest, a startup with offices in Manhattan, offers a technology platform that claims to do all these things and more. A company seeking to raise money through Crowdfunding, or a brokerage firm seeking to raise money for its clients, or an angel group seeking to manage multiple investments, would in effect “rent” the SeedInvest platform as an alternative to spending the time and money to build its own.

Today, thousands of entrepreneurs – perhaps some of them reading this blog – are planning to jump into the Crowdfunding space. One entrepreneur might be building a portal for biotech companies in the Northeast – a place where investors could find and invest in the best the research centers in the Northeast have to offer. Another might be doing the same for Manhattan commercial real estate, believing there must be many accredited investors around the country who would like to own a piece of New York. And on and on, in every industry and every region.

By using SeedInvest’s platform, or a similar platform offered by a competitor, the entrepreneur overcomes some of the most significant technological and logistical barriers to entry. In effect, the entrepreneur can focus on the business of attracting quality companies and investors while outsourcing the technological back office.

Crowdfunding is already creating new opportunities for entrepreneurs in many industries. SeedInvest is one example; there will be many, many more.

Questions? Let me know.

Will Crowdfunding Hurt My Company Later On?

On By crowdfundattnyIn Crowdfunding, Entrepreneurs, JOBS ActLeave a comment

With bona fide JOBS Act Crowdfunding about to launch, many entrepreneurs wonder whether raising money through Crowdfunding will hurt their company in the future.

The simple answer: not if you do it the right way.

A company raises money for its current needs, naturally. But no matter where the money is coming from, Crowdfunding or otherwise, the company must have one eye on the future to ensure that nothing it does today will keep it from raising more money tomorrow.

Here are a few tips to avoid problems in the future:

  • The Crowdfunding investors should not have the right to veto later rounds of financing.
  • The Crowdfunding investors should not be able to control the company’s Board of Directors.
  • The Crowdfunding investors should have very limited liquidity rights, if any.
  • The company should be able to grant later investors economic and management rights – for example, a preferred return on sale – that are superior to the rights of the Crowdfunding investors.

These things and much more can be accomplished with the right legal structure for the company and the Crowdfunded investment. In fact, if Crowdfunding is done correctly, it should not interfere with subsequent rounds of investment at all.

Questions? Let me know.

SEC Finalizes “General Solicitation” Regulations: Full Steam Ahead

On By crowdfundattnyIn Crowdfunding, Crowdfunding Portals, Entrepreneurs, FundersClub, General Solicitation, Investing, Investor, JOBS Act, Kickstarter, Rule 506, SEC, Securities Exchange CommissionLeave a comment

Since President Obama signed the JOBS Act into law on April 5, 2012, we have been waiting for the SEC to finalize the rules on Crowdfunding.

At long last the SEC has done just that, at least with respect to one of the two components of Crowdfunding. Sometime in mid-September, company will be allowed to use “general solicitation” in certain “Rule 506 offerings.” The rules governing the other component of Crowdfunding, where small issuers will be allowed to raise money through Internet portals from small, unsophisticated investors, will have to wait for later in the year.

Even so, these new regulations mark the largest change to the securities laws in almost 80 years. Companies will now be allowed to raise money from accredited investors (in the case of individuals, those with over $1 million of net worth or incomes over $200,000 per year) through social media, print materials, email, and other means. Not only will companies have greater access to the capital they need, but the new rules are likely to significantly disrupt the money-raising industry, displacing brokers, lawyers, and other middlemen just as the Internet has displaced so many middlemen before them.

Now the technical rules.

The rules allow general solicitation and general advertising where:

  • All purchasers are accredited investors; and
  • The company takes reasonable steps to verify that the purchasers are accredited investors; and
  • All of the requirements in Rule 501, Rule 502(a), and 502(d) are satisfied.

Whether the company has taken “reasonable steps” will be determined on a case-by-case basis. Among the relevant factors:

  • The type of accredited investor that the purchaser claims to be (e.g., the CEO of a Fortune 100 company or a store clerk).
  • The amount and type of information that the issuer has about the purchaser.
  • The nature of the offering, including the manner of the solicitation.

When the regulations were proposed last August, many people complained about the absence of hard-and-fast rules and the resulting ambiguity. The final rules take a large step in the direction of certainty by providing that a company will be considered to have taken reasonable steps to verify that a natural person is an accredited investor if it does any of the following:

  • If basing the decision on the purchaser’s net income:
    • Reviews W-2s, 1099s, or other IRS documents that report the person’s income for the past two years; and
    • Obtains a written representation that the person reasonably expects to reach the income level required to qualify as an accredited investor in the current year.
    • If basing the decision on the purchaser’s net worth:
      • Reviews one or more types of documents dated within the past three months, including bank statements, brokerage statements, tax assessments, and a report from one of the national consumer reporting agencies concerning liabilities; and obtains a written representation that the person has disclosed all liabilities necessary to make a net worth determination; or
      • Obtains a written representation from certain third parties, including registered broker-dealers or investment advisors, that they have taken reasonable steps to verify the person’s accredited investor status within the past three months and have determined that the person is an accredited investor; or
      • Permits existing security-holders who had acquired issuer securities in a previous Rule 506 offering and had qualified as accredited investors at that time to certify his or her accredited investor status at the time of the sale.

These steps are neither exclusive nor mandatory. The final rules also discuss other factors and procedures.

In addition to taking reasonable steps to verify that purchasers are accredited, the company must also have a reasonable belief that they are accredited. This has always been part of Rule 506 and was not changed by the JOBS Act.

NOTE:  These new rules offer enormous opportunities for entrepreneurs seeking to raise money for their existing businesses or start new businesses. Please contact us if you would like to discuss your idea.

Questions? Let me know.

SEC: FundersClub, AngelList Not Required To Register As Broker-Dealers

On By crowdfundattnyIn AngelList, Crowdfunding, Crowdfunding Portals, Entrepreneurs, FundersClub, Investing, Investor, LLCs, SECLeave a comment

Through “no-action letters” dated March 26, 2013, the Securities and Exchange Commission has just ruled neither FundersClub nor AngelList, both nationally-recognized equity-based Crowdfunding portals, is required to register as a broker dealer under Federal securities law.

But portals are structured as investment advisory services and are registered as investment advisors. When a company is funded by investors, the portals do not receive cash compensation, as a broker would typically receive, but instead receive compensation more customary for a fund advisor: an interest in the future profits of the company – a “carried interest.” The form of the compensation seemed to be the principal factor that convinced the SEC to rule favorably.

Other equity-based portals might register as broker-dealers to avoid the issue altogether. Because both of these coordinated decisions could have gone the other way, however, the larger lesson may be that the SEC is taking a relatively hands-off approach to the rapidly-evolving Crowdfunding industry. If you are a portal or company waiting anxiously for the SEC regulations later this year, that is good news.

Questions? Let me know.

When Can My Investors Sue Me?

On By crowdfundattnyIn Business Judgement Rule, Crowdfunding, D&O Insurance, Investing, Investor, JOBS Act, LLCsLeave a comment

You’ve raised money from investors, through Crowdfunding or otherwise. You did everything right through the money-raising process, such as disclosing all the right information. What are your obligations to the investors/shareholders as you now operate the company? Or, to ask the question in a more negative but practical way, when can they sue you successfully?

The exact answer depends primarily on (1) the state you chose to incorporate, (2) whether you are a corporation or a limited liability company, and (3) whether you included provisions in your governing instruments (Certificate of Incorporation, Operating Agreement) to protect yourself. State laws are not uniform and there can be enormous differences between LLCs and corporations.

Nevertheless, we will assume that you are in a “normal” state and that your lawyer prepared “normal” documents. That allows us to generalize by saying you can be sued successfully under these two circumstances:

  • You make business decisions that are unusually bad and careless.
  • You take actions that unfairly benefit yourself to the disadvantage of your company.

Under the laws of “normal” states, if you try your best, pay attention, review relevant information beforehand, and have the best interests of the company at heart, it is fairly hard to make a business decision so poor that you can be sued successfully by investors. The hands-off approach taken by statutes and courts in this area – referred to as the “business judgment rule” – recognizes that management must often make decisions without complete information, that decisions are easy to challenge with the benefit of hindsight, and that if investors were allowed to sue for every poor decision, judges could never take vacations.

It is much easier to be sued successfully where you take actions that unfairly benefit yourself to the disadvantage of your company. Examples:

  • You lease office space to your company for higher-than-market rent.
  • You borrow money from your company when you shouldn’t, or on unfair terms.
  • Your company is in the business of developing digital imaging software, but when you are approached by an inventor with a new technique, you form a new company with the inventor and don’t offer the opportunity to your old company.

Investors are an odd group inasmuch as when they lose their money they tend to be unhappy. This means that even before raising money you should:

  1. Make sure your governing instruments include the right language;
  2. Get good legal advice; and
  3. Get a quote for Director and Officer (“D&O”) insurance.

Questions? Let me know.

The Gold Rush – Part II

On By crowdfundattnyIn Crowdfunding, Crowdfunding Gold Rush, Crowdfunding Portals, Entrepreneurs, Investing, JOBS Act, KickstarterLeave a comment

Many young companies fail for lack of capital. With Crowdfunding making much more capital available, it seems plausible that more young companies will succeed. Even so, the nature of capitalism is that many will fail and investors will lose their money. And unfortunately, with so much money flowing through new channels, the nature of human beings is that Crowdfunding will attract its share of the outright unscrupulous.

You can never protect yourself completely, but here a few tips to reduce the risk.

If you are an Investor:

  • Use common sense. If something seems too good to be true it probably is.
  • A company financed by Crowdfunding is no more likely to be successful than a company financed the old-fashioned way.
  • One of the great things about Crowdfunding is that you get to see a lot of companies. It follows that you can afford to be picky.
  • By all means, register at more than one portal.
  • Don’t invest in a company just because others are investing.
  • Often, it makes sense to invest in industries you already know something about.
  • Make sure you are satisfied with the due diligence.
  • Figure out how much money the business must earn for your investment to be worthwhile, i.e., to earn a profit commensurate with your risk. Do you understand how the business will make that much money? If not, you probably shouldn’t invest.

If you are a Portal:

  • You are going to be swamped with companies looking to raise money. Your greatest risk is that a company you sponsor turns out to be a fraud. Beware:  con men are very good at what they do.
  • Develop strong contracts with companies and investors, making clear exactly what everyone can expect, and what they can’t.
  • Do not allow your portal to infringe upon the rights of third parties.
  • Comply with all laws and in particular the securities laws. When – not if – investors lose money, the chances are very high that you will be sued.
  • Buy insurance.

If you are a Company:

  • You are now using OPM – Other People’s Money. Your expenditure of every nickel may be scrutinized by a plaintiff’s lawyer with the benefit of 20/20 hindsight. Have strong accounting systems in place.
  • Develop strong contracts vis-a-vis investors.
  • Disclose everything about your company up front, especially all the bad news, and otherwise comply with Federal and State securities laws. Your greatest risk, by far, is that you fail to comply with these laws.
  • Make sure your portal is reputable and complies with the law also. If the portal doesn’t comply, you are going to be sued.
  • Try to raise enough money the first time around.
  • Make sure your corporate structure allows you flexibility in the future, including the flexibility to raise more money.
  • Buy insurance.

Questions? Let me know.

The Gold Rush – Part I

On By crowdfundattnyIn Crowdfunding, Crowdfunding Gold Rush, Crowdfunding Portals, Entrepreneurs, Investing, JOBS Act, Kickstarter, SECLeave a comment

A man and woman created a Crowdfunding campaign for their newborn. A company raised $2 million in one day. The SEC regulations to launch “real” Crowdfunding per the JOBS Act might be far off, but the Crowdfunding gold rush is already well underway.

The excitement – the discovery of an enormous vein of money flowing into a brand-new channel – holds many opportunities. If you are an entrepreneur looking for funding there have never been more places to look. No longer beholden to a broker or a wealthy aunt or a lawyer with a big Rolodex, every entrepreneur now has ready access to the biggest Rolodex in the world: the Internet.

Seizing their own opportunity, Crowdfunding portals are springing up like Western mining towns with names that can become nationally-recognized overnight. Circle Up, SeedInvest, and Funders Club are among the equity-based portals while Kickstarter and Indiego remain the leaders in donation- or rewards-based projects, at least for the time being. New portals are being formed and coming online all the time as eager prospectors look for their share of the gold.

Others are poised to benefit as well:

There is an enormous and growing need for someone to perform meaningful due diligence on all the new companies, beyond the information that might be posted online. The new structures and relationships will require new insurance products, some of which are already being developed. If it hasn’t happened already, someone is going to offer to represent Crowdfunding investors on the Boards of Directors of far-flung companies. Every company funded by the Crowd will need an investor relations platform.

With so few barriers to entry, the opportunity to stake a claim in the Crowdfunding gold rush is practically unlimited today.

Bear in mind, all this is happening before true JOBS Act Crowdfunding springs to life, probably by late summer. When that happens, companies will be able to legally raise money from large numbers of non-affluent, unsophisticated investors for the first time in 80 years, uncovering the largest vein of capital yet.

One thing seems certain. With all the gold and all the gunslingers, some things will go wrong and some people will get hurt. In our next post, we’ll offer some pointers so you’re not one of them.

Questions? Let me know.