Tag: JOBS Act

Improving Crowdfunding Legal Documents

On By crowdfundattnyIn Crowdfunding, Legal DocumentsLeave a comment

I don’t know much about videos or marketing, but I know a lot about legal documents. In a series of posts I’m going to suggest improvements to some of the legal documents used in Crowdfunding. Most of the time, I’ll suggest actual language a portal or issuer can cut and paste – after talking with a lawyer, of course.

By and large, the legal documents you see on Crowdfunding websites were pulled from other deals. For example, the Operating Agreement you see on a real estate Crowdfunding website is usually the same document the lawyer used for pre-Crowdfunding deals. And in many respects that’s okay because legal documents are pretty agnostic as to industry.

But in other respects it’s not okay. Sometimes you have to tailor the legal document to the industry.

An example is the section of the Operating Agreement that talks about an investor’s right to information. The provision from one well-known site says that the records of the company “. . . shall be available at the Company’s principal office for inspection and copying by any Member at any and all reasonable times during normal business hours at such Member’s expense.” Another says “A Member and the Member’s authorized representative shall, upon reasonable request and for purposes related to the interest of that Member, have reasonable access to, and may inspect and copy, during normal business hours all books, records and other materials pertaining to the Company or its activities.”

No! These provisions were typical in the pre-Crowdfunding world, but they don’t work with Crowdfunding.

You might have 218 investors in a Crowdfunding deal. You have to limit the right of investors to come to your office to inspect the books, and you have to limit what they can see. Under the Delaware limited liability company statute, if you don’t provide otherwise, your investors have the right to see basically everything, including a list of all the other investors. With one or two unscrupulous or irrational investors, that’s a recipe for losing sleep.

We want to:

  • Be fair to investors and provide all the information they need
  • Avoid spending an inordinate amount of management time dealing with bad apples
  • Protect your confidential information
  • Avoid dealing with 218 investors each asking for the same information
  • Give you discretion to protect your business and the interests of your investors

For an example of actual legal language that does just that while, I believe, fully complying with the Delaware Limited Liability Company Act, click here.

Questions? Let me know.

Choosing And Protecting A Name For Your Crowdfunding Business

On By crowdfundattnyIn Crowdfunding, Crowdfunding Articles, Crowdfunding Real Estate, Investing, Investor, LLCs, Real Estate, Technology PlatformsLeave a comment

Names matter, even for a local business, but they matter a great deal for a Crowdfunding business, where your customers know you only from a distance.

Generally speaking you can choose three kinds of names:

  • A name that describes what you do, e.g., Real Estate Crowdfunding Portal, LLC.
  • A name with no inherent meaning, e.g., Xeta, LLC.
  • A name somewhere in between, e.g., Lifelong Investments, LLC.

Each category has advantages and disadvantages:

  • A name that describes what you do…well, it describes what you do. When a consumer sees the name she knows what you’re selling. On the other hand, a name that describes what you do is often not very memorable.
  • The strongest names are those that start out with no inherent meaning. Amazon, Starbucks, E-Bay. When consumers think of Amazon they think about the gigantic online retailer, nothing else. The name is worth a billion dollars! On the other hand, Amazon had to spend more than a billion marketing dollars to give meaning to a name that otherwise belonged to a river.
  • A name somewhere in between is somewhere in between. It might be sexier than a name that is merely descriptive and require a lot less marketing fuel than a name with no meaning, but with the associated disadvantages as well.

In the Crowdfunding industry to date, most portals have chosen the more descriptive over the more powerful. Poliwogg is an exception. Fundrise might be another.

With two well-known Crowdfunding companies – Crowdentials and VerifyInvestors – we see two different approaches to choosing a name. And we can’t say for certain whether one is better than the other. That will depend on what each company does with its name.

Having chosen a name, how do you protect it?

To start with, a business acquires “common law” rights to a name merely by using it, without filing anything with the government and without involving lawyers. If another real estate Crowdfunding portal tried to use the Fundrise name today they couldn’t do it, even if the Miller brothers had never done anything to protect their name (they have).

Contrary to common belief, merely registering a company name with the state by forming a corporation or other entity provides no real protection. State filings are simply a matter of bureaucracy – the state wants to make sure that no two names are confusingly similar on its own records.

For the best protection, however, the business owner should obtain a Federal trademark from the U.S. Patent and Trademark Office. A Federal registration provides important benefits, including:

  • The registration constitutes “constructive notice” to all later users in all locations.
  • The registration permits the owner to get an injunction against a trademark infringer and sue for damages, including profits, costs, treble damages and attorneys fees.
  • The registration can strengthen the value of the name as a corporate asset.
  • The registration demonstrates your right to use the name to the owners of other websites, such as Google, Facebook, and Twitter, which are often called on to “officiate” disputes over names.

The trademark application process normally takes about a year, assuming no significant problems. Once granted, a trademark registration can last forever if continuously used and renewed.

NOTE: Not every name can be trademarked. A name like “Real Estate Crowdfunding Portal,” which merely describes the product or service, probably cannot be registered by itself. But it might be registered with a distinctive logo.

Finally, don’t forget to acquire the domain name.

Questions? Let me know.

Crowdfunding To Foreign Investors Through Regulation S

On By crowdfundattnyIn Crowdfunding, Regulation S, SEC, Securities Exchange CommissionLeave a comment

crowdfunding_investorMost portal operators think sooner or later about raising money from foreign investors. SEC Regulation S offers a convenient mechanism to do just that.

Regulation S allows a U.S. company to sell debt or equity securities to foreign investors under the following conditions:

  • The issuer must reasonably believe that the investors are offshore.
  • The issuer may not engage in any “direct selling efforts” in the U.S.
  • For debt securities, sales to U.S. persons are prohibited for 40 days. For equity securities, the period is increased to one year.
  • Various legends and Bylaw provisions are required to enforce the prohibition on U.S. sales.

(Careful readers will note that none of these requirements is geared toward protecting the foreign investors. Instead, all of the requirements are geared toward ensuring the the securities are sold only to foreigners. As a U.S. regulatory agency, the SEC simply has no jurisdictional mandate to protect foreign investors.)

Three features make Regulation S especially useful for Crowdfunding portals and issuers:

  • A Regulation S offering may be conducted using general solicitation and advertisement, i.e., through Crowdfunding.
  • A Regulation S offering to foreign investors may be conducted concurrently with a Regulation D offering to U.S. investors, even for the same securities.
  • Under Regulation S, the issuer can be indifferent as to whether foreign investors are accredited.

That’s not the end of it, of course. Other countries have their own securities laws and their own SEC’s, and a U.S. issuer must comply with those rules as well.

Questions? Let me know.

Update On Accredited Investor Definition

On By crowdfundattnyIn Accredited Investor, Crowdfunding, Investor, JOBS Act, SEC, UncategorizedLeave a comment

I wrote to my close friend Mary Jo White, the Chair of the SEC, urging that the SEC expand, rather than restrict, the definition of accredited investor. My letter is here.

SEC letter_Roderick

Questions? Let me know.

Carriages, Cars, And Policeman – By Scott Picken, Senior Managing Partner of Wealth Migrate

On By crowdfundattnyIn Crowdfunding, Investing, JOBS Act, Real Estate, UncategorizedLeave a comment

WM ScottBy: Scott Picken, Founder & Senior Managing Partner of Wealth Migrate.

I’m Scott Picken, the founder and Senior Managing Partner of Wealth Migrate. Our investment committee has collectively 227 years of experience in international real estate. We have facilitated 10,779 investments to a value of over $1.3 billion and invested on five continents. We’re passionate about Crowdfunding as an enabler of our current business, helping to make everything more efficient, accessible, and transparent.

When I spoke at the Coastal Shows event in New York City at the end of June, many of those speaking and attending seemed to believe that Crowdfunding was invented in America in 2012. Far from it! In Australia and elsewhere around the globe, companies have been Crowdfunding for years. At this moment I’m returning from a Crowdfunding conference in Singapore, which was conservatively speaking 10 times the size of the New York City event.

Why invest globally? Because real estate markets do not all move in synch. When the U.S. market was plummeting in 2007-8, the Australian market was doing quite well, actually growing on average by 8.6% in 2009. And if anyone hasn’t noticed, the U.S. dollar has lost about 72% of its value against other major currencies over the last 10 years. No one market, not even the U.S., can protect itself against that kind of loss.

It is just like in nature. When winter comes in the Northern hemisphere the birds fly south and when summer returns they fly north. Migration is a law of nature, and yet we humans remain firmly planted in one place, winter and summer. It is why we called our company Wealth Migrate, as in the 21st century it is about finding the safest and best returns, globally.

Robert Kiyosaki, the author of Conspiracy of the Rich and Jim Rogers in Street Smarts, both teach that the easiest way to get rich is to follow long-term trends. If the globalization of the international economy is not a long-term trend, then I don’t know a long-term trend.

Actually, globalization is not enough – just try selling American cheeseburgers in China. At Wealth Migrate we believe in glocalization, which means thinking globally and acting locally. McDonald’s modifies its menu to fit local tastes and we find best-of-breed partners on the ground in local markets and then partner with them. A bird in a flock can fly 70% further than a bird flying on its own.

Read my book, Property Going Global. It’s all about successful investing in foreign markets.

When I read Ben Miller’s post about the problems he faced with his first Crowdfunding offering, I knew exactly what he was talking about. You can’t imagine how many accountants and lawyers told us “No!” when we started to look at the U.S. investor market and the opportunities in the US. With everyone using the Internet for everything, with Twitter literally driving the Arab Spring, the investment world needed to change from horse-drawn carriages to automobiles and these “experts” were like policemen not giving us a license to drive a car. It just about drove me crazy but fortunately not so crazy that I gave up.

In 1998 I wrote a dissertation about the real estate market and the coming IT revolution. My synopsis said “taking an old industry, steeped in tradition and run by many smaller, disparate and often inefficient operators, and redefining it through the use of web technology to increase global reach, partnerships and efficiencies of scale, so as to provide a ‘one stop’ enhanced and personalized service to our clients.” I didn’t realize then that I was talking about Crowdfunding, the real estate finance market, and Wealth Migrate, but that sums up our business model pretty well.

Look, almost 50% of the world’s wealth is held in real estate yet only a small fraction of the world’s population (12.9%) owns real estate, much less has access to great deals. I am a firm believer in the business philosophy of Zig Ziglar that “You can have anything you want in life if you help enough other people get what they want.” The Afrikaans say “Ver van jou goed, na aan jou skade,” which loosely translated means “Keep your assets close to home, if you don’t want to lose them.” But in the 21st century that is no longer true. To give millions of individuals what they want, we need to look beyond our own homes, even beyond our own national borders, and ultimately help create global wealth for all.

In my opinion it’s a great time for cars, not a great time for carriages or outdated policemen, but the cars do need to be driven safely. It is all about trust, transparency and most importantly everyone’s interests being aligned. You are no longer bound to a country, a currency, an economy or even an asset class. I believe it is less about where you live and more important about where you wealth lives.

 

Title III And The Evolution Of Business Law

On By crowdfundattnyIn Crowdfunding, Entrepreneurs, JOBS Act, SECLeave a comment

I’m not optimistic about Title III for the usual reason:  I think the cost of complying with the statute will prove too high. I’ve even proposed my own fix to the statute. But there are plenty of smart people who think otherwise, including Ron Miller of StartEngine, and ultimately opinions don’t matter. The market will decide whether Title III can work in its current form.

The SEC proposed regulations last October 23rd and the comment period ended long ago. Rather than wait for the statute to improve, I’m ready for the SEC to consider the comments, make changes to the proposed rules as it sees fit, finalize the regulations, and let the market do its job.

Whatever the defects of current Title III, and there are many, chances are they will be fixed over time. Time after time, almost from the beginning of time, the legal system has responded to the needs of the business community. Examples:

  • Hundreds of years ago, governments created corporations in direct response to the need of traders and investors to limit liability on foreign adventures.
  • With the advent of income taxes in the 20th century, business people had to choose between the limited liability of a corporation and the pass-thru tax treatment of a general partnership. But not for long. Soon legislatures created limited partnerships and S corporations, providing the best of both worlds.
  • When defects were discovered in limited partnerships and S corporation – for example, the risk that limited partners could face unlimited liability – legislators fixed them and fixed them until, lo and behold, Wyoming created an even better entity, the limited liability company we all know and use today (which, in turn, has already been improved).
  • Private placements have always been legal, regulated by the SEC through no-action letters and other guidance. But the private placement market needed clear rules. Hence, Regulation D in 1982. And now Title II of the JOBS Act has improved Regulation D by adding Rule 506(c).
  • Since I have been practicing law (less than a century) the corporate laws of most jurisdictions, including Delaware, have improved dramatically, as state legislatures respond to the needs of businesses large and small.

There are two things you never want to see being made:  sausage and law. But over time, commercial laws do change, usually for the better. If Wyoming can invent limited liability companies, surely we and our Federal government can improve Title III as the need becomes apparent.

So with malice toward none, with charity toward all, let’s stop debating whether Title III can work and let the market figure it out.

Questions? Let me know.

The Decision-Making Ability Of Crowds Vs. Experts: A Case Study

On By crowdfundattnyIn Crowdfunding, JOBS Act, KickstarterLeave a comment

Ethan Mollick of the Wharton School of the University of Pennsylvania and Ramana Nanda of the Harvard Business School collaborated recently on a Working Paper captioned Wisdom or Madness? Comparing Crowds with Expert Evaluation in Funding the Arts. The full Working Paper, which I recommend for everyone in the Crowdfunding space, academic or otherwise, is available here.

Professors Mollick and Nanda seek to compare the decisions of crowds with the evaluations of experts in a rigorous academic study.

Using data supplied by Kickstarter, the authors focus on campaigns involving theatrical projects, which
involve both a highly subjective judgment about artistic merit and a predictive judgment about commercial success. On one hand, the data from Kickstarter indicate which projects were funded by the crowd. On the other hand, the authors obtained evaluations from a panel of industry experts, in this case recognized theater critics. The authors were then able to compare the judgments of the crowd to the evaluations of the industry experts.

The results were illuminating:

  • There was a very high correlation between the judgment of the crowd and the evaluations of the experts. In this respect the study seems to strongly confirm the ability of crowds to make good decisions.
  • Where the crowd and the experts disagreed, the crowd tended to be more positive than the experts, i.e., the crowd funded projects that the experts would not have funded. Moreover, those projects turned out to be no less successful than projects approved by the experts. As the authors put it, “Overall, our findings suggest that the democratization of entry that is facilitated by Crowdfunding has the potential to lower the incidence of ‘false negatives.’”
  • Projects funded by the crowd tended to share certain characteristics, suggesting that “there is an ‘art’ to raising money from crowds.” According to the authors, “The crowds seem to place emphasis on, or extract information content from different attributes of the process than experts.”

I find this fascinating and instructive. For one thing, the finding that industry experts tend to be overly negative correlates with my own experience in the world of law and venture funding. More important, the study suggests that in a world where access to capital is controlled by experts the likelihood is that good projects will go unfunded.

That insight has enormous implications for the capital formation industry and the world economy. If more worthwhile projects are funded, with the accompanying economic growth, that is a strong justification for Crowdfunding. And if crowds tend to avoid false negatives, then it makes sense for the U.S. to adopt a robust Title III as soon as possible.

I want to thank Professors Mollick and Nanda for making me aware of this study and for their continuing work in this space. As this study illustrates, the academic world has important lessons for portals, lawyers, legislators, investors, and everyone else in Crowdfunding.

Questions? Let me know.

A Constructive Approach To Accredited Investor Definition

On By crowdfundattnyIn Accredited Investor, Crowdfunding, Dodd-Frank Act, JOBS Act, SECLeave a comment

crowdfunding_investorSection 413(b) of Title IV of the Dodd-Frank Act allows the SEC to evaluate the current definition of “accredited investor,” which has been in place since 1982, and to revisit the issue at four year intervals. As the SEC deliberates, alarm bells are sounding in the industry, warning that a new definition could destroy not only the nascent Crowdfunding industry but the entire ecosystem around private capital formation.

Though well-intended, these warnings are misguided, in my opinion.

If the SEC indexed the existing definition to the CPI over the last 32 years, leading to an income threshold of about $500,000 and a net worth threshold of about $2.5 million, the effect would indeed be devastating, with only star athletes and Google employees allowed to invest. However, I see no reason to believe the SEC has anything like that in mind, for several reasons:

  • The SEC could have changed the definition on its own initiative at any time over the last 32 years but hasn’t.
  • Not only has the SEC not changed the definition, it has never expressed any particular concern with Rule 506, where most private placements take place.
  • Most important, the Dodd-Frank Act instructs the SEC to modify the definition “as the Commission may deem appropriate for the protection of investors, in the public interest, and in light of the economy.” In my own extensive but necessarily anecdotal experience, I have seen no evidence that the current income or net worth requirements fail to protect investors or, for that matter, that they are particularly relevant to protecting invesors. In the absence of widespread problems, there is simply no reason to make the definition more stringent than it is today and, given the Congressional mandate to keep one eye on the economy – that is, on the economic benefits of making capital available – there are probably stronger reasons to relax the current definition.

According to the Chairman of the SEC, Mary Jo White, the SEC is considering a more nuanced definition of accredited investor, one that takes into account not just income and net worth but also financial sophistication. That sounds right to me.

For now, the best way to help the SEC adopt a sensible definition of accredited investor is to provide real data. If you have reliable information about the incidence of fraud in private placements, for example, or about the correlation (or lack thereof) between financial sophistication and annual income, the SEC would love to see it. Feel free to send it to me and I will forward it.

In the meantime, don’t worry. . . .too much.

Questions? Let me know.

Investor Verification: Questions & Answers from The SEC

On By crowdfundattnyIn Investor, Investor Verification, Rule 501(a)(5), SEC, Securities Exchange CommissionLeave a comment

The SEC recently issued four questions and answers dealing with investor verification.

Question #1

If a purchaser’s annual income is not reported in U.S. dollars, what exchange rate should an issuer use to determine whether the purchaser’s income meets the income test for qualifying as an accredited investor?

Answer: The issuer may use either the exchange rate that is in effect on the last day of the year for which income is being determined or the average exchange rate for that year.

Question #2

Can assets in an account or property held jointly with another person who is not the purchaser’s spouse be included in determining whether the purchaser satisfies the net worth test in Rule 501(a)(5)?

Answer: Yes, assets in an account or property held jointly with a person who is not the purchaser’s spouse may be included in the calculation for the net worth test, but only to the extent of his or her percentage ownership of the account or property. [July 3, 2014]

Question #3

Rule 506(c)(2)(ii)(A) sets forth a non-exclusive method of verifying that a purchaser is an accredited investor by, among other things, reviewing any Internal Revenue Service form that reports the purchaser’s income for the “two most recent years.” If such an Internal Revenue Service form is not yet available for the recently completed year (e.g., 2013), can the issuer still rely on this verification method by reviewing the Internal Revenue Service forms for the two prior years that are available (e.g., 2012 and 2011)?

Answer: No, the verification safe harbor provided in Rule 506(c)(2)(ii)(A) would not be available under these circumstances. We believe, however, that an issuer could reasonably conclude that a purchaser is an accredited investor and satisfy the verification requirement of Rule 506(c) under the principles-based verification method by:

  • Reviewing the Internal Revenue Service forms that report income for the two years preceding the recently completed year; and
  • Obtaining written representations from the purchaser that (i) an Internal Revenue Service form that reports the purchaser’s income for the recently completed year is not available, (ii) specify the amount of income the purchaser received for the recently completed year and that such amount reached the level needed to qualify as an accredited investor, and (iii) the purchaser has a reasonable expectation of reaching the requisite income level for the current year.

Where the issuer has reason to question the purchaser’s claim to be an accredited investor after reviewing these documents, it must take additional verification measures in order to establish that it has taken reasonable steps to verify that the purchaser is an accredited investor. For example, if, based on this review, the purchaser’s income for the most recently completed year barely exceeded the threshold required, the foregoing procedures might not constitute sufficient verification and more diligence might be necessary.

Question #4

A purchaser is not a U.S. taxpayer and therefore cannot provide an Internal Revenue Service form that reports income. Can an issuer review comparable tax forms from a foreign jurisdiction in order to rely on the verification method provided in Rule 506(c)(2)(ii)(A)?

Answer: No, the verification safe harbor provided in Rule 506(c)(2)(ii)(A) would not be available under these circumstances. In adopting this safe harbor, the Commission noted that there are “numerous penalties for falsely reporting information” in Internal Revenue Service forms. See Securities Act Release No. 33-9415 (July 10, 2013). Although the safe harbor is not available for tax forms from foreign jurisdictions, we believe that an issuer could reasonably conclude that a purchaser is an accredited investor and satisfy the verification requirement of Rule 506(c) under the principles-based verification method by reviewing filed tax forms that report income where the foreign jurisdiction imposes comparable penalties for falsely reported information.

Where the issuer has reason to question the reliability of the information about the purchaser’s income after reviewing these documents, it must take additional verification measures in order to establish that it has taken reasonable steps to verify that the purchaser is an accredited investor.

The Takeaway

The lesson is that issuers and portals should not try to verify investors on their own. Leave that to a third party service like Crowdentials or VerifyInvestor – they keep track of these rules so you won’t have to.

Questions? Let me know.

Our Experience With Regulation A – by Ben Miller, Co-Founder of FundRise

On By crowdfundattnyIn Crowdfunding, Crowdfunding Portals, Crowdfunding Real Estate, Guest Blog, JOBS Act, Regulation ALeave a comment

To improve the user experience, I am inviting guest bloggers. The first is Ben Miller, a Co-Founder of Fundrise, who explains how he and his brother Dan invented Crowdfunding through Regulation A.

Please let me know if you would like to post. I’m looking for content like Ben’s – interesting, informative, educational.

-MARK RODERICK

____________________________________________________________________________________

By: Ben Miller, Co-Founder of Fundrise.

My brother Dan and I were in the real estate business for a long time, developing commercial and residential projects in the Washington, D.C. area, before we thought about crowdfunding. We got some of our capital from the same place many real estate developers get their capital: from investment funds in New York or even outside of the country.

Most of them had little connection to the places we were building and often had never even heard of the neighborhood. On the other hand, our friends and neighbors, people with real connection to the projects, couldn’t invest with us.

fundriseWe started to imagine a world where everyone could invest in high-quality real estate deals, which were then limited to professional investors. We thought about ordinary people investing in their own communities, creating a win-win for the community and business owners. Like every other developer, we’ve had our share of battles with local zoning agencies. We imagined how that process might change if actual investors from the community showed up at council meetings to support the project.

This was before crowdfunding or the JOBS Act were on the table, and every lawyer we spoke to (and we spoke to plenty) told us that our idea was impossible.

Finally we discovered SEC Regulation A. Although Regulation A had been around since 1936, before we came along it had been used very rarely, which probably explains why the lawyers hadn’t heard about it. In all of 2012 fewer than a dozen companies had used Regulation A to raise capital across the whole country, as compared to more than 7,000 Regulation D offerings.

We soon found out why. Although Regulation A allows you to raise money from anybody, including from non-accredited investors, first you have to file a disclosure document with the SEC and with the state securities regulators in any state where you offer the security, and get the regulators to approve your offering. Regulation A is nothing like the new Crowdfunding under SEC Rule 506(c), which is simple and streamlined by comparison.

Once we figured out how to file the disclosure document, which is really like a mini registration statement, we learned that neither the SEC nor the state regulators had ever seen a real estate development project offered under Regulation A. We spent hundreds of hours and way too much in legal fees working through all of the issues. We were literally doing something that had never been done in the history of the U.S. capital markets, and at the same time paving the way for everyone else.

After lots of work, lots of frustration, and lots of conversations with regulators, we succeeded. Our Regulation A filing was approved and we raised $325,000 for the project. I won’t even tell you how much it cost to raise that $325,000, but we were okay with it because we saw the experience then, and still do, as an investment in our future.

We have completed three Regulation A offerings since then. Each time we’ve gotten better and faster, not to mention that the regulators have learned along with us.

Here’s what it took to complete our most recent Regulation A offering:

reg a breakdown

Our most recent filing:

fedex

Fundrise has branched out since those early days. As the leading real estate portal in the world we offer not only Regulation A projects but Rule 506(c) investments under the JOBS Act. And we’re very excited about the new Regulation A+. Regulation A+ improves on Regulation A by allowing us to raise up to $50 million of equity from non-accredited investors (subject to a limitation on how much each person can invest) and further streamline the process by filing only with the SEC, and not with state securities regulators. Fundrise has always been a pioneer, and we expect to pioneer the possibilities of Regulation A+ as well as soon as it becomes available.

Whatever the future holds for Fundrise, and we believe our future is unlimited, we’ll always remember that Regulation A allowed us to open the door into the world of crowdfunding and give unaccredited investors the chance to invest in real estate for the first time in history.

Follow @BenMillerise and @Fundrise on Twitter.