Tag: Title II Crowdfunding

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

On By crowdfundattnyIn Crowdfunding, Portals, Title II, Title II Crowdfunding, Title III, Title III CrowdfundingLeave a comment

CF Portal Mall

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

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

Now consider these situations:

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

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

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

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

Questions? Let me know.

Crowdfunding Interview

On By crowdfundattnyIn Crowdfunding, Crowdfunding Interviews, Crowdfunding Speaking EngagementsLeave a comment

Last Thursday I joined Jack Miller, the host of “Down to Business” on 880 AM The Biz in Miami, for a discussion about Crowdfunding and what it means for entrepreneurs and investors. Jack is a terrific interviewer and an entrepreneur himself, and brings a great perspective to the subject.

We had a lot of fun and might have even shed some light on this brave new world for Jack’s listeners.

Caution:  material not appropriate for all ages.

Questions? Let me know.

Crowdfunding Is Just the Internet

On By crowdfundattnyIn Crowdfunding, Crowdfunding Laws, Crowdfunding PortalsLeave a comment

red mouse with money and comment

Fortunately for me, there are a lot of complicated legal issues around Crowdfunding, including:

  • The differences among Title II, Title III, and Title IV
  • The differences between Rule 506(b) offerings and Rule 506(c) offerings
  • The differences between accredited investors and non-accredited investors
  • The Trust Indenture Act of 1939
  • The Investment Company Act of 1940
  • Applying broker-dealer and investment adviser laws to Crowdfunding portals

But at a higher level Crowdfunding isn’t complicated at all. Crowdfunding is just the Internet coming to the capital formation industry.

What happens when the Internet comes to an industry? Look at the publishing industry and the travel industry and the music industry and, increasingly, the entire retail industry:

  • Buyer and sellers connect directly
  • Middlemen are displaced
  • Prices decrease as the industry becomes more efficient
  • The middlemen being displaced are sure it won’t happen as it’s happening
  • In the end, the industry looks completely different and we all take it for granted

In Crowdfunding, the “sellers” are entrepreneurs and real estate developers seeking capital and the “buyers” are investors. The middlemen are the lawyers, bankers, finders, brokers, venture capital funds, investment advisors, and all the others who for the last 80 years have played an indispensable part in connecting entrepreneurs with investors. Today, for the first time, entrepreneurs and investors can connect directly, via the Internet. The middlemen have already started to be pushed to the side. The picture in my mind is an ice field slowly breaking apart as temperatures warm.

People sometimes ask whether Crowdfunding will last. I respond “When was the last time you planned a vacation through a bricks-and-mortar agency?” The Internet is here to stay!

The capital formation industry is enormous – far, far bigger than the book selling industry or the travel industry. And the middlemen in the capital formation industry enjoy far greater political power than Barnes & Noble. But in the end, resistance is futile.

As you’re planning and managing your own portal, or any other Crowdfunding business, pause every now and then and remember that for all the legal complexity, for all the nuts-and-bolts, day-to-day grind of generating cash flow, Crowdfunding is nothing more or less than the Internet come to the capital formation industry.

Questions? Let me know.

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

On By crowdfundattnyIn Crowdfunding, Crowdfunding Portals, Investing, Investor Disclosures, Portals, SEC, Title II, Title II CrowdfundingLeave a comment

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

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

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

There are at least three things wrong with this approach:

• Investors can’t be happy with it.

• It doesn’t convey information effectively.

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

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

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

Questions? Let me know.

Title II Needs Company

On By crowdfundattnyIn Crowdfunding, Entrepreneurs, Fundrise, Title II, Title II CrowdfundingLeave a comment

Statue of Lib CF_Purchased

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

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

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

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

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

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

Title II has been lonely for too long!

Find My Congressman and Senators

Sample Email

Questions? Let me know.

Crowdfunding And The Trust Indenture Act Of 1939

On By crowdfundattnyIn Crowdfunding, JOBS Act, Regulation A, Trust Indenture Act of 1939Leave a comment

Handing over moneyThe Securities Act of 1933. The Exchange Act of 1934. The Investment Company Act of 1940. Those are the pillars of the U.S. securities laws, as relevant today as they were 80 years ago. And here’s one more old law relevant to Crowdfunding: the Trust Indenture Act of 1939.

Here’s the idea. A company issues its promissory notes (obligations) to a large group of investors. If the company defaults on one or two notes, it might not be financially feasible for those particular investors to take legal action. Even if the company defaults on all the notes it will be a mess sorting out the competing claims. Which investor goes first? If there is collateral, which investor has priority? At best it’s highly inefficient, economically.

The Trust Indenture Act of 1939 imposes order and economic efficiency. It provides that where a company issues debt securities, like promissory notes, it must do so pursuant to a legal document called an “indenture” and, most important, with a trustee, normally a bank, to represent the interests of all the investors together. The TIA goes farther:

  • It provides that the indenture document must be reviewed and approved by the SEC in advance.
  • It ensures that the trustee is independent of the issuer.
  • It requires certain information to be provided to investors.
  • It prohibits the trustee from limiting its own liability.

Why don’t Patch of Land and other Crowdfunding portals that issue debt securities comply with the TIA? Because offerings under Rule 506 are not generally covered by the law. Conversely, because Lending Club and Prosper sell publicly-registered securities (their “platform notes”), they are covered, and have filed lengthy indenture documents with the SEC.

The real surprise is with Regulation A+. If a Regulation A+ issuer uses an indenture instrument to protect the interests of investors then it will be subject to the TIA and its extensive investor-protection requirements. If the issuer does not use an indenture, on the other hand hand, it will not be subject to the TIA as long as it has outstanding less than $50 million of debt. That’s a strange result – giving issuers an incentive not to use an indenture even though indentures protect investors.

That’s what happens sometimes when you apply very old laws to very new forms of economic activity. Welcome to Crowdfunding.

Questions? Let me know.

The Next Big Thing In Crowdfunding: Pooled Assets

On By crowdfundattnyIn Crowdfunding, Entrepreneurs, Investing, JOBS Act, SEC, Title II CrowdfundingLeave a comment

September 23rd marks the first anniversary of Title II Crowdfunding. The number of portals has grown exponentially but most or all portals continue to offer investments in single deals, e.g., an apartment building in Austin. Before long, I believe the market will shift to investments in pools of assets. Rather than the single apartment building in Austin, a portal will list a pool of 20 apartment buildings in the Southwest.

Accredited or not, very few individual investors have the knowledge or experience to invest in individual deals. And based on the stock market, most individual investors don’t want to. Individuals have historically preferred mutual funds over individual stocks; a mutual fund is just a form of pooled assets.

An investor can create his own pool, investing $5,000 in each of 20 apartment buildings rather than $100,000 in a single property. On Prosper or Lending Club, I bet most investors participate in multiple loans.

But that doesn’t give consumers quite what they want. What they want is a fund manager, someone who will choose the 20 apartment buildings and also decide when to sell them. A stock market investor who wanted to creat her own pool could buy 20 individual stocks, but instead she buys a mutual fund.

Do Crowdfunding investors view the portals themselves as mutual funds? Maybe investors expect Fundrise, Patch of Land, Wealth Migrate, or iFunding to play the role of the mutual fund manager, selecting only deals worthy of investment. On the advice of counsel, every portal tries hard to disclaim that legal responsibility, but maybe investors ignore the disclaimers, looking for a “brand” for investing.

I certainly expect portals to start offering asset pools. I’ll go out on a limb and say the first portal offering curated pools will have a great competitive advantage, and I’ll go further and say that Crowdfunding won’t reach its potential until pooled asset investments are widely available.

Pooling assets makes things a bit more complicated and a bit more expensive: more legal rules come into play; you have to think harder about giving investors liquidity; and, most important, you have to pay someone to make investment decisions and take the legal risk. But that’s where the market is headed.

Questions? Let me know.

Crowdfunding.Biz Interview

On By crowdfundattnyIn Crowdfunding, Crowdfunding Interview, Crowdfunding.Biz InterviewLeave a comment

CFBizJosef Helm runs a terrific site called crowdfunding.biz focused on the Crowdfunding industry. This week Josef interviewed me as part of his Crowdfunding Industry Spotlight series. He asked how I got into the Crowdfunding industry, my advice for those getting in today, my hopes and expectations for the future of Crowdfunding, and a bunch of other illuminating questions.

If you’re interested, my interview is here. But as long as you’re at the site, take a look at the eight other people Josef has identified as industry leaders, people like Richard Swart and Joy Schoffler. Responding to the same questions, you might find their answers more interesting.

I’m honored to have been selected. Josef, thank you for what you do in this space.

Questions? Let me know.

The Federal Basis For Intra-State Crowdfunding

On By crowdfundattnyIn Intra-State Crowdfunding, JOBS Act, SEC, SEC Rule 147, Title III, Title III CrowdfundingLeave a comment

Texas is the latest of a half dozen states to propose an intra-state Crowdfunding law. Typically, these laws allow issuers to raise money from non-accredited investors, even before Title III of the JOBS Act comes into effect, as long as all the investors are residents of the state in question and the offering satisfies requirements that vary from state to state.

At the Austin event, an audience member asked a very good question: If I comply with the Texas law, do I also have to comply with a Federal law? The answer is a qualified Yes.

Federal law begins with the proposition that securities may not be issued unless registered under the Securities Act of 1933. However, section 3(a)(11) of the Act provides an exemption for:

Any security which is a part of an issue offered and sold only to persons resident within a single State or Territory, where the issuer of such security is a person resident and doing business within or, if a corporation, incorporated by and doing business within, such State or Territory.

Thus, Federal law includes an exemption for some purely intrastate offerings.

SEC Rule 147 (17 CFR 230.147) provides a “safe harbor” under section 3(a)(11). Where all the conditions of Rule 147 are satisfied, the SEC will assume that the offering is exempt from Federal registration:

  • The issuer may neither offer nor issue any securities within the six month period before the first offer or sale of the intrastate offering nor within six months after the last offer or sale of the intrastate offering.
  • The issuer must be incorporated in the state where the offering is made. (Caution: Many lawyers use Delaware entities as a matter of course. Unless you’re in Delaware, don’t.)
  • At least 80% of the issuer’s revenues must come from business within the state.
  • At least 80% of the issuer’s assets must be located in the state.
  • At least 80% of the money raised in the offering must be used in the state.
  • All of the investors in the offering must be residents of the state.
  • While the offering is being conducted and for nine months thereafter, all resales must be to state residents.
  • The issuer must place a legend on stock certificates referencing these restrictions, and take other steps to ensure that the offering remains intrastate only.

Rule 147 is just a “safe harbor.” An intrastate offering that does not satisfy all of these conditions might still qualify for the statutory exemption under section 3(a)(11), depending on all the facts.

Some State Crowdfunding exemptions, Texas included, require that that the issuer satisfies Rule 147. In those States, by definition, an issuer that satisfies the requirements of the State exemption satisfies the Federal requirements as well. In other States, an issuer that dots all the I’s and crosses all the T’s of an intrastate Crowdfunding offering has a very good chance of qualifying under the Federal statutory exemption as well, even if the State exemption does not refer to Rule 147 explicitly.

That’s why the answer is a qualified Yes. An issuer that complies with the Crowdfunding rules of a State still has to qualify for the Federal exemption, but that shouldn’t be hard.

Questions? Let me know.

 

 

 

 

 

PPM Or No PPM: That Is The Question

On By crowdfundattnyIn JOBS Act, PPM, Private Placement Memorandum, Regulation D offerings, Title II, Title II CrowdfundingLeave a comment

Crowdfunding Image - XXXL - iStock_000037694192XXXLargeSome Title II Crowdfunding portals use a full-blown Private Placement Memorandum for each offering, while others do not. What’s the deal?

For readers unfamiliar with the term, a Private Placement Memorandum, or PPM, is usually a long document, often half an inch thick or more printed, that is given to prospective investors and used partly to describe the deal but mostly to explain the risks.

The PPM finds its origins in the lengthy prospectus required of companies selling securities to the public in a registered offering. Following suit, Rule 502(b)(2) of Regulation D requires an issuer to provide specified information to prospective investors in some offerings and in some situations – for example, where securities are offered to non-accredited investors in an offering under Rule 506(b).

But where securities are sold only to accredited investors under Rule 506(b) or 506(c), the issuer is not required to provide the information described in Rule 506(b)2) – or any other information, for that matter. The idea is that accredited investors are smart enough to ask for the important information and otherwise watch out for themselves.

Companies like Fundrise that offer securities under Regulation A or Regulation A+ are required to provide specific information to investors. But Crowdfunding under Title II of the JOBS Act involves selling only to accredited investors in transaction described in Rule 506. Therefore, the law leaves to the issuer and the portal what information to provide and in what form.

For them, what are the pros and cons of a full-blown PPM?

The cons are obvious. Nobody but a lawyer could love a PPM. A full-blown PPM is bulky and unattractive, repetitive and filled with legalese. Ostensibly written to provide information to prospective investors, PPMs have, through time and custom, become so daunting that prospective investors rarely even read them. From a business perspective, a PPM creates friction in the transaction.

However, the pros are also obvious. Although Regulation D does not require an issuer or portal to provide any information, an issuer that fails to provide information, or provides incomplete or inaccurate information, may be liable to disgruntled investors under 17 CFR 240.10b-5, the general anti-fraud rule of Federal securities law, or various state statutory and common law rules.

That’s why the PPM exists: to provide so much information to prospective investors (albeit in an unreadable format), and to describe the risks of the investment in such repetitive detail, that no investor can claim after the fact “I didn’t know.”

The question is whether the issuer and the portal can get the same benefit without all the disadvantages. And the answer, in my opinion, is a resounding Yes!

In fact, the trend in private placements over the last two decades has been away from the full-blown PPM and toward a simpler disclosure document. I have been representing issuers in private placements of securities for more than 25 years and never prepare a PPM except where required by law (e.g., with non-accredited investors). None of the issuers I have represented during those 25+ years has been sued for securities law violations – much less successfully – and in my anecdotal experience, claims arising from alleged failures to disclose material information rarely if ever hinge on the presence or absence of a full-blown PPM.

Not only are portals not required to provide a full-blown PPM, in my opinion the question presents portals with a great business opportunity. Given that information must be provided, the manner in which it is provided, in what format, with what visual effects, how clearly and with what explanation, could well distinguish a portal in the minds of prospective investors. With the technology inherent in the platform, not to mention the creative minds in the industry, I expect that the manner of providing information will become one of the key ways that individual Title II portals distinguish themselves from one another and that the Crowdfunding industry in general improves the process of capital formation. Someday we will look back on the thick PPM and ask “Can you believe we once did it that way?”

A portal that gets it right – and there will be more than one way to get it right – will also create some protectable intellectual property interests and the accompanying breathing space vis-à-vis its competitors and additional valuation on exit.

Questions? Let me know.