crowdfunding: moving beyond kickstarter - updated 6 22-16

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  1. 1. Roger Royse Royse Law Firm, PC Silicon Valley , San Francisco, Los Angeles rroyse@rroyselaw.com www.rogerroyse.com www.rroyselaw.com Skype: roger.royse Twitter @rroyse00 Crowdfinancing: Moving Beyond Kickstarter
  2. 2. JOBS Act Overview Improves access to capital markets for emerging growth companies o Relaxes reporting and disclosure requirements for public companies with less than $1 billion in gross revenues Crowdfunding/Crowdfinancing o Exemption from registration for issuance of securities o Securities issued through crowdfunding do not count towards registration threshold o Possible Problems Fraud Costs Unsophisticated nature of investors Increases 500 shareholder registration threshold General solicitation in Rule 506 offerings, provided that all investors are accredited
  3. 3. JOBS Act Key Provisions Crowdfunding (Title III of the JOBS Act) o Allows companies to raise a limited amount of funds from the general public (Effective as of May 16, 2016) o Investment must be through an intermediary broker or funding portal General Solicitation (Title II of the JOBS Act) o The SEC has extended the exemption for private offerings under Rule 506 to allow for general solicitation providing certain requirements are satisfied o Can only issue securities to accredited investors and there are additional filing requirements New Regulation A, nicknamed Regulation A+ (Title IV of the JOBS Act) o Preempts state registration, allow for what some call a mini-IPO
  4. 4. Crowdfunding Exemption from Registration The private company issuer (aggregated with predecessors and companies under common control) may sell up to $1 million of securities in a 12-month period Individual investments in all crowdfunding issuers in a 12-month period are limited to: o If either their annual income or net worth is less than $100,000, then the greater of: $2,000 or 5 percent of the lesser of their annual income or net worth o If both their annual income and net worth are equal to or more than $100,000, then 10 percent of the lesser of their annual income or net worth (up to a maximum of $100,000) o Issuer may rely on intermediarys calculation of investor limits, unless issuer knew it was or would be wrong Process is likely to prove expensive and overly burdensome Effective as of May 16th, 2016
  5. 5. Crowdfunding Investment must be through the online platform of an intermediary broker or funding portal o Intermediary must register with the SEC and any applicable self- regulatory organization and national securities association (e.g., FINRA); o Issuer can only use one intermediary in any concurrent offerings based off of crowdfunding exemption o Many limitations on what entities ca be intermediaries (e.g., must be good actor) o Stringent limitations on having financial interests in issuers using platform o Only allow issuers if reasonable to believe they are compliant, and there is no reasonable basis to think there is a potential for fraud o Cannot accept commitment from investor until investor has account with platform, and platform provides needed information o Must make sure investors arent exceeding their caps, and that they acknowledge and understand the risks o Must provide communication services between investors and issuer o Many other requirements and filings
  6. 6. Crowdfunding No integration with non-crowdfunding offers o Be careful to ensure crowdfunding communications do not go to wrong offerees who are not supposed to receive them (e.g., Rule 506(c) offerees) Limits on advertising and compensation for promoters Post fundraising o Securities cannot be resold within 12 months (unless to an accredited investor) o Private right of action for material misstatements/personal liability
  7. 7. Crowdfunding Issuer disclosure requirements o File basic business, offering details in Form C with SEC; then display publicly o Amend Form C if any material changes occur via Form C/A o File updates with SEC within five days of certain milestones (such as enough commitments, offers, or closing of issuance) o File financial statements meeting GAAP, and GAAS or PCAOB if applicable Audited if offering exceeds $500,000, except first time issuers need only have independent CPA review Reviewed by an independent CPA if offering is between $100,000 and $500,000 If $100,000 or less, certain information from tax forms and CEO- certified financials In any event, if more trustworthy financials available than are required (i.e., if audited or CPA-reviewed are available), use those instead o File annual SEC reports via Form C-AR o File Form C-TR to terminate reporting obligations in five days of eligibility (e.g., became Exchange Act issuer, has too few assets or shareholders)
  8. 8. Crowdfunding Points for Consideration Crowdsourcing through donations (e.g., IndieGoGo and Kickstarter) may be cheaper and easier, and does not require the company to issue equity Advertising terms of offer is restricted o Issuer can only direct investors to broker/funding portal Costs of disclosure and reporting (15%) Use of intermediary Risk of fraud High number of unsophisticated investors o Fiduciary duties to all investors o Could be a concern for VCs in future fundraisings
  9. 9. General Solicitation Rule 506 now provides for two different types of private offering: o Rule 506(b) is essentially the same as the old Rule 506, providing an exemption for non-public offerings but prohibiting general solicitation o Rule 506(c) is a new exemption that allows general solicitation, but with certain restrictions and filing requirements Rule 506(c): issuers can offer securities through means of general solicitation as long as: o All purchasers are accredited investors; and o The issuer takes reasonable steps to verify the purchasers accredited investor status
  10. 10. General Solicitation A determination of reasonable steps requires consideration of: o Nature of the purchaser; o Amount of information the issuer has about the purchaser; and o Nature of the offering, terms, amount, and method of solicitation The SEC has provided a non-exhaustive list of methods to verify status: o Review IRS forms that report income e.g. Form W-2 or K-1; o Review documents for asset details e.g. bank or brokerage statements; or o Obtain confirmation from CPA, lawyer, SEC-registered investment advisor, or broker-dealer that reasonable steps were taken to verify accredited investor status
  11. 11. General Solicitation Proposed Rules Form D Filing o Under the current rules only one Form D filing is required (within 15 days of the first sale of securities) o Under the Proposed Rules a Rule 506(c) issuer must file: Advance Form D at least 15 days prior to the first use of general solicitation materials in an offering; Full Form D within 15 days of the first sale of securities; and Form D Closing Amendment within 30 days of the termination of the offering o Rule 506(b) issuers must file the Full Form D and Closing Amendment
  12. 12. General Solicitation Proposed Rules Filing of General Solicitation Materials o Proposed Rule 510T requires 506(c) issuers to electronically submit general solicitation materials to the SEC o Current intention is for this requirement to expire within 2 years o Submissions would not be made publically available Legends all general solicitation materials will need a legend that states the following: o The securities may only be sold to accredited investors; o The securities are offered under an exemption to the Securities Act and therefore certain disclosure requirements do not apply; o The SEC has not given approval to the securities, terms of the offering, or the accuracy of the offering materials; o The securities are subject to legal restrictions on resale; and o Investing in securities involves risk and investors should be able to bear a loss
  13. 13. Private Offerings Under Rule 506(b) Under what is now Rule 506(b), issuers are prohibited from making general solicitations o The emergence of internet funding websites creates some potential problems for issuers relying on Rule 506(b) A communication that is publically available (e.g. on a website that is not password protected) is a general solicitation o This can be avoided by only providing access to accredited investors Direct communications to persons with whom the issuer or its broker has a pre-existing, substantive relationship are not considered general solicitations o However, the SEC believes that such a pre-existing relationship usually only exists where the communication is from a registered broker-dealer
  14. 14. SEC No Action Letters In 2013, the SEC released two no-action letters confirming that certain fund-raising websites did not need to register as broker-dealers: o AngelList LLC Matches investors with companies Exclusively available to accredited investors No transaction-based compensation o FundersClub Inc Posts details of companies to its website after they pass initial due diligence Exclusively available to accredited investors No transaction-based compensation In 2012, the SEC charged some companies operating secondary markets for private stock o SecondMarket escaped unscathed which it puts down to its transparency, rigid accreditation process, and strict adherence to rules on general solicitation
  15. 15. Pitch Competitions The proposed regulations pose a number of potential problems to pitch competitions, for example: o The pitch could be considered a general solicitation and therefore any presentation materials would need to be filed with the SEC o If the pitch is amended after feedback from judges then the new presentation would need to be filed with the SEC before the next pitch Issuers that break the rules are subject to a one year penalty o Very onerous and essentially a death penalty for early stage companies
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