crowdfunding: moving beyond kickstarter - updated 6 22-16
TRANSCRIPT
Roger RoyseRoyse Law Firm, PC
Silicon Valley , San Francisco, Los Angelesrroyse@rroyselaw.comwww.rogerroyse.comwww.rroyselaw.comSkype: roger.royse
Twitter @rroyse00
Crowdfinancing:
Moving Beyond Kickstarter
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
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”
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, then10 percent of the lesser of their annual income or net worth (up to a
maximum of $100,000)o Issuer may rely on intermediary’s 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
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 exemptiono Many limitations on what entities ca be intermediaries (e.g., must be
good actor)o Stringent limitations on having financial interests in issuers using platformo Only allow issuers if reasonable to believe they are compliant, and there
is no reasonable basis to think there is a potential for fraudo Cannot accept commitment from investor until investor has account with
platform, and platform provides needed informationo Must make sure investors aren’t exceeding their caps, and that they
acknowledge and understand the riskso Must provide communication services between investors and issuero Many other requirements and filings
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
Crowdfunding• Issuer disclosure requirements
o File basic business, offering details in Form C with SEC; then display publiclyo Amend Form C if any material changes occur via Form C/Ao 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-ARo 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)
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
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
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
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
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
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
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
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
Intrastate Crowdfunding
• SEC has proposed updates to Rule 147 with new exemption, and to expand Rule 504 of Regulation D to have higher limits (up to $5M from $1M), to facilitate the use of these new state laws
• The North American Security Administrator Association (NASAA) has recently released a model rule for states to use in implementing crowdfunding
• As of late 2015, 22 states have finalized legislation granting crowdfunding exemptions
o Others are in the final leg of passing the legislation
o Others yet in the early stages of considering legislation
o A few have rejected crowdfunding legislation
Intrastate Crowdfunding
• Per NASAA, these exemptions from state securities rules tend to involve:
o Qualifying for the federal intrastate offering exemption from Federal registration (if intrastate offer to intrastate buyers, Federal securities rules do not apply)
o Wide ranging offering caps ($100k-$5M over 12 months)
o Wide-ranging investment limits ($100-$100k, with increase for accredited investors)
o Internet-based offerings and platforms are increasingly important to new exemptions, as are broker-dealers
o Registration-lite and periodic reporting-lite
Reg. A – History
• The oldest exemption issued by the SEC
• Although it allowed non-accredited investors to invest, was rarely used, because of high compliance costs relative to the maximum funds raisedo $5 million maximum offering
o Did not preempt state law registration, requiring registrations in many states
• The JOBS Act included legislation to create what is nicknamed “Regulation A+”, an upgrade to Regulation A
• The new Regulation A keeps the allowance of non-accredited investors, and features two kinds of Regulation A offerings, called “Tiers”:o Tier 1, with a $20 M maximum, does not preempt state law registration, but has low
federal compliance burdens
o Tier 2, with a $50 M maximum, preempts state law registration, but has high federal compliance burdens including ongoing semi-annual, annual, and current disclosures
• Went into effect June 19th
• States do not like Tier 2
o Tier 2, per the JOBS Act, only preempts state registration for “qualified purchasers” with the seeming intent to not totallypreempt the states
o However, the SEC defined “qualified purchasers” to mean all Tier 2 purchasers
o State securities regulators resent this loss of power
• States have been creating a multistate single-registration process to make Tier 1 more palatable, and to show they deserve to not be preempted
• The “mini-IPO” of the new Regulation A has excited investors, and for many companies may be better than relying on the crowdfunding exemption
o Including for offerings done via Internet portals
Reg. A – History Continued
• Two kinds of Reg. A offerings, called “tiers”, with different qualities:
Issue Tier 1 Tier 2
State law regulations? Not preempted; multistate
coordinated review program to help
Preempted
Maximum amount raised? $20 M in 12 months, up to $6M of which
from current holders
$50 M in 12 months, up to $15M of which from current holders
Per investor maximums? None Up to 10% of greater of non-accredited investor’s net worth or
net income; unlimited for accredited
Investor limitations Accredited and non-accredited okay
Issuer limitations Cannot be public, shell company, bad actor, those failing certain SEC compliance rules
Reg. A – Two Options (“Tiers”)
• Two kinds of Reg. A offerings, called “tiers”, with different qualities:Issue Tier 1 Tier 2
Solicitation, advertising Testing for interest, soliciting OK, though notices needed and materials may be exhibits on SEC filing; potential to
keep confidential SEC filings during this time
Initial disclosures Financial statementsfor past two years,
plus offering circular
Same as tier 1, plus audited financials
Disclosure to buyers? Circular or most recent Tier 2 report due to buyers by specific time before sale
Ongoing disclosures File exit report atend of offering
Yes, if 300+ holders; annual, semiannual, and current events.
Limitation on need for full Exchange Act registration
Securities restriction Unrestricted; affiliates have some limitations
Allowed securities? Asset backed-securities banned
Integration safe harbor Exists; allows non-US and crowd-funding to be separate
Reg. A – Continued
Issue 506(b) 506(c) Reg. A Tier 2
State law regulations?
Preempted Preempted Preempted
Maximum amount raised?
Unlimited Unlimited $50 M in 12 months, up to $15M of which from
current holders
Per investormaximums?
Unlimited Unlimited Up to 10% of greater of unaccredited investor’s
net worth or net income; unlimited for accredited
Investor limitations Unlimited accredited, and 35 sophisticated non-accredited; self-certification
standard
Accredited only, and issuer
must take steps to certify
they are accredited
Unlimited accredited (self-certified), unlimited non-
accredited
506(b), 506(c), and Reg. A Tier 2
• Two kinds of Reg. A offerings, called “tiers”, with different qualities:Issue 506(b) 506(c) Reg. A Tier 2
Issuer limitations No bad actors No bad actors
Cannot be public, shell company, bad actor, those failing
certain SEC compliance rules
Solicitation, advertising
Banned Soliciting of anyone is allowed
Testing for interest,soliciting OK
Initial disclosures Non-accredited: Equivalents of what they get in registered offering, plus anything accredited
investor can get
For accredited, see 506(c)
Optional; must be
available to answer
questions
Financial statementsfor past two years
disclosed, plus offering circular
with audited financials
506(b), 506(c), and Tier 2 (Continued)
Issue 506(b) 506(c) Tier 2
Ongoing disclosures Form Ds Form Ds Yes, if 300+ holders; annual, semiannual, and
current events. But special exemption from Exchange Act registration until over
$75M float.
Share restriction Restricted for a year
Restricted for a year
Unrestricted; affiliates still have some limits
Allowed securities? ABS not specifically
banned
ABS not specifically
banned
Asset backed-securitiesbanned
506(b), 506(c), and Tier 2 (Continued)
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