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Crowd-financing for P3s.docx


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Crowd-financing for P3s.docx

  1. 1. Crowd-financing for Public-Private Partnerships in the U.S.1 How would it work?2 3 4 Morteza Farajian, Ph.D.5 Office of Transportation Public-Private Partnerships6 600 E. Main St., Suite 2120, Richmond, VA 232197 Tel: 804-786-0470; Email: Morteza.Farajian@p3.virginia.gov8 9 Brian Ross, MSCEE, MBA, LEED AP10 InfraShares11 2713 Belmont Canyon Road, Belmont CA 9400212 Tel: 415-312-2224; Email: brianross@infrashares.com13 14 15 16 17 Word count: 5,911 words text + 4 tables/figures x 250 words (each) = 6,911 words18 19 20 21 22 23 24 Submission date: July 31, 201525
  2. 2. Farajian, Ross 2 ABSTRACT1 In January 2015, President Obama introduced a $302 billion proposal known as the Grow America Act2 to help federal agencies find new ways to increase infrastructure investments by at least 35% in an3 attempt to partially resolve the significant funding need for the aging infrastructure in the U.S.4 Public-private partnership (P3) model remains a tool that can facilitate private investment. However,5 the current P3 model does not allow for broad based public equity investment in P3 projects. The6 Jumpstart Our Business Startups (JOBS) Act in 2012 has led to a rapidly changing legislative and7 regulatory environment, which provides for the ability of new ventures to raise equity and debt8 investment. This new form of investment crowdfunding, or crowd-financing, provides flexibility9 for start-ups to raise low cost capital from supporters of their project or business. This flexibility10 can also be utilized in P3 projects providing the opportunity to engage small institutional and11 individual investors as direct equity participants. This crowd-financing enhanced P3 model creates12 value beyond just the financing benefits. Due to the novelty of the approach and potential impact13 to taxpayers, a comprehensive look at the approach is needed. This paper introduces an implication14 framework for the P3 crowd-financing model and builds on a previous paper that provided a policy15 review on the model using a SWOT analysis. This paper also highlights similarities between16 crowd-financing models being implemented in the real estate industry and applications to P3s, and17 then describes the current regulatory framework for crowd-financing. An outline of how18 crowd-financing would be implemented for P3s is provided, including discussions of investment19 type, SEC exemptions, and crowd-financing platform interaction.20 21 22 23 Keywords: Public-Private Partnership, Crowd-financing P3 Model, Investment Crowdfunding,24 Direct Equity Investors,25 26
  3. 3. Farajian, Ross 3 Introduction1 2 The need to address aging infrastructure due to growing capacity demands and decreasing3 economic competiveness is greater than ever in the United States. In fact, this need is becoming a4 critical issue for the nation and evident in an overall grade of D+ given to American infrastructure5 by the American Society of Civil Engineers (ASCE) (1). The question is how the needed new6 infrastructure development and the aging infrastructure maintenance should be funded particularly7 given U.S. government budgetary constraints and “shortages in lending capacity and more8 stringent regulation in the banking system” (2). This question has been the core of numerous9 academic and non-academic studies. In January 2015, President Obama introduced a $302 billion10 proposal known as the Grow America Act to help federal agencies find new ways to increase11 infrastructure investments by at least 35% (3). The 2015 Grow America Act, the 2014 Build America12 Investment initiative and the 2012 Jumpstart Our Business Startups (JOBs) Act all can pave the road13 to increase private investment in the U.S. infrastructure.14 15 One of the tools that has been used worldwide, as well as in the U.S., to facilitate private sector16 investment in the infrastructure is an innovative form of project delivery model which is called17 Public-Private Partnership (P3). Over the past two decades, P3s in the U.S. have evolved18 drastically, expanding to over thirty three U.S. states, District of Columbia and one U.S. territory19 with various P3 approaches and enabling legislations (4). In general, most of the P3 approaches20 have similar elements in their financial package: public funds, debt and potentially equity. Debt is21 usually repaid through project revenues which typically come from user fees or availability22 payments. Different forms of bonds such as Private Activity Bonds (PABs) and Qualified Public23 Infrastructure Bonds (QPIBs), provide the opportunity for individual or institutional investors to invest24 in the U.S. infrastructure at the debt level.25 26 Similar to debt, equity is usually repaid through project revenues if sufficient revenue is available27 after debt service payments. Therefore, investing at the equity level is riskier than investing at the28 debt level, and as a result is rewarded at a higher rate of return. While the current P3 model29 provides the opportunity for individual investors to invest in P3 projects at debt level, it provides30 little or no opportunity for individual investors to have a direct equity investment in those projects.31 Therefore, the current P3 model can be easily criticized since the direct equity opportunity is32 primarily limited to large infrastructure funds and developers who usually enjoy a high rate of33 return on their equity. It might be true that equity investment in P3 projects is risky and therefore34 should be rewarded with a higher rate of return; however, this high rate of return can be justified35 only if it is determined by the market based on a true interaction between supply and demand. An36 individual investor can easily criticize the high rate of returns on equity investment in P3 projects37 by stating that he/she would be willing to take similar risks at a lower return rate compared to38 investment funds. The only way that this claim can be validated and the criticism can be addressed39 is providing the equity investment opportunity to such investors.40 41 Farajian et al. (2015) discuss policy implications of a new P3 model that uses the crowdfunding42 concept to provide individual investors the opportunity to invest equity in P3 projects (5). Under43 this new P3 model, part of the equity investment for a P3 project is raised from individual investors44 (the crowd), particularly the ones in the same region or state, through a competitive process and an45 intermediary online platform. This new form of investment crowdfunding, or crowd-financing,46 provides flexibilities that can be utilized in delivery of P3 projects. Although Farajian et al.47 acknowledge potential financial benefits may be gained through this new approach as a result of48
  4. 4. Farajian, Ross 4 higher competition at equity level and potential lower cost of capital for equity investments, they1 mainly focus on policy benefits such as enhanced transparency, providing equal investment2 opportunities to local stakeholders and users of the facility, and enhanced local stakeholder3 support. In particular, this new model provides the opportunity to extend the partnership to4 potential users of the project or people who are impacted by the project and better align their5 interests with the interests of the public agency and the P3 developer. Figure 1 summarizes the6 strengths, weaknesses, opportunities and threats of this new P3 approach.7 8 Figure 1: SWOT Analysis Summary9 10 Source: Farajian, et al (2015) (5)11 12 This paper is taking the discussion of the P3 crowd-financing model from the policy level to the13 application level and intends to address the question that how this concept can be implemented in14 practice. In particular, this paper discusses (1) precedents in real estate development for a15 crowd-financed P3 model, (2) available options based on the JOBS Act, SEC regulations and State16 legislations, and (3) a process to utilize the crowd-financing model in P3 procurement and post17 procurement.18 19 Background and Comparison to Current Applications in Real Estate20 21 The 2012 JOBS Act made significant changes to the ways that new companies can raise capital.22 Specifically, the JOBS Act lifted the ban on general solicitation thereby allowing, under certain23 conditions, new companies to sell equity shares and debt instruments (collectively referred to as24 securities) to the general public via the internet without the onerous process of registering the25 offering with the SEC as an IPO. The ability to raise small amounts of investment from many26 more individual investors, referred to in this paper as crowd-financing (as opposed to27 crowd-funding which refers to raising money through donations), is typically facilitated by online28 Equal investment opportunity Induced complexity Return on equity Lack of track record and market confidence Enhanced stakeholder support Administrative and accounting challenges Increased transparency Third-party confidential information Social equality Strengths Weaknesses Opportunities Threats Prioritization Business failure Idea exchange Fraud Possible misconceptions Internal in Origin Disadvantages Advantages External in Origin
  5. 5. Farajian, Ross 5 platforms that cater to specific industries such as information technology, health products, or real1 estate development. Small investors who are interested in specific projects can now invest directly2 in projects they have not been able to previously because such investment opportunities were3 limited, statutorily and practically, to institutional investors with large sums of investment capital.4 5 The changes implemented in the JOBS Act apply only to new business ventures, or “start-ups”.6 Because the Special Purpose Vehicles (SPV) established by the Development Company, equity7 sponsors, design/build firm, and O&M partners to undertake the P3 is technically a new venture, it8 is able to take advantage of the regulations established by the JOBS Act. While crowdfunding has9 received the most recent attention with regard to new venture capital and start-up businesses, the10 mechanism is also gaining popularity as a tool in civic projects and real estate development11 investments. This evolution in the use of crowdfunding demonstrates the potential of12 crowd-financing for P3 projects (5).13 14 Crowd-financing for a P3 would generally follow the successful model established by the15 commercial real estate industry for crowdfunding investment in real estate development projects.16 Websites such as,, and exemplify the various17 regulatory frameworks, security structures, fees, and revenue models employed for crowdfunding18 investment in real estate, but at a fundamental level the process consists of a developer offering19 investment in a SPV established to undertake a new real estate development project that will20 generate returns for the investors.21 22 Similarly in a P3 project, the P3 developer sets up a SPV and investors purchase debt or equity23 shares in the SPV. The SPV then makes debt service payments or equity returns depending on the24 success of the project. The key differences between a typical infrastructure P3 project and a real25 estate development project are the associated development risks (design, construction, O&M), the26 size of projects, the duration of projects, the types of customers (the public and public agencies),27 and the role of public agencies in selection, oversight, and financing of projects. Just as there are28 numerous real estate crowd-financing platforms that specialize in specific project types (retail,29 apartments, single family residences, etc.), there is a need for crowd-financing platforms that cater30 to the unique aspects of infrastructure as an asset class (6).31 32 Another key difference between crowd-financing for real estate and large transportation P3s is the33 role of debt. As discussed earlier, the debt financing in a typical transportation P3 project is34 usually provided through various government loan programs such as the Transportation35 Infrastructure Finance and Innovation Act (TIFIA), tax-exempt project revenue bonds such as36 PABs, or other bonds that are offered competitively in the bond market. This reduces the need for37 debt crowd-financing for transportation P3 projects; therefore, this paper focuses on the role of38 equity crowd-financing used by the P3 SPV. However, if necessary or desirable, the SPV could39 issue debt securities via crowd-financing platforms, which is common in the real estate investment40 crowdfunding industry. Debt crowd-financing may also be appropriate for P3s in other41 infrastructure sectors such as water/waste-water, telecoms and social infrastructure where public42 debt facilitation is not as advantageous.43 44 Another key comparison to crowd-financing for commercial real estate is the role of pension45 funds. While pension funds typically have a portion of their assets allocated to commercial real46 estate, individuals with interest in a pension fund are not able to select specific projects in their47
  6. 6. Farajian, Ross 6 community that they want their specific funds to be invested in; they are subject to the investment1 decisions of the fund managers. As with pension fund investment in infrastructure, the wishes of2 the individual participants are not a consideration in the fund’s investment decision and therefore3 investments through pension funds do not represent the same level of benefits that a4 crowd-financing model can offer. For instance, pension funds do not provide the same level of5 public engagement and support that can be gained through crowd-financing of direct equity6 investment from individual investors who may be the users of the project or live close to the7 project.8 9 Furthermore, pension funds do not provide the same level of transparency and ongoing10 engagement that investors will receive as direct equity participants through crowd-financing.11 Also, the competitive crowd-financing process provides a great opportunity to make the rate of12 return on equity investment more competitive by offering it to qualified individuals in the same13 way that bonds are offered in the bond market. Finally, the returns offered to investors through14 pension funds may be mitigated by management fees and limited project selection due to the15 Employee Retirement Income Security Act of 1974 (ERISA) restrictions.16 17 However, while inclusion of pension funds as equity participants in a P3 does not provide the same18 level of public engagement or economic impact as crowd-financing equity from individuals,19 pension funds do play a critical role in private investment in public infrastructure and P3s.20 Because pension funds often desire the long-term, stable, inflation hedged returns of infrastructure21 assets, they are a natural fit as equity sponsors of P3s and frequent investors in infrastructure funds22 that participate in P3s. Unfortunately, because the investment thresholds for direct investment in23 P3s and infrastructure funds can be quite high, typically over $1 million, many smaller pension24 funds are unable to participate. Crowd-financing for P3s, and potentially infrastructure funds, will25 allow smaller, local funds to participate alongside individuals and large institutional investors,26 providing more competitive and resilient sources of equity.27 28 Initiating Crowd-financing for a P329 30 In real estate development crowdfunding, the crowdfunding campaign is initiated by the real estate31 developer. However, in a P3, the crowd-financing process could be initiated by either the P332 developer or the public agency sponsor. P3 developer partners are typically selected by the public33 agency partner through a competitive RFQ/RFP process. The public agency may include a34 requirement or preference for some portion of the capital to be raised through crowd-financing in35 the RFQ/RFP documents. If the evaluation is based on a minimum price that as long as all36 requirements are met, the lowest bid is selected, a minimum amount to be crowd-financed can be37 required by the public agency in the procurement document. Under the best value evaluation38 approach in which a combination of technical and financial scores is used to select the proposal,39 the public agency can develop scoring criteria for the value placed on the type, or amount, of40 crowdfunded capital offered to the public. Similar to how points are awarded to innovative design,41 points could be awarded for innovative financing structures that include community investment.42 As an example, the City of Oakland recently released a Request for Proposals for the43 redevelopment of the Henry J. Kaiser Convention Center that included the following language (7):44 45 “Community-based Financing Tools: The City is interested in exploring the viability of new46 community-based financing models that allow Oakland residents of all income and wealth levels47
  7. 7. Farajian, Ross 7 to participate in the profits generated by becoming investors in the project. To the degree possible,1 and to the degree it is feasible in combination with other financing mechanisms, respondents2 should consider using community-based financing tools such as community development IPOs or3 other innovative community financing tools and platforms.”4 5 In general, less prescriptive requirements allow the developers to become more innovative and6 compete in terms of public benefit or cost reduction. Theoretically, crowd-financing could provide7 a lower cost of capital, so developers that propose the largest offering could also potentially8 provide the best value for money (this needs to be explored further). However, if the P3 developer9 wishes to limit crowd-financing participation due to lack of overall financial benefits in particular10 cases but the public agency still believes crowd-financing provides non-financial benefits to the11 public, a policy decision can be made to mandate a minimum amount of equity to be12 crowd-financed. Similarly, the public agency can mandate a ceiling on the maximum amount of13 equity that can be crowd-financed. It is unlikely that equity crowd-financing will replace entirely14 traditional P3 equity sources such as private sponsor equity (developer/EPC partner), insurance15 companies, pension funds, and infra funds, but putting a ceiling on the percentage of equity that16 can be raised through crowd-financing ensures the developer still has enough equity stake “skin in17 the game” incentivizing its performance. This is necessary to ensure the P3 developer is18 incentivized to utilize its resources in the most efficient way to increase performance and mitigate19 the risk of default or bankruptcy. Ultimately, rating agencies would also consider this element as20 one of their evaluation criteria while providing a rating on debt.21 22 The crowd-financing process could also be executed as an auction for particular projects, allowing23 for investors to bid on securities and letting the market establish the risk weighted returns24 appropriate for the project instead of a limited number of institutional equity sponsors (8). On the25 other hand, the public agency may decide to define more restrictive terms of the offering to26 mitigate the potential political risk of riskier crowd-financing offerings.27 28 Alternatively, the P3 developer may include crowd-financing as part of their proposal without any29 specific requirement from the public agency; particularly in unsolicited proposals. The P330 developer may recognize the benefit of public engagement that crowdfunding offers and highlight31 it as part of their unsolicited proposal to increase public engagement and transparency in hopes of32 reducing the chance of political resistance associated with unsolicited proposals.33 34 In all these scenarios, the P3 developer (and possibly the public agency) may engage in a “testing35 the waters” campaign by providing preliminary information via the crowdfunding platform and36 soliciting non-binding indications of investment interest from the public. Strong indications of37 interest may signal strong public support for the project, as well as financial viability. Investors38 who indicate interest could be contacted prior to the general public once the actual offering is39 executed. However, “testing the waters” campaigns need to adhere to strict SEC regulations to40 avoid market tampering (see discussion of Regulation A+ offerings below).41 42 Regardless of the amount to be offered via crowd-financing, the P3 developer needs to retain43 responsibility for obtaining the necessary rating and securing financing for the project. The risk on44 assumptions related to rate of return will stay with the P3 developer although some benchmarking45 protections can be provided by the public agency to mitigate risks associated with market46 conditions similar to risk protections provided on interest assumed in debt financing. If the P347
  8. 8. Farajian, Ross 8 developer is unsuccessful in raising the planned crowd-financed amount, either it can increase the1 internal rate of return on crowd-financed portion of the equity to attract more investors or back-fill2 the gap. In either case since the P3 developer has the responsibility to deliver the proposed3 financial package, the weighted average cost of equity should stay the same. This means the P34 developer will need to reduce the internal rate of return on the other portion of equity which is not5 crowd-financed.6 7 Figure 2 summarizes the above discussion and represents a preliminary framework on how equity8 crowdfunded P3 model can be implemented.9 10 Figure 2: A Preliminary Framework for Equity Crowd-financed P3 Model (Source: Authors)11 12 Source: Created by the authors13 14 The type of capital raised through crowd-financing is very flexible and can be any type of security15 ranging from equity to debt. However, as discussed above, this paper focuses on the role of16 crowd-financed equity for transportation P3s. Equity financing involves not just the sale of17 common equity stock, but also the sale of other equity or quasi-equity instruments such as18 preferred stock, and convertible preferred stock:19  Common Stock: A security that represents ownership in a corporation. Holders of common20 stock exercise control by electing a board of directors and voting on corporate policy.21 Common stockholders are on the bottom of the priority ladder for ownership structure. In22 the event of liquidation, common shareholders have rights to a company's assets only after23 bondholders, preferred shareholders and other debtholders have been paid in full.24 Procurement Documents Define minimum threshhold for Crowd-financed equity if the public agency believes equity crowd-financing brings non-financial value Define maximum threshhold to maintain P3 developer's skin in the game Impose more restrictive terms of offering in case public agency wishes to control the level of risk for individual investors Evaluation In a best price evaluation, only minimum and maximum threshholds should be met In a best value evaluation, points will be given for equity crowd-financing, and potentially internal rate of return at offering, based on evaluation criteria defined in the RFP Financial Close A crowdfunding platform will be used for equity- crowdfinancing If offering is unsuccessful, the P3 developer can increase the internal rate of return to attract more investors The P3 developer will ultimately be responsibile to back-fill any financing gaps as a result of an unsuccessful offering at no cost to the public agency
  9. 9. Farajian, Ross 9  Preferred Stock: A class of ownership in a corporation that has a higher claim on the assets1 and earnings than common stock. Preferred stock generally has a dividend that must be2 paid out before dividends to common stockholders (preferred return) and the shares usually3 do not have voting rights. The precise details as to the structure of preferred stock is4 specific to each corporation. However, the best way to think of preferred stock is as a5 financial instrument that has characteristics of both debt (fixed dividends) and equity6 (potential appreciation). Also known as "preferred shares".7  Convertible Preferred Stock: Preferred stock that includes an option for the holder to8 convert the preferred shares into a fixed number of common shares, usually any time after9 a predetermined date.10 The type of equity offered could depend on several factors including: investor demand,11 developer’s determination of the most cost efficient structure, and possibly on the desires of the12 public agency as outlined in the RFP. However, given that the P3 developer will want to limit the13 crowd investors involvement in operations (voting rights), and that the public agency will most14 likely want to shield community investors from severe underperformance of the project15 (construction risk, ramp-up risk, economic downturn, T&R shortfalls, etc.), preferred stock is the16 most likely security to be offered. However, preferred stock will naturally offer lower equity17 returns than common stock.18 19 The P3 developer will also be responsible for providing the offering documentation required by the20 SEC filing exemption being used (e.g. 506(c), Regulation A+, Rule 147, etc. as discussed below).21 The SEC filing exemption will depend on the capital needs of the developer, the level of22 community investment required by the public agency, and the nature of the project. The SEC has23 finalized rule-making on Title II and Title IV of the JOBS Act, enabling Regulation D 506(c) and24 Regulation A+ offerings. Many states have also enacted “intrastate” crowdfunding regulations25 which operate under the Rule 147 intrastate offering exemption.26 27 Crowdfunding Regulations and Types of Offering Registration Exemptions28 29 Regulation 506(c)30 31 For Regulation D 506(c) general solicitation offerings enabled by the 2012 JOBS Act, the primary32 benefit is that the amount of capital that can be raised is unlimited (9). 506(c) offerings are the33 main SEC crowdfunding exemption currently used by commercial real estate crowdfunding34 platforms, with multiple projects raising over $50 million dollars (10). In addition to being exempt35 from SEC registration, 506(c) offerings are exempt from state securities registration as well (Blue36 Sky exemption). Because 506(c) offerings are the most common, there are numerous service37 providers that facilitate the legal process for low fees.38 39 Drawbacks to the use of 506(c) offerings include a limit of 2000 investors, and the investors must40 be accredited (11). This limits participation to investors that have a net worth over $1 million, or41 made over $200,000 per year in gross income in both of the prior two years (9). An accredited42 investor may also be an entity such as a bank, partnership, corporation, nonprofit or trust, when the43 entity satisfies certain criteria. Also, the securities sold through 506(c) offerings are restricted44 from being resold for one year, except under special circumstances, which make them highly45
  10. 10. Farajian, Ross 10 illiquid.1 2 Because of the opportunity for large capital raises, but the restriction to accredited investors,3 506(c) offerings are best suited for large regional mega-projects that may serve multiple states4 (power generation, toll roads, oil & gas, etc.). These projects will typically require larger capital5 raises and will have a risk/return profile more suitable for accredited investors.6 7 Regulation A+8 9 Regulation A+ exempt offering rules were finalized by the SEC in June 2015 and are currently10 allowed for implementation. Reg A+ offerings are split into two tiers of offering with the ability to11 raise up to $20 million under tier 1 offerings and $50 million for tier 2 offerings (12). While the12 amount that can be raised is limited, unlike 506(c) offerings, Regulation A+ offerings are open to13 both accredited and unaccredited investors; with certain restriction on unaccredited investors for14 tier 2 offerings. Another benefit of Regulation A+ offerings is that the securities sold are15 un-restricted, meaning they can be sold at will by the investors; this adds liquidity to the securities16 making them more valuable to short-term investors. Regulation A+ also allows for “test the17 waters” campaigns that allow developers to gauge interest in a potential offering prior to any filing18 with the SEC.19 20 Because Regulation A+ offerings are open to all investors, the SEC requires that tier 1 offerings21 are qualified within each state where securities will be sold. Because each state has different22 securities regulations (Blue Sky Laws), this requirement makes it impractical for Regulation A+23 tier 1 offerings to be sold in more than just a few targeted states. Unlike 506(c) offerings, most24 Regulation A+ offerings will require that investors are provided annual reviewed or audited25 financial statements by the P3 SPV. While most intrastate offering regulations (discussed below)26 also allow for accredited and unaccredited investors, intrastate offerings typically require the27 offeror to be located in the state of the offering and have much lower limits for amounts that can be28 raised. Another benefit of regulation A+ offerings is that they can be combined with 506(c)29 offerings.30 31 Rule 147 - Intrastate Crowdfunding32 33 Not wanting to wait for full the SEC to finalize Title III of the JOBS Act, several states have passed34 intrastate crowdfunding laws to allow for businesses that operate solely in their state to raise35 crowdfunded capital from any local (residents of the state) investors (13). States active in36 transportation P3s such as Florida, Texas, Georgia, Colorado and Indiana have all passed intrastate37 crowdfunding legislation, while many other states are in the process of passing legislation or38 investing (see Figure 3 below).39 40 41 42 43 44 45 46 47
  11. 11. Farajian, Ross 11 Figure 3: State by State Map of Intrastate Crowdfunding Exemptions1 2 Source: Crowdfund Insider (13)3 4 The majority of the proposed bills continue the precedent of setting the overall offering cap at5 $2,000,000 (provided they deliver independently audited financials, otherwise $1,000,000).6 However, a few of the states (i.e. Illinois and Minnesota) propose to allow for significantly higher7 offering caps, and certain of the states (i.e. New Mexico and North Carolina, and South Carolina)8 have not included a cap at all. Moreover, many of the newly proposed bills specifically require the9 offering caps to be reviewed and increased every five (5) years to reflect changes in the Consumer10 Price Index (CPI). This option is best for small projects that will serve specific communities11 within a state (wastewater treatment plant, fire-station, school) selling to an investor demographic12 with a buy/hold mindset that can easily digest the nature of the project.13 14 Each type of offering discussed above has unique characteristics, limitations, advantages and15 disadvantages of each type of offering. It also suggests that each one of the offerings, and therefore16 may deliver better value for certain projects or certain policy goals. Table 1 summarizes the17 discussions in this section and provides additional information on specifics of each type of offering18 and what projects may benefit the most from that type of offering.19 20 21 22 23 24 25 26 27 28
  12. 12. Farajian, Ross 12 1 Table 1: Summary of Offering Exemptions2 3 4 5 Source: Created by the authors6 7 8 9 10 Reg A – Tier 1 Reg A – Tier 2 Reg D: Rule 506 ( c ) Intrastate (Typical) Maximum Offering $20,000,000 $50,000,000 Unlimited $2,000,000 Offeree Types All, including non- -‐accredited investor All, including non‐‐‐ accredited investor Accredited Investors Only All ‐‐‐ Unaccredited Individual Investment Limits None All offerings: 5% of income or net worth below $100k, 10% above $100k, $100k max None $2,000 minimum; 5% of income or net worth below $100k, 10% above $100k, $100k max Investor Verification N/A Self‐‐‐Certification Heightened Accredited Verification; Financial Infrmation Required Self‐‐‐Certification Advertising / General Solicitation Unrestricted Unrestricted Unrestricted Limited to investors within state Pre--‐filing / Testing the Waters Testing the waters allowed with no pre‐‐‐filing; must file solicitation materials with first offering statement; offering circular must be filed 48 hours prior to first sale Testing the waters allowed with no pre‐‐‐filing; must file solicitation materials with first offering statement; offering circular must be filed 48 hours prior to first sale No filing requirements (yet) Pre‐‐‐filing with state required before any offer (no testing the waters) Closing Speed Slow ‐‐‐ SEC and State Qualification Required Slow ‐‐‐ SEC Approval Required Fast ‐‐‐ NO SEC Involvement Fast ‐‐‐ NO SEC Involvement Offering Documents Robust --‐ SEC Qualification and State Approval Robust ‐‐‐ SEC Approval No Specific Requirements Robust, State Filing Required Financials Disclosure Reviewed Financials Audited Financials No Specific Requirements None under $100k; Reviewed $100k ‐‐‐ $500k, Audited above $500k Ongoing Disclosure/Filing None Annual, Semi‐‐‐Annual, Current Reports including audited financials None Annual Disclosure & Financials Transfer Restriction None None 1 Year 1 Year or to Issuer or Accredited Shareholder Limit None with conditions None with conditions 2,000 accredited investors Unlimited Intermediary None Required None Required None Required Funding Portal or Broker‐‐‐ Dealer Required; Internet Portal Required State Pre‐‐‐ emption No; Coordinated Review Yes Yes; but expensive blue sky filing fees Yes Investor Education Req. None None None Tests Required Best for Small to medium sized projects serving 1 state that will benefit from all levels ofpublic engagement Medium to large sized projects that will benefit from all levels ofpublic engagement Regional Mega-projects with high capital needs and targeting affluent individuals and small institutional investors Small community projects with need for broad-based community engagement and targeted economic impact
  13. 13. Farajian, Ross 13 1 The Crowdfunding Campaign and Internet Platform Function2 3 In terms of timing, the crowdfunding campaign will begin once the P3 project has been awarded4 and the P3 terms are agreed to (commercial close). Then the private developer works with a5 crowdfunding platform, such as, that specializes in crowdfunding6 investment for P3s to develop and run the crowdfunding campaign (14) The length of the7 campaign is determined by the financial close schedule, but will need to be long enough for the8 developer to promote the project and for investors to evaluate and make an investment decision.9 10 Retail investor traffic is driven to the crowdfunding platform through the use of public agency11 outreach, social media, traditional media, search engine optimization (SEO, google AdWords) and12 complimentary sites such as other investment crowdfunding sites targeting other industries. A13 teaser summary is posted on the site that can be viewed by potential investors that includes14 summary commercial terms and a video describing the project. Investors visiting the site can15 browse by project type, geography, security type, IRR, etc. to find an offering that fits their16 investment objectives. The site will also offer comparison and analysis tools to help investors17 determine which projects are right for them. If an investor is interested in a specific project, then18 they request access to the full offering materials such as offering statements, financial models,19 concession agreements, credit rating agency reviews, etc.20 21 If, after reviewing the offering documents and performing any other due diligence, they decide to22 invest, they make a pledge to invest upon successful completion of the campaign. Campaigns are23 considered successful if they reach the funding goal determined by the P3 developer. However,24 the crowdfunding platform may retain the option to backfill any shortfall with its own funds. As25 discussed earlier, since the P3 developer financing plan shouldn’t be structured to be dependent on26 the crowd-financing campaign, an unsuccessful campaign does not, in anyway, jeopardize27 reaching financial close. Under this scenario the P3 developer should readily have access to equity28 which should backfill the gap at no additional cost to the public agency (under certain29 circumstances the public agency may choose to develop a risk sharing mechanism).30 31 In order to make management of the crowd-financed equity investors as easy as possible for the P332 developers, the crowdfunding platform forms a discrete project fund LLC for each offering to act33 as intermediary between the P3 developer and the crowd investors. The project fund LLC acts on34 behalf of the crowd investors when dealing with the P3 developers in issues such as voting rights,35 management and consent, if granted. If a board seat is warranted, the platform management will36 represent the LLC. In general, the crowd investors will be passive investors in the project fund37 LLC, but the details of this relationship will vary by project. All disclosures, reports, financial38 statements issued by the P3 developer are distributed through the platform project fund LLC to39 investors. Third party escrow/ACH services (as required by the SEC) are used to facilitate the40 collection of investment monies and disbursement of returns. This structure removes P341 developers concerns regarding management of multitudes of individual investors.42 43 In order to facilitate this structure, the P3 developer enters into a private placement agreement with44 the project fund LLC, whereupon success of the crowdfunding campaign, securities of the P345 operating company are purchased from the P3 developer by the project fund LLC. The project46 fund LLC then subsequently issues securities of its ownership to the crowd investors through a47
  14. 14. Farajian, Ross 14 506c, Regulation A+ or intrastate offering. The project fund LLC securities are backed by the1 performance of the P3 project. This is the structure used by many of the commercial real estate2 crowdfunding sites1 .3 4 In addition to mitigating P3 developer concern over crowd investor management, the project fund5 LLC structure allows the P3 developer to avoid any SEC registration or navigation of6 crowdfunding regulation. SEC compliance is left to the experts at the platform who can leverage7 technology and industry acumen to manage the mechanics of the fund as efficiently as possible.8 Because of the rapid growth of the crowdfunding industry, there has been a proliferation of9 white-label providers that offer SEC filing, accreditation, escrow, payment distribution, document10 management, signature, and Customer Relationship manager (CRM) services. These vendors are11 offering commodity services that allow the platform to drive operational expenses very low12 relative to what a P3 developer would have to expend on their own.13 14 Post Financial Close15 16 Following investment and financial close of the P3, the crowdfunding platform will act as an17 ongoing engagement tool for the investors. The platform will distribute all financial statements,18 disclosures and construction/O&M updates issued by the SPV. The platform will also facilitate all19 disbursements of returns to investors and allow investors to track the performance of their20 individual investments or portfolio of projects. Any secondary market for existing securities will21 also be facilitated by the platform allowing investors to buy and sell securities as their individual22 liquidity needs require. This ongoing interaction between investors and the P3 project provides23 high levels of transparency and public oversight, making sure the developers incentives are24 aligned with crowd-financed investors over the long-term.25 26 Summary of Discussions and Future Research Need27 28 The goal of the crowd-financed P3 model is to facilitate involvement of the public, especially local29 communities, as a major partner in the current P3 model. In addition, aligning the interest of P330 developer, public agency and the crowd-financed equity investors who may be the users of the31 project or local stakeholders impacted by the project can act as catalyst to facilitate delivery of the32 project. This engagement provides the opportunity to use the interests and power of the crowd to33 bring down the investment barrier under the current P3 model and create opportunities for34 additional transparency and enhanced public engagement in the policy decisions.35 36 This paper explains how the crowd-financed P3 model can be implemented in practice. The37 lessons from utilizing crowdfunding in civic projects and commercial real estate can be used to38 design an implementation framework for the crowd-financed P3 model. Based on policy goals,39 project characteristics and market conditions different provisions can be added to procurement40 documents to define the rules around this implementation framework. Those provisions should41 instruct the P3 developers on how crowdfunding can be used in their financial proposals. The42 detail of those provisions and potential risk sharing mechanisms that can be utilized under the43 crowd-financed P3 model to achieve certain policy objectives can be the subject of future research44 studies.45 1 See Fundrise “Project Dependent Notes”:
  15. 15. Farajian, Ross 15 1 In summary, the benefits of the crow-financed P3 model and its readiness to be implemented make2 it an attractive topic both for public agencies and P3 developers. However, additional research is3 still needed to further study the implication of the crowd-financed P3 model, particularly to4 provide more information on popularity of the crowd-financed P3 model among individual5 investors and their appetite for infrastructure investing. Also, additional data on rate of the return6 that those individual investors may demand and a comparison against what investment funds or7 institutional investors demand will better enable decision makers to evaluate financial benefits of8 the crowd-financed P3 model.9 10 References:11 12 1. American Society of Civil Engineers. (2013). Report Card for America’s Infrastructure13 2. McKinsey Global Institute. (2013). Infrastructure productivity: How to save $1 trillion a year.14 Mckinsey and Company15 3. Dynan, K. (2015, January 16). Build America Investment Initiative- Expanding Opportunities to16 Invest in America's Infrastructure. Retrieved on July 20, 2015 from U.S. Department of the17 Treasury:18 pportunities-to-Invest-in-America%E2%80%99s-Infrastructure.aspx20 4. Federal Highway Administration (2015). State P3 Legislation. Retrieved on July 20, 2015 from21 5. Farajian, M., Lauzon, A., Cui,Q. (2015) An Introduction to a Crowdfunded Public-Private23 Partnership Model in the U.S.: A Policy Review on Crowdfund Investing.Transportation Research24 Record Journal25 6. Ross, B. (2015, January 27). Opportunities for Crowdfunding in the P3 Industry. Retrieved July 27,26 2015, from InfraShares: www.infrashares.com27 7. City of Oakland (2014, September 22). Request for Proposals. Retrieved July 27, 2015, from28 8. Masscatalyst. (2015). Price Discovery with our Auction Market Platform. Retrieved on July 26,30 2015 from 9. U.S. Securities and Exchange Commission. (2013, September 22). Eliminating the Prohibition32 Against General Solicitation and General Advertising in Rule 506 and Rule 144A Offering.33 Retrieved on July 27, 2015 from34 10. Drake, D. (2014, November 4). Five Realty Crowdfunding Projects Raising $50M Or More.36 Retrieved on July 26, 2015 from37 m-or-more/39 11. Levine, M. L., & Feigin, P. A. (2014). Crowdfunding Provisions under the New Rule 506(c): New40 Opportunities for Real Estate Capital Formation. The CPA Journal, 46-51.41 12. Bergman, M. H. (2014). SEC Proposes rules to update regulation A. Insights; the Corporate &42 Securities Law Advisor, 32-35.43 13. Zeoli, A. (2015, May 7). State of the States: An Update On Interstate Crowdfunding.Retrieved on44 July 27, 2015 from45 wdfunding-2/47 14. Cho, A. (2015, April 20). Entrepreneurs Hope To Bring Crowdfunding To P3 Projects. Engineering48 News-Record, pp. 22-23.49