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Crowdfunding: Moving Behind Kickstarter


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Financing a company through Crowdfunding campaigns, and alternative funding for startups. (6/16)

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Crowdfunding: Moving Behind Kickstarter

  1. 1. Roger Royse Royse Law Firm, PC Silicon Valley , San Francisco, Los Angeles 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 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
  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 aren’t 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
  16. 16. 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
  17. 17. 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
  18. 18. 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 raised o $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
  19. 19. • 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 totally preempt 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
  20. 20. • 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”)
  21. 21. • 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 statements for 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 at end 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
  22. 22. 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 investor maximums? 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
  23. 23. • 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 statements for past two years disclosed, plus offering circular with audited financials 506(b), 506(c), and Tier 2 (Continued)
  24. 24. 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-securities banned 506(b), 506(c), and Tier 2 (Continued)
  25. 25. Royse University: Providing business, tax, technology and personal finance ideas to founders and executives. Royse Law Legal Wizard: Offering legal document templates and more. Royse Law Incorporator: Incorporate your company the Silicon Valley way. RoyseLaw Legal Wizard
  26. 26. Contact Us SILICON VALLEY 149 Commonwealth Suite 1001 Menlo Park, CA 94025 LOS ANGELES 445 S Figueroa Street 31th Floor Los Angeles, CA 90071 SAN FRANCISCO 135 Main Street 12th Floor San Francisco, CA 94105 Silicon Valley Office: 650- 813-9700 CONTACT US www.rroyselaw.c om @RoyseLaw