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“Learn from the mistakes of others” - Ancient Philosopher Kendall Almerico
The Securities and Exchange Commission recently brought their regulatory hammer down on several ICO-related companies. After months of public statements from officials and rumors of numerous subpoenas and investigations, the SEC sent a strong and undeniable message to companies that have held unregulated initial coin offerings, and to those who are considering it.
Don’t do it.
There are lessons to be learned from these recent regulatory actions. These lessons confirm what I have been preaching in my securities law practice to all of the coin/token/crypto companies I have been talking to or representing: Follow the existing securities laws to raise capital selling tokens or be prepared to suffer some extreme consequences. In this article, I will dig into the story of Carrier EQ, also known as AirFox, whose story is a perfect illustration of the dangers a company faces when they hold an ICO without following securities laws.
I am going to get into a lot of specific facts because what AirFox did is so common in the ICO world, so we can all learn from their mistakes. I will also explain in layman’s’ terms what happened to AirFox as the SEC reviewed their offering, in an effort to provide a “heads-up” to companies that still believe they can get away with holding an ICO in the United States without going through the SEC. It appears that AirFox did not receive very good advice in their ICO, and despite all the recent warnings and negative publicity, I still have ICO companies contacting me wanting to use these same methods (“But I’m selling a utility token!”) that got AirFox in trouble.
Two things are obvious after this SEC enforcement action:
You cannot call what you are selling a “utility token” and have securities laws magically not apply to your offering (see Lesson 7 below), and
Unless you can definitively prove what you are selling is not a security, you need to follow securities laws in your offering.
The AirFox ICO
AirFox is a U.S. company that sells mobile technology that allows prepaid mobile phone customers to earn free or discounted airtime or data by interacting with ads on their smartphones. From August to October 2017,[1] AirFox offered and sold blockchain-issued digital tokens called AirTokens in an ICO where the company raised about $15 million to create a new international business and ecosystem. AirFox told potential ICO investors that the new ecosystem would include the same functionality of AirFox’s existing U.S. business (allowing prepaid mobile users to earn airtime or data by interacting with ads) and would also add new features such as the ability to transfer AirTokens between users, peer-to-peer lending, credit scoring, and eventually using AirTokens to buy and sell goods and services other than mobile data. In the ICO, AirFox stated that AirTokens would potentially increase in value as a result of AirFox’s efforts, and that AirFox would provide investors with liquidity by making AirTokens tradeable in secondary markets.
Any advisor who even has a basic understanding of securities law would look at this and say “Hey, AirFox, you are selling securities. You are selling tokens to the general public, that you are alluding to an increase in value, to finance a new business.” Apparently, AirFox’s “crypto advisors”[2] and lawyers (if they had any) did not bother to Google “what is a security?”[3]
The SEC Penalties
On November 16, 2018, the SEC instituted “cease and-desist proceedings” against AirFox. This means, in laymen’s terms, that the SEC told AirFox to “Stop Breaking The Law!” because the SEC is about to come in, and effectively shut their company down with penalties. As a result, AirFox reached a settlement with the SEC so they could have some hope of continuing in business. The settlement requires AirFox to:
· Pay a $250,000 fine,
· Inform each person that purchased AirTokens of their right to get their money back if they still own the tokens or if they can show they sold them for a loss,
· Issue and post a press release on the company’s website notifying the public of the SEC’s order, containing a link to the order, and containing a link to a “Claim Form” for investors to get their money back,
· File the appropriate paperwork with the SEC to register the AirTokens as a class of securities — this means the AirFox now must follow all securities regulations and ongoing reporting requirements as to these tokens — an extremely expensive requirement, and
· Deal with a lot of other ongoing reporting requirements related to these penalties to keep the SEC informed.
In essence, the SEC made AirFox pay a large fine, forced them to return up to $15 million back to investors, publicly admit on online and in the press that they broke the law, and be subject to a ton of time-consuming and expensive paperwork (disclosing information like audited financial records that investors typically need to decide if a stock is a good investment ).
How many companies that held an unregistered ICO could financially stay viable with the imposition of such penalties? My suspicion is that there are very few.
What do we learn from the AirFox settlement?
1. The SEC is going to follow the Howey test[4] at least as a baseline to determine if a token sold in an ICO is a security. AirTokens were “securities” under the Howey test because people buying the tokens would have had a reasonable expectation of obtaining a future profit based upon AirFox’s efforts, including AirFox revising its app, creating an ecosystem, and adding new functionality using the proceeds from the sale of AirTokens.
Lesson: If your token offering cannot pass muster with a well-known 76-year old Supreme Court ruling, you are selling securities.
2. If you sell tokens that are securities, you have to either (a) register the securities with the SEC or (b) qualify for one of the well-known exemptions from registration such as Regulation D or Regulation A when you sell the tokens. In other words, follow existing securities laws. AirFox, like many ICO companies, did neither of these things, which is illegal.
Lesson: This isn’t rocket science. Either file an S-1 and register your token offering or be sure you qualify under one of the exemptions from registration (like Regulation A) before you sell any tokens to anyone.
3. The SEC is going to read your “white paper”[5] and review everything[6] related to your token offering. With AirFox, the SEC specifically noted that “in September 2017, AirFox explained to prospective investors in a blog post that the ‘AirFox browser is still considered ‘beta’ quality and will continue to be improved over the coming months as we execute on the AirToken plan.’” This blog post helped the SEC satisfy one of the Howey prongs of what constitutes a security: Money from the token sale was being used in a common enterprise for the company raising capital to build their business.
Lesson: Follow securities laws in all offering documents, marketing materials, media interviews, and everything whatsoever associated with the token offering.
4. AirFox’s white paper informed investors that 50% of the proceeds of the offering would be used for engineering and research and development expenses. In AirFox’s whitepaper, the company proposed a potential timeline of development milestones which covered from August 2017 through the second quarter of 2018.[7] Again, the company’s own documentation showed they were selling securities under Howey, by explaining that the company was going to use the funds from the token sale to fulfill their business plan.
Lesson: If you are using the funds from the token offering to build your business, follow your business plan, or build your ecosystem the tokens will be uses in, you are probably selling securities.
5. In its ICO, AirFox raised approximately $15 million by selling 1.06 billion AirTokens to more than 2,500 investors. The number of investors is important: A company selling securities is required to register their equity securities under “Rule 12(g)”[8] if the class of securities was held of record by more than 2,000 persons and more than 500 of those persons were not accredited investors. In other words, if you sell securities to 2,001 total investors, or 501 non-accredited investors, you have to be registered with the SEC.[9] With more than 2,500 investors, AirFox would be subject to these expensive registration requirements, if their tokens were considered to be securities.
Lesson: Watch the number of investors in your offering. Even when you are selling tokens that are clearly securities, you must pay attention to the rules surrounding how many investors you are allowed based on the laws applicable to your offering.
6. AirTokens were available for purchase by individuals in the United States and worldwide through websites controlled by AirFox. The company is based in the United States. The websites selling the tokens in the U.S. were controlled by the company. This all subjected AirFox to the jurisdiction of the SEC.
Lesson: If your company does business in the U.S., or wants to touch the U.S. investor market, you need to follow U.S. securities laws. If you are not a U.S. company[10], and do not sell or market at all to U.S. investors, most of this article may not apply to you at all.
7. The terms of AirFox’s the ICO required purchasers to agree that they were “buying AirTokens for their utility as a medium of exchange for mobile airtime, and not as an investment or a security.” In other words, AirFox assumed they could agree with their token purchasers that they were selling a “utility token” and not a security. It doesn’t work that way. Calling something a “utility token” and saying it “is not a security” is meaningless to the SEC. As the SEC notes “at the time of the ICO, this functionality was not available. Rather, the AirFox App was a prototype that only enabled users to earn and redeem loyalty points, which could be exchanged for mobile airtime. According to the company, the prototype was “really just for the ICO and just for investment purposes so people know . . . how it’s going to work” and “[did not] have any real users” at the time of the ICO. Despite the reference to AirTokens as a medium of exchange, at the time of the ICO, investors purchased AirTokens based upon anticipation that the value of the tokens would rise through AirFox’s future managerial and entrepreneurial efforts.”
This quotation from the SEC is important for two reasons:
· It makes it clear that the AirTokens violate the Howey test. Investors purchased AirTokens anticipating that the value of the tokens would rise through AirFox’s future managerial and entrepreneurial efforts. That is, almost literally, the definition of a security contract from Howey — someone investing in a company where the company’s efforts will increase the value of the investment.
· More importantly, the SEC seems to have cracked the door open a little. The SEC specifically set out several reasons why the AirTokens are securities and not “utility tokens” …but what if those reasons did not exist? What if this ICO had taken place later, and the following facts had been in existence:
(a) At the time of the ICO, the tokens’ functionality was available,
(b) The app was a not a prototype but was fully functional,
(c) The app had real users at the time of the ICO,
(d) The tokens were being used onlyas a medium of exchange at the time of the ICO, and
(e) Purchasers of the tokens had no anticipation that the value of the tokens would rise through the company’s future managerial and entrepreneurial efforts, because the tokens were not allowed to be traded on an exchange or otherwise.
While the marketplace for such tokens would not likely yield nearly $15 million in purchasers like in AirFox’s ICO, it seems that the SEC mightentertain characterizing tokens in the scenario[11] above as not being subject to securities laws.
Lesson: You can’t call what you are selling a “utility token” and have securities laws magically not apply to you. What you call your tokens is irrelevant to the SEC’s legal analysis.
8. AirFox’s whitepaper described an ecosystem to be created by the company where AirTokens would serve as a medium of exchange and that the company would maintain the value of AirTokens by purchasing mobile data and other goods and services with fiat currency that could be then purchased by holders of AirTokens and that the company would buy and sell AirTokens as needed to facilitate the purchase and sale of goods and services with AirTokens. In other words, the investors in the tokens would, again, be relying on the future efforts of AirFox, clearly one of the Howey prongs that make the AirTokens clearly securities under the law.
Lesson: If you are relying on the future efforts of the company selling the tokens to give the tokens value, the tokens have failed one portion of the Howey test.
9. Prior to the ICO, AirFox communicated to prospective investors that it planned to list the tokens on token exchanges to ensure secondary market trading. Obviously, liquidity in any investment is a huge part of the investment decision by a purchaser, and AirFox made it clear (a very common trait in unregulated ICOs) that their tokens would be traded on crypto exchanges, so buyers could sell them and potentially make a profit. This satisfies the “investment” arm of the Howey test. If investors have a reasonable expectation of profit from being the tokens, the tokens are very likely securities.
In fact, in the middle of the ICO, AirFox announced that it was reducing the token supply from 150 billion to 1.5 billion without changing the anticipated market cap “to alleviate concerns raised by many current and potential token holders and token exchanges who prefer each individual token to be worth more.”
Imagine a tradition initial public offering of stock, where the IPO company suddenly changed the number of shares of stock available but kept the valuation of the company the same. “Hey, those shares you first-in buyers got for $20 are now worth $2000 each because we decided to sell 1/100thof the number of shares.” This kind of market manipulation would likely end of with a few people in federal prison.
Lesson 1: If you tell purchasers of your token that the tokens are going to be traded and that you are going to do things to make the tokens more valuable for these investors, you are selling securities, without any question.
Lesson 2: Changing the material terms of a securities offering in the middle of it = bad idea.
10. The SEC noted the following interesting bit of information. Following the ICO, AirFox attempted to list AirTokens on a major digital token trading platform, and answered an application question that asked, “Why would the value increase over time?” AirFox’s response was “As time lapses the features and utility of AirToken will go up as we continue to build the platform. As of today, the people are able to download our browser to earn and purchase AirTokens to redeem mobile data and airtime across 500 wireless carriers. Over the next two years, the utility of the token will expand and therefore, more people across the world will need to have AirTokens in their possession to participate on our platform and ecosystem.”
Lesson: The SEC reads and reviews everything, including interactions a company has with third-party companies.
11. AirFox offered and sold AirTokens in a general solicitation to potential investors. This means AirFox advertised the ICO to the general public and solicited investments from anyone willing to send them money. In the securities world, general solicitation is limited to certain types of securities under certain exemptions, and allowing any investor to purchase securities, regardless of their accredited status, is not allowed in most cases.
Lesson: If you are going to advertise your token offering (and how else would you get the word out and find investors?) you need to follow securities laws and regulations related to general solicitation.
12. Through a “bounty” campaign, AirFox provided “free” AirTokens to people (crypto advisors) who helped the company’s marketing efforts. AirFox entered into an agreement with a crypto advisor who had previously led similar ICO promotions by other companies. This crypto advisor received a percentage of the AirTokens issued in the ICO in exchange for his services, recruited other people to translate AirFox’s whitepaper into multiple languages and to tout AirTokens in their own internet message board posts, articles, YouTube videos, and social media posts. More than 400 individuals promoted the AirToken initial coin offering as part of the bounty campaign. These individuals also received AirTokens in exchange for their services.
While the SEC did not specifically address this point in their ruling, I would not be surprised to see some regulatory or legal investigation undertaken against these crypto advisors. Depending on several factors that there is not enough publicly available information to know for certain, it is possible these crypto advisors may have conducted illegal broker-dealer activities subject to various regulations. The advertising and marketing of securities is highly regulated and based upon the representations made by those who were paid “bounties” by AirFox, it is also possible that some of these individuals did not follow existing laws and regulations as to how such advertising should be conducted.
Lesson: Follow all securities laws and regulations related to marketing, and only deal with advisors who understand and follow securities laws. When interviewing advisors, ask them about their experience in token offerings that were done in compliance with SEC regulations, not their experience with unregulated ICOs.
13. AirFox aimed its marketing efforts for the ICO at digital token investors rather than the anticipated users of AirTokens.
· AirFox promoted the offering in forums aimed at people investing in Bitcoin and other digital assets, that attract viewers in the United States even though the AirFox App was not intended to be used by individuals in the United States.
· AirFox’s principals were interviewed by individuals focused on digital token investing.
· In a blog post, AirFox wrote that an AirToken presale was directed at “sophisticated crypto investors, angel investors and early backers” of the AirToken project and in a pre-sale, prior to the public offering, AirFox made AirTokens available to early investors at a discount.
AirFox made no effort to market the ICO to the anticipated users of AirFox tokens — individuals with prepaid phones in developing countries. Instead, AirFox marketed the ICO to investors who “viewed AirTokens as a speculative, tradeable investment vehicle that might appreciate based on AirFox’s managerial and entrepreneurial efforts.”
Lesson: If you are going to claim you are selling “utility tokens” in an offering, you should sell those tokens to the ultimate users of the tokens. If you do not, you are likely selling securities to speculating investors, and your argument of selling “utility tokens” falls apart very quickly.
Conclusion (The Final Lesson)
I’ve been talking to (and in some cases, actually representing) token and crypto companies ever since the DAO decision when the floodgates opened to companies realizing that the only safe way in the U.S. to issue a digital asset, token or coin is to follow securities laws. It’s not that hard. Every mistake AirFox made was avoidable, and everything they did to violate well-established securities laws could have been avoided if they had received good advice. Selling investments to U.S. citizens is one of the most highly regulated industries in the world. To think a company can avoid following these well-established laws and regulations just because of a new technology, and because “everyone else is doing it,” is ridiculous.
Can I start openly selling cocaine online to anyone who wants to buy it because I keep the records of the sales on a distributed ledger and track each kilo on a blockchain? No, and nobody would be so stupid to try.[12]
This is not that difficult. The final lesson is: If you want to sell tokens without following securities laws to the U.S. market, you need to be 100% certain they are not securities, and that is going to be very difficult to do in most cases. If you and your advisors are not 100% certain that what you plan to sell is not a securitiy, get advice from reputable securities counsel before you do anything.
Once more thing: if you find yourself creating arguments to get around parts of the Howey Test rather than being able to definitively prove your tokens do not fit the Howey definition of a security, then the SEC is most likely going to disagree with you, and deem your tokens to be securities.
[1]It is important to note these dates. One month before the AirFox ICO, in July 2017, the SEC announced that it viewed the tokens offered by The DAO, an ICO that raised more than $150 million in 2016, as securities. This ruling was widely reported and sent shockwaves through the “unregulated” ICO industry. It would be hard to imagine that those advising AirFox were not aware of the DAO ruling when they started their ICO one month later.
[2]Some “crypto advisors” are persons (nearly always without a law degree) who advertise that they have “helped companies raise millions” in other ICOs (none of which followed U.S. securities laws). They often have influence in the ICO community and on ICO review websites where, in many cases, the review of an unregistered ICO is based on how much money you pay the website.
[3]Or, their advisors Googled it, read the Howey test, and decided “Let’s make like an ostrich and ignore the obvious.” Advisors to ICO companies should not take the attitude of “but everyone else is doing it and raising millions of dollars so it must be okay” or, my favorite, “there are no rules for ICOs, these are unregulated!”
[4]SEC v. W. J. Howey Co., 328 U.S. 293 (1946). The “Howey Test” is the U.S. Supreme Court’s definition of what a security is and has been the law for 76 years. In a nutshell, the four-part Howey Test determines that a transaction represents an investment contract if a person (a) invests his money (b) in a common enterprise and is (c) led to expect profits (d) solely from the efforts of the promoter or a third party.
[5]A “white paper” in the ICO world is a document that explains the business and the offering. In most cases, these documents are heavy on technical language regarding the tokens and blockchain but offer little to no guidance on the financial health of the business and rarely disclose all the risks of investing in the offering. In many cases, these “white papers” are not even close to what a securities lawyer would draft for any securities offering. But, many ICO companies apparently are advised to believe their white paper, with its page of legal disclaimers copied from other white papers found online, will magically protect them from any securities laws repercussions.
[6]The SEC will look at a company’s white paper, any other offering documents, websites, social media, media interviews, and any other online or offline matter related to the offering. If it is publicly available, the SEC is going to review it. Even if it is not publicly available, the SEC may subpoena it. In the AirFox case, the SEC noted that AirFox talked about prospects for development of the AirToken ecosystem on blogs, social media, online videos, and online forums and even gave a specific example of quotes from AirFox’s principals making claims in a YouTube video.
[7]These are typical White Paper 101 inclusions in an ICO. A breakdown of what the funds will be used for (which is actually a normal part of a securities law compliant offering document) and a timeline. While there is nothing wrong with these disclosures, the problem is that these white papers rarely discuss the risks involved with the offering, and almost never disclose anything about the financial condition of the company — staples of a compliant securities offering.
[8]17 CFR 240.12g-1
[9]There are notable exceptions to this rule under certain exemptions from registration, including under Regulation A, as amended in the JOBS Act.
[10]Without getting too technical, if you are a New York City based company, with offices and employees in Manhattan, who sets up a shell company in the Virgin Islands that has no office or employees and you run that company out of New York, you are not being clever and avoiding the fact that the SEC is probably still going to consider you a U.S. company. All you have done is sent up a red flag.
[11]There are other factors to consider, as Howey is just part of the analysis as to whether something is, or is not, a security. But, for illustrative purposes, this section of the SEC’s analysis is very helpful for companies considering a token sale, because it illustrates a potential path to a token not being subject to securities laws, and the possible ability in very narrow circumstances to sell a token outside of securities laws.
[12]Okay, someone might be dumb enough to try. Never underestimate the stupidity of some people. The TV show America’s Dumbest Criminals filled three years of episodes with people who might have tried this. For the record, if a stupid criminal tries this, and says it was my idea, please remember that they are, as noted, a stupid criminal and do not believe them.
Disclaimer (because I am wearing my lawyer hat): Kendall Almerico is a securities lawyer who represents companies raising capital in JOBS Act offerings (Regulation A in particular) and companies that want to sell tokenized securities in a compliant manner through a security token offering. This article does not contain legal advice and should not be relied upon bu anyone for legal advice. It is simply the opinions of Kendall Almerico interpreting certain matters that were recently in the news. Do not rely on this article for legal advice as every situation is different. In all cases, consult your own attorney or advisors.
There, I said it.
With Securities and Exchange Commission Chair Jay Clayton making the public announcement last July he believes every ICO he’s seen is a security, every company in the cryptocurrency, blockchain and token world was put on notice that raising capital by selling coins or tokens was entering a different phase in the United States. As a result, securities lawyers like myself, have been flooded with calls and requests for our services.
I was interviewed by one of my favorite journalists, Tony Zerucha at Bankless Times, about how ICOs, token offerings and the like can be legally done these days and you can (and should) read the entire published article here. For those who want the CliffNotes version, here you go:
- Any U.S. company that wants to raise capital by selling coins, tokens or cryptocurrency, and any company that wants to access the 325 million potential investors who live in the United States, must follow securities laws at this point. With my work in the JOBS Act legal realm, I have been been talking to dozens of crypto companies. Because the grand majority will use one of two JOBS Act provisions: Regulation D, rule 506(c) (if they limit the offering to accredited investors), or Regulation A+ if they want to access the entire U.S. population, those of us who specialize in JOBS Act offerings and equity crowdfunding have become quite popular.
- I've lost count of the number of companies I have had to turn down at this point because they already have done something that is not compliant or legal. The first step is to make sure each company has not already screwed up what they want to do because they were not well informed as to how they should proceed. I ask some pretty simple questions to start, and you would be surprised at how few companies have the right answers.
- I start with the basics. I ask every company to explain to me in a sentence why they need a token and how blockchain is integral to their business. If I had a Bitcoin for every company that came to me with a concept that used the term “blockchain” or “token” without even knowing what it meant or how it was going to be used, I’d be a Bitcoin billionaire. Or maybe a Bitcoin millionaire, depending on the fluctuating exchange rates.
- You would be amazed at how many people cannot answer this question in one hour, much less one sentence. Some businesses do not need a blockchain, or a token. For example, I do a pretty good job of running a law firm without a blockchain. A pilot does not need a coin to fly an airplane. A chef does not need a utility token to cook a perfect steak. I realize that blockchain technology is revolutionary in many ways for many things. But, you can’t just throw the term “blockchain” into every business model. If a company is not able to explain in simple terms why they need blockchain in their business, they probably don’t need blockchain, and probably should not be doing a coin offering.
- I hate it when I hear, “Kendall, our pre-sale is next week. Would you take a look at our white paper and be sure we are okay?” If they are already online soliciting for their sale, there is a good chance they’ve already violated a law or two. And if they already have anything scheduled in terms of a sale, it’s probably too late for any securities lawyer to help unless they are willing to pump the brakes.
- I also hear this one a lot: “We’re okay because we’ve hired” followed by ‘a top ‘ICO’ ‘Blockchain’ or ‘Crypto’ consultant on our Board of Advisors.” I ask these companies if their advisor is a securities attorney who has experience with the JOBS Act and securities token offerings, and then I look at my iPhone to see if the call has been disconnected because there is always dead silence. Ninety-five per cent of these “crypto experts” have absolutely no idea how to do a securities law-compliant token offering in the United States, and many charged these companies a lot of money to give them bad advice.
- I received a ton of emails, most of them spam, over the past few years with the newest hottest ICO offers, and I saw the news about the crazy amount of money being raised. I think most securities lawyers saw these ICOs raising millions with no disclosures, no investor protections, no financial statements and no real information revealed other than hype and the repeated use of the term “blockchain.” Not only were these obviously sales of securities, many of them were just blatant scams that couldn’t pass a sniff test in allergy season. No, I can’t say that seeing the SEC jump in and state regulators filing enforcement actions and class action suits being filed was at all surprising.
- A company needs to assume that what they are selling is a security, because the SEC is certainly going to assume that. You can’t call something a “utility token” and assume you can get away with not following securities laws. It does not matter what you call it, if it cannot pass the Howey Test, or if you are selling it with the idea that the purchaser may be buying something that will increase in value over time, you should treat it like a security. There are well defined exemptions that allow U.S. companies to sell securities without registering, so follow those laws in your token sale, and the capital raise portion should be legal.
- To me, Reg A+ is the holy grail for token security offerings. Everyone can invest, not just rich people. The tokens sold can immediately be listed on an Alternative Trading System (ATS) and are liquid and tradable. I love that the SEC must qualify a Reg A+ offering before it can be sold. This means if you have any problems in your offering, there is a likelihood it is going to be flagged by someone at the SEC before you start selling, rather than after when something goes wrong like with Reg D or Reg S. It is not cheap to do, but nowhere near as expensive as an S-1 and full registration with the SEC. You will have ongoing reporting requirements and a company is limited to raising $50 million per year. While most companies would be thrilled with raising $50 million per year, this limitation would prevent some companies from using Reg A+ if their capital needs are higher. That said, a Reg A+ raise can be done in conjunction with a Reg D offering, if it’s structured correctly, to raise more that the limit.
- The big questions are: What happens after someone purchases the token or coin? Can they sell it outside of an ATS? How? Can they use it as a currency? Can they use it as a utility token? There is a huge amount of uncertainty as to how the courts and regulators are going to treat security coins and tokens after they are in the hand of investors. This is one reason why I like Reg A+ so much. As soon as the offering closes, the Reg A+ securities tokens may be listed on a secondary trading platform and be bought or sold. This immediate liquidity is a huge selling point. There are rules and restrictions that limits sales under Reg D and Reg S, so this is not possible with either of those exemptions.
- My experience is that the SEC is very open to this new method of raising capital, as long as you follow securities laws and protect investors. The SEC is well aware that if they shut down all crypto offerings, another country will become the leader in this area, and billions of dollars of capital will flow out of the U.S. They do not want this to happen, so they are working with securities lawyers and their counterparts at the CFTC, Department of Treasury, FinCen and others to try to find solutions. Yes, you have a target on your back if you do a crypto offering. But, as long as you have a justifiable legal basis in securities law for what you plan to do, the chances are the SEC is not going to stand in your way.
As I said in the interview, the days are gone of some random millennial plagiarizing a white paper found on Google while their tech geek buddy sets up a website to promote and accept Bitcoin for an ICO followed by millions of dollars magically appearing, unless those people want to risk going to jail or being sued.
Anyone who wants to do this right in the U.S. is going to need experienced securities counsel. They are very likely going to need a licensed broker-dealer. They are going to need a secondary trading platform. They are probably going to need accountants and maybe auditors. Doing this right is not going to be cheap. But, then again, getting sued or arrested and having your business shut down is far more expensive than simply doing this legally and compliantly from the beginning.
Read the entire interview here, to learn more:
In my role helping companies raise up to $50 million in new capital using equity crowdfunding, I am frequently asked if a company that wishes to pursue a Regulation A+ capital raise must hire a broker-dealer for the offering. I have written an in-depth article about this on Medium, which you can read here (if you like to read stuff lawyers write and enjoy footnotes and long-winded legal analysis). On the other hand, if you want the simple Cliff Notes version, keep reading below!
The simple answer to the title question above is that moving forward with a Regulation A+ offering without a broker-dealer attached is a dangerous move for an issuer, even though it technically can be done. However, if an issuer wants to sleep well at night and not worry that one of the 50+ state securities regulators or the SEC will come knocking on their door, then bite the bullet and hire a broker-dealer who is licensed in all 50 states and by FINRA for your Regulation A+ offering.
The big issue related to hiring a broker-dealer for most issuers is the cost. A broker-dealer will likely have up front due diligence costs, and will charge a percentage of the funds raised in the offering as a commission. This raises this important question: Will an issuer save money by not hiring a broker-dealer?
Up front, maybe. In the long run, probably not. As illustrated below, in order to go forward on a Regulation A+ offering without a broker-dealer, an issuer may have to register as a “dealer” in many states and at the federal level, which will cost thousands in legal and filing fees. Assuming everything is done correctly and runs smoothly, registering with all of these entities could involve hefty up-front costs, and in most cases far more than the broker-dealer would have charged for due diligence. More importantly, if anything is done wrong in that registration process in any of the venues, or if any state or federal securities regulator thinks something was done wrong, then there will be huge costs to fight the enforcement actions that could arise all over the country.
Why do companies even consider taking on all of this risk by not hiring a broker-dealer?
Regulation A+ of the JOBS Act is silent as to whether an issuer must hire a broker-dealer in order to sell unregistered securities to the general public under this JOBS Act exemption. Given this silence, most legal authorities agree that the law and SEC rules related to Regulation A+ do not, on their own, require an issuer to hire a FINRA licensed broker-dealer to sell their unregistered securities. Therefore, some issuers feel this is enough of a justification to go at it without a broker-dealer.
What these companies are missing is that the text of Regulation A+ and the SEC regulations related to the statute are not the sole consideration in this matter given that securities are being sold. Other state and federal laws and regulations that regulate who may sell securities may prevent an issuer from selling their own Regulation A+ securities without a licensed broker-dealer in some jurisdictions. The JOBS Act waiver of state Blue Sky review does not necessarily prevent the states from regulating who can sell Regulation A+ securities in their state. Because each state has its own set of laws related to who is allowed to sell securities, who must be registered to do so, and under what circumstances securities can be sold by that entity, there are valid concerns that a state regulator could impose significant penalties on an issuer who chooses to sell its Regulation A+ securities within that state, without a broker-dealer licensed in that state.
So, you ask, what is the worst case scenario if a company decides to try to save a few dollars, and sell their Regulation A+ securities on their own? Let me give you the scenario that would keep me awake at night, and the one that typically compels me to advise my clients to hire a broker-dealer and not go at it alone:
Let’s say the company sells its Regulation A+ securities to a little old lady in Florida, without using a broker-dealer registered in Florida. The company does not do well, or the stock is listed on an exchange and the price drops. Little old lady hires a lawyer, and wants her money back. She also contacts the state securities regulators in Florida, and tells them about this mean and awful company that took her retirement savings away from her.
The lawsuit and the state securities regulators review will probably show that the company did not comply with every aspect of Florida securities law, in particular, by not hiring a broker-dealer (which would have rendered the case moot).
Do you think a Florida jury is going to side with a company that violated state law and sold stock to the little old lady? Do you think securities regulators are going to help the little old lady, or the company that violated its state’s securities laws?
The result could be rescission of the agreement to sell the stock – meaning the little old lady gets her money back. There could also be rescission ordered for all investors in the state, meaning a huge financial problem for the issuer who has to give money back to everyone who invested, not just the little old lady. On top of that, fines and penalties could be ordered. And, to make matters worse, a court or the state regulators could extend the penalties against the officers and directors of the company personally, particularly if they were involved in selling activities themselves.
Ouch.
All avoidable by simply hiring a broker-dealer.
I’m not alone in my concerns here. Kat Cook is the Chief Compliance Officer for Keystone Capital Corporation, a FINRA licensed broker-dealer with experience in Regulation A+ arena and other areas of the rapidly emerging FinTech industry. Cook believes that this threat is very real of having to rescind all subscriptions agreements and return capital raised if a state securities regulator finds that local laws were not complied with. “Compliance with Reg A+ means that the issuer should hire a very knowledgeable JOBS Act securities attorney and retain a supporting broker-dealer to help…or prepare to give the funds raised back to the investors,” warns Cook.
If you want far more in-depth analysis and some state law citations that let you dig deep into this, click here https://medium.com/@KendallAlmerico/do-you-need-a-broker-dealer-for-regulation-a-7308535d9b19 and read my Medium article.
Kendall Almerico is an attorney based in Washington DC whose practice involves JOBS Act related securities offerings such as those involving Regulation A+ or Regulation CF. This article should not be considered as legal advice, and the opinions expresses in the article are personal opinions of Mr. Almerico and should not be relied upon by anyone as legal advice. Other lawyers may have different opinions. The topics covered in this article are very complex, and any company considering using Regulation A+ or selling securities in any manner should seek the advice of competent and experienced legal counsel before making any decisions related to the matters set out in this article.
Crowdfunding is a multibillion dollar worldwide industry that continues to disrupt the traditional world of corporate finance, as well as change the way products go to market. Businesses new and old, small and large, are now incorporating both rewards crowdfunding and equity crowdfunding. The capital raising playbooks have changed. The interest in how to use crowdfunding and equity crowdfunding effectively is reaching new heights every day.
Where is the good information?
It's no surprise that a lot of good information is already out there about how crowdfunding works. Unfortunately, though, bad information is also rampant on the internet. In my JOBS Act law practice, I field questions every day as someone who "quarterbacks" equity crowdfunding campaigns for companies raising millions of dollars of new capital.
These questions make it clear that most people still do not truly understand how crowdfunding works, or what it takes to raise capital successfully using these amazing tools. Clearly, more education is desperately needed.
I try to do my part with Entrepreneur.com columnsand media appearances. But I've found that there are some other ways to help yourself and learn the nuts and bolts of crowdfunding:
1. Look at successful crowdfunding campaigns.
Take the time to study and see how a successful crowdfunding campaign worked. Imitation is the sincerest form of flattery. Looks at crowdfunding home runs like Pebble Time and Coolest Cooler that both raised millions of dollars with rewards crowdfunding campaigns.
Watch their videos. Look at their perks. Learn from their successes. See the common threads that go through successful rewards crowdfunding campaigns: a great video, simple and easy-to-understand text on the campaign or offering page, a clear “call-to-action” and great rewards.
2. Look at unsuccessful crowdfunding campaigns and see what went wrong.
Kickstarter, Indiegogo and other crowdfunding platforms are filled with failures you can learn from. Did that make a bad video? Did they not explain their campaign well? Did they have bad rewards or perks? Look up these companies online and on their social media and see what they did to market their campaign.
In most cases, you will see that they did not market at all, the biggest mistake a crowdfunding campaign can make. Do some research, and don’t make the same mistakes.
3. Learn from marketing experts.
Crowdfunding is all about marketing. Getting the word out, driving traffic and messaging correctly are the keys to every successful crowdfunding campaign. If you know how to market your business or your product, you know how to drive traffic to a crowdfunding campaign.
If you are a marketing novice, read books by marketing gurus and watch their online videos. Learn from people like Gary Vaynerchuk and Seth Godin who have large amounts of great material available online. Read, learn, and implement! A crowdfunding campaign with poor marketing will be a failed crowdfunding campaign.
4. Attend a crowdfunding conference.
To do a deep dive and learn about both rewards and equity crowdfunding, one of the best methods is to attend a crowdfunding conference. One such event is The Global Crowdfunding Convention in Las Vegas run by crowdfunding pioneer and top expert Ruth Hedges. Hedges, whose roots in the crowdfunding industry are exemplified by her invitation to the White House for its Crowdfunding Champions of Change event when the JOBS Act was passed.
Hedges puts on a multi-day event that covers all aspects of the crowdfunding world. To illustrate how far crowdfunding has come in a short time, this year's Global Crowdfunding Convention, held at Planet Hollywood October 23-24, 2017, is sponsored by Microsoft.
5. Learn how to make a compelling video.
A great crowdfunding video enhances your chances of success. A terrible video practically guarantees failure. In addition to watching videos from successful campaigns and seeing what they did right, learn a little about video production yourself.
There are tons of YouTube videos about simple video creation -- things like basic lighting and decent audio -- that make a huge difference in what your crowdfunding video will ultimately look and sound like.
Learn how to tell your story with passion, explain your campaign, and most importantly, how to ask for either a donation or investment. The "ask" is an incredibly important part of every crowdfunding campaign, and one all-too-often missing -- particularly from failed campaigns.
So, crowdfunding fans, with these tips you can read, research and learn on your own, or have it spoon fed to you in Vegas while you eat at a ridiculously huge buffet.
Also, try to get tickets to the latest Cirque Du Soleil show. Either way, education about how to prepare for, launch and conduct a crowdfunding campaign is the key to all success in this amazing new world of raising capital online.
Crowdfunding is shrinking the risk of investing in potential next-big-things.
How could you make $63 billion investing through equity crowdfunding? It’s easy. Just find the "next big thing."
In 1976, Ron Wayne owned 10 percent of a small, startup company with two young, renegade founders working from a California garage. Not wanting to take the risk of being liable for 10 percent of the company’s debts, Wayne sold his stock for $800. Had Wayne held on to that stock in Apple Computer, today it would be worth about $63 billion.
Does that mean you should buy $800 worth of stock in every company using equity crowdfunding to raise capital online? Of course not. But, Wayne’s story illustrates that having the ability to invest in companies at the earliest stages can lead to huge returns. It also shows that those who invest relatively small amounts in startups could generate millions -- cue Dr. Evil ...or even billions! -- of dollars in profits.
I know investing in startups is risky. The Small Business Administration says that about one-third of all startups fail in the first two years. The U.S. Bureau for Labor Statistics says that 50 percent of new businesses fail within five years. Really, all investing has risks. Even investing in blue chip stocks can lead to financial disaster. In November 2006, the country’s largest bank, Bank of America, probably seemed like a safe investment at $55 a share, after years of its stock price climbing without fail. But when the bank’s stock plummeted below $4 a share in 2009, the blue chip stock no longer seemed like such a good investment. Let’s do the math on that one. If, in 2006, you had invested in Bank of America the same $800 Wayne sold his Apple stock for, your investment was worth $58 three years later.
With legalization of JOBS Act equity crowdfunding, for the first time in 80 years, anyone can invest in startups, new companies, growing private companies and other small businesses that only rich and well-connected investors were legally allowed to invest in before. Those nerdy guys down the dorm hallway making an app that lets you ride around town in the backseat of someone’s car rather than a taxi that smells like Bourbon Street on a hot August night? It’s true, you may be able to buy shares in the next Uber through equity crowdfunding.
How do you pick the startup winners and leave behind the losers? What can you do to increase the odds that you will make a good return investing in startups? Here are some tips from your favorite equity crowdfunding expert.
1. Does the business model make sense?
Warren Buffett has made a fortune investing in companies with simple businesses models. If you see a crowdfunding campaign and do not understand what a company does or how they will monetize or scale their business, you probably should pass on that company.
2. Look at the management team.
Who are the founders of the company? Harvard Business Review says that experienced entrepreneurs -- failed entrepreneurs included -- have a much higher predicted success rate then first time entrepreneurs. Check out the management team, and research their prior experience and accomplishments.
3. Find committed founders.
Startups have a better chance of success when the founders make the company their full time job. That means they are getting paid a reasonable salary they can live on. I don’t want to see the founders working two hours a day on the startup and 10 hours a day at Subway making sandwiches to make ends meet.
4. Look at the use of investment funds.
As an investor, you need to understand how the company intends to spend the money you give them. See if the funds the startup is raising will be sufficient to reach important milestones like building a prototype, taking a product to market or ramping up production to scale a business.
5. Be patient.
Even if one or more of the equity crowdfunding companies you invest in becomes successful, it could take five or more years to get a return on your investment. You will probably have to wait for a “liquidity event” such as an IPO or an acquisition by another company. Think about our $63 billion example. Wayne sold his Apple stock in 1976. Apple went public in 1980, four years later, and instantly created more millionaires than any company in history. But the stock splits over the next 30+ years, and the increase in the company’s value during those decades, are what would have amounted to Wayne being a multi-billionaire, rather than a just another millionaire (sarcasm intended).
As Aristotle said, “Patience is bitter, but its fruit is sweet.”
When you research something online, you become a hot lead.
Under the JOBS Act, small companies now have two methods of equity crowdfunding to raise millions of dollars in capital online from the general public. Unfortunately, most people think that all a company needs to do is post a cool video, some fancy graphics and some engaging text, and the investment money will start pouring in. Wrong.
As one of the foremost experts on crowdfunding, I have seen this time and again. When companies ask me why their equity crowdfunding campaign failed, the answer is nearly always the same -- they did not market the offering correctly. Crowdfunding is not the "field of dreams." Just because you build it, does not mean investors will come. Companies have to drive investors to their equity crowdfunding campaign with effective marketing.
Ever wonder why you looked at that gadget on Amazon, and for the next two weeks you are suddenly bombarded by ads for that gadget or similar products every time you are online? Welcome to the wonders of digital advertising. Someone is paying to serve you those ads, knowing you are a highly likely buyer based on hidden bits of data called pixels and cookies some company was kind enough to attach to your computer while you browsed. By looking at anything online, you have become a hot lead to someone trying to sell you something.
The same logic works for equity crowdfunding. If your company is funding a new product, for example, it’s easy and cost effective to put ads in front of potential investors, based on data of their prior online habits. A crowdfunding marketing plan involves many aspects, but these five tips related to digital marketing are essential to equity crowdfunding success.
1. Use Facebook ads.
An effective Facebook ad campaign allows a company to effectively target likely investors based on Facebook users’ location, demographics and interests. Stephanie Heinatz, CEO of The Consociate Group, is not only a public relations guru with a special expertise in the digital marketing space, but has also successfully marketed several equity crowdfunding campaigns. “Facebook is the number one platform in social media marketing where you can target a customized audience. No more wasting money on a megaphone of messaging to who-knows-who. Facebook is like picking up the phone and selling directly to someone.”
2. Use “lookalike” audiences.
If you have an email database of customers or investors, you can create a lookalike audience and serve ads to them on Facebook. Delray Wannemacher of First Look Equities is a financial industry veteran whose success in driving investors to equity crowdfunding offerings comes from delivering ads to lookalike audiences created from his proprietary investor database. Wannemacher exemplifies this with a case study showing the impact that a well-designed, targeted audience ad campaign can have on a crowdfunding offering. “One Facebook ad campaign we ran showed an improvement on the amount of investments per day of 252 percent, with the average investment being three times higher than before the campaign.”
3. Search Engine Marketing (SEM).
The most basic form of SEM involves paying for certain search terms and having Google drive traffic to your crowdfunding campaign based on what you paid for. Heinatz explains "With SEM, we know somebody is a potential investor based on their search terms, so you are directly reaching out to people who have already identified themselves as someone looking to make a purchase or an investment.”
4. Twitter and LinkedIn ads.
With these two popular social media sites, Heinatz emphasizes context over content. “Twitter is a fast moving headline source, but you can use Twitter advertising to promote and grow your community. LinkedIn ads work best in a B2B context and can be used to drive people to a lead generation page for the right crowdfunding offerings.”
5. Email marketing.
While email marketing may not be as sexy as newer marketing tactics such as social media and video, it can still be a huge factor in driving a successful equity crowdfunding offering. Rob Clarke and Andrew Eckard of Lin Digital have spent almost a decade crafting successful digital marketing strategies for local, regional and national businesses, and both agree that email is a crucial factor in driving conversions. Eckard explains, “There are plenty of digital platforms available to deliver your message, but good old fashioned email marketing continues to offer one of the best opportunities to build relationships and drive sales.” Clarke added, “Early momentum is crucial in any crowdfunding campaign, and building your email list to engage people in what you are doing before asking them to invest or contribute will put you at a huge advantage on launch day.”
Digital marketing is an essential part of every equity crowdfunding offering, just as it has been for rewards-based crowdfunding. Working with the right professionals with the correct strategy and knowing who to target is the key to success. One last tip from your favorite crowdfunding expert: Digital marketing is a process that takes time. Most say it takes a potential investor seeing an average of five ads before they make a decision to invest. Converting digital advertising is a process, so start early in the crowdfunding campaign.
Originally Published at Entrepreneur.com on May 10, 2017
BrewDog plc, the irreverent Scottish craft brewery that has built a successful international business through many rounds of equity crowdfunding involving 50,000+ online investors, recently announced that a U.S. private equity company has acquired approximately 22 percent of the company in a $264 million transaction. This minority investment values BrewDog at $1.24 billion.
BrewDog's Lineup of Craft Beer
Most importantly, this transaction allows BrewDog's “equity punks” -- the name for its shareholders who invested in the company through crowdfunding -- to sell a portion of their stock to the private equity firm, providing some liquidity to these investors. By doing so, BrewDog has offered a substantive response to critics of equity crowdfunding who wonder how small investors will benefit from these types of offerings.
Keep in mind, BrewDog is still a private U.K. company. Their shares are not publicly traded on any exchange, which also gives some liquidity for their early crowdfunding investors, despite the company remaining private. For those who invest in private companies, whether through crowdfunding or otherwise, we all know returns on private company investments before the company becomes public are few and far between.
James Watt, BrewDog’s co-founder, explains: “Shares purchased in Equity for Punks I are now worth 2,765 percent of their original value. Even craft beer fans that invested in Equity for Punks IV, which closed in April 2016, have seen the value of their shares increase by 177 percent in just one year.” The deal gives BrewDog plc’s army of equity punks the opportunity to sell 15 percent of their shares (capped at 40 shares per investor) at the $1.24 billion valuation.
BrewDog Founder Martin Dickie and James Watt
This has tremendous significance to the world of equity crowdfunding. With Regulation CF, where a startup company can raise up to $1 million online, and Regulation A (the “Mini-IPO”), where a company can raise up to $50 million online from anyone in the general public, the popularity of raising capital online grows every day. Crowdfunding has become a multi-billion industry in a very short period of time. But because the JOBS Act, the law that made equity crowdfunding legal, only went into effect in 2015, success stories with an exit for investors are rare. BrewDog's success, using U.K. laws very similar to the JOBS Act, and leading to a return on investment for those who backed the company online for the past few years, bodes well for the development of equity crowdfunding under the newer U.S. laws.
This is welcome news to those in the equity crowdfunding industry. It was not long ago that the $2 billion buyout of Oculus by Facebook caused the media and many rewards crowdfunding backers to lose their minds. Oculus had run a rewards-based crowdfunding campaign on Kickstarter that raised $2,437,429 from 9,522 backers. In rewards crowdfunding, no shares in the company are sold, but rather the backers received the virtual reality hardware and software in return for a donation. When Facebook acquired Oculus for a couple of billion dollars, some backers from the Kickstarter campaign went ballistic, claiming they did not receive a return on their “investment.”
At the time, a New York Times editorial and a Bloomberg column showed that even the media failed to grasp the huge difference between rewards-based (a donation) and equity crowdfunding (an actual investment). The Bloomberg article even accused Oculus of pulling off a scam because the supporters of its Kickstarter campaign did not get a share of the profits from the buyout. One blogger was so angered that he wrote an article with one of the better headlines in the history of blogging -- “I'd Rather Stick My Head In A Whale's Blowhole Than Play Facebook's Oculus Rift.”
As I pointed out at the time, each of Oculus’ 9,500+ Kickstarter backers knew that they were not investing in the company, and that they were not getting equity when they swiped their credit cards in exchange for an early version of Oculus’ new VR headset. Had equity crowdfunding been legal in the U.S. at the time, and had Oculus run the same campaign on an equity crowdfunding website, those who invested would likely have seen phenomenal returns. However, equity crowdfunding wasn’t legal at the time.
Now, equity crowdfunding has its poster child.
BrewDog has raised tens of millions in several equity crowdfunding rounds since 2010. They have built a community of tens of thousands of people who have not only invested, but who have also become brand ambassadors and evangelists for everything BrewDog. And now, those investors will have an opportunity to not only continue to savor the perks of having invested, like free beer and online discounts, but also to see a financial reward for their equity crowdfunding investment.
BrewDog plc's headquarters and Scotland brewery
Equity crowdfunding finally has a success story that should spur on the growth of this nascent industry. BrewDog has given us an example of how investing in equity crowdfunding offerings is far different than donating to a Kickstarter or Indiegogo campaign. Investors finally have an example of how an equity crowdfunding investment can bring them a very real return.
Image credit: Joe Raedle | Getty Images
Originally published at Entrepreneur.com on January 10, 2017
Donald Trump will soon be inaugurated as the country’s 45th president and will potentially impact the burgeoning crowdfunding industry in a "yuge" way. Before I share my thoughts as one of the country’s top crowdfunding attorneys, let me tell you what five industry leaders believe the Trump presidency will mean for crowdfunding.
Disclaimer: This is NOT a political article. For those on the right, please don’t send me red baseball caps embroidered with “Make Crowdfunding Great Again.” For those on the left, please do not label me or the crowdfunding leaders in this article as “deplorable” or worse.
Indiegogo has been at the forefront of rewards crowdfunding since the very beginning. Indiegogo’s co-founder and Chief Business Officer, Slava Rubin, had this to say: "It's obviously impossible to know exactly how the next four years will play out since the new administration hasn't moved into the White House yet. Trump's platform included easing up on banking regulations -- which the stock market has reacted well to -- and it will be interesting to see how that translates for equity crowdfunding. The one year anniversary of Title III is coming up this May, so that will be a good time to examine what kind of progress has been made under the new administration."
RocketHub was one of the world's pioneering crowdfunding portals and has developed into a global community for entrepreneurial growth through a partnership with luxury lifestyle network ELEQT. RocketHub's CEO Ruud Smeets shared his take on the Trump presidency.
“Any abrupt change in the political landscape is a challenge and can have ripple effects throughout one's business," Smeets said. "Having a strong support 'crowd' can be a great benefit to any entrepreneur, especially in times of change. The emerging Trump presidency may create more volatility, but it also holds the promise of potentially bringing less regulation and more freedom for innovation and entrepreneurship. That would be good news for alternative funding options like crowdfunding, which still is a highly regulated market space with certain barriers to growth. It remains to be seen though how Trump’s plans on healthcare, international trade, isolationism and any attendant currency effects will affect small business ownership as a whole.”
Roy Morejon, whose firm Command Partners has been one of the most prolific and successful PR and marketing agencies in the crowdfunding space said the initial effects of a Trump presidency seem to be positive for the crowdfunding industry. Recent meetings with top technology leaders from Apple, Microsoft, Amazon, Facebook, Intel and Tesla seemed to be productive with innovation and jobs being a top priority.
"With Trump's business background, American innovation and job creation should flourish," Morejon said. "At our crowdfunding marketing agency, we're seeing a flurry of activity in the equity crowdfunding space in hopes that Trump will alleviate some of the red tape with some of the current crowdfunding regulations.”
Ruth Hedges is one of the pioneers of the JOBS Act and executive producer of the Global Crowdfunding Convention, the largest and longest running crowdfunding convention in the country. Here are her thoughts on the Trump presidency related to crowdfunding: "As America enters uncharted waters with social safety net programs and medical insurance for 20 million people threatened with destruction, we'll need to call on crowdfunding to provide help to those people who will surely suffer, because crowdfunding is not red or blue, black or white, Christian, Muslim or Jew. It is not left or right, but showcases the best of our humanity. And it demonstrates the potential to bring together people from all backgrounds and beliefs to work for our common good as Americans."
Craig Denlinger is one of the go-to auditors for financial reports needed to comply with equity crowdfunding laws. His firm, Artesian CPA, has provided the SEC financial filings for several companies using Regulation A+ to raise capital. Denlinger said "while it is difficult to decipher between what Trump says and what Trump intends, I anticipate that Trump will be a positive force for the crowdfunding community based on his words and actions to this point. With the incumbent SEC Chair Mary Jo White set for early retirement next month, Trump is poised to appoint a more regulation-averse head of the agency looking to scale back on barriers to innovation and job creation. Trump’s planned federal hiring freeze and quotes such as 'eliminating two regulations for every one created' or 'rank all regulations and cut those least important' further confirm this belief.”
The experts have spoken. Here is my two cents.
The “crowd” is a dynamic group that effects change one dollar at a time. With its support, Pebble Watch raised $32,000,000+ in two Kickstarter rounds, BrewDog raised more than $40,000,000 through several equity crowdfunding offerings, and countless other ideas and businesses have been afforded the opportunity to succeed. Crowdfunding brings people together in a way that is truly American because political affiliation isn't a factor in the equation. Each project or offering can be a melting pot of Democrats, Republicans and maybe even Whigs -- anyone can support a business they like regardless of gender, race or religion. Even Congress managed to find common ground to pass the JOBS Act with bipartisan support.
Because navigating the legal maze of rules and regulations is presently the biggest thing hampering equity crowdfunding, President Trump will have a positive influence on the industry if he delivers on his promise to reduce regulations. Reducing regulations will slash attorney fees and compliance costs for companies wishing to use equity crowdfunding. I truly hope the Trump administration will remove unnecessary red tape and open the door for even more democratization of the capital formation process through equity crowdfunding.
And, if the new administration wants to create a new unpaid cabinet position of “Secretary of Crowdfunding” to help them reduce the barriers to entry for small businesses, I happen to know a lawyer/writer/entrepreneur who lives in D.C. and might be available to fill that role.
Originally Published at Entrepreneur.com on September 7, 2016
Three months have now passed since Title III of the JOBS Act legalized true equity crowdfunding where startups can raise up to $1 million in capital online to jumpstart and grow their companies. As an attorney whose practice centers around the JOBS Act and helping companies raise funds through crowdfunding, I am excited to see that Regulation CF’s first report card shows some very encouraging grades for entrepreneurs everywhere.
Image credit: Chip Somodevilla | Getty Images
Let’s remember: the JOBS Act was signed into law on April 5, 2012 and it took the Securities and Exchange Commission four years, five months and six days (but who’s counting) to put out the rules that allowed this law to finally go into effect. On May 19, 2016, the multi-named law (in addition to being called “Title III” and “Regulation CF,” is known as the CROWDFUND Act – which is a ridiculously contrived acronym Congress concocted that stands for “Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure Act”) went into effect. Three months later, equity crowdfunding gets its first report card. The early results look like the law is on the verge of making the honor roll, as it finishes its first quarter of securities law kindergarten.
- Despite limitations in the law that prevent a Regulation CF offering from marketing the campaign like a rewards campaign on Kickstarter, or like a Regulation A+ Mini-IPO, the rate of success of these new equity crowdfunding campaigns has been pretty good. Eighty-two Title III equity crowdfunding campaigns were filed with the Securities and Exchange Commission in the first quarter and 20 campaigns have exceeded their target amount so far. That 24.4 percent success rate is two to three times the success rate that most rewards-based crowdfunding sites like Indiegogo or GoFundMe reportedly have.
- The average investment commitment to date is $810, which is more than 10 times the average donation on Kickstarter, the most well-known rewards-based crowdfunding site. This should not be surprising, given that investors are actually buying equity and owning stock in these companies, not just paying for a “reward” or a pre-sale of a product to be manufactured.
- Three campaigns have already raised $1,000,000, the maximum allowed by the law. This is remarkable when you put it into perspective. This means that 4 percent of all Title III equity crowdfunding campaigns raised $1,000,000 in three months. According to Kickstarter’s published statistics, of all rewards-based campaigns on their site, only .06% have raised $1,000,000. For those of you without a calculator (or an abacus) that means one out of 25 equity crowdfunding campaigns was able to raise $1,000,000, compared to one out of 1,667 on the most popular rewards-based crowdfunding site.
- The target goal of Regulation CF offerings so far has been a huge predictor of success. Companies that set lower and realistic target goals (the minimum amount they need to raise to be allowed to keep the committed investment funds) have exceeded these minimums by 423 percent. Companies that have set unrealistic target goals have failed miserably. As I preach to my clients, set the lowest realistic goal that allows you to fulfill your promises to investors with the money they are giving you, then blow through that goal and be able to over-perform. As I mentioned in one of my Entrepreneur articles many moons ago, setting a realistic crowdfunding goal is one of the biggest predictors of crowdfunding success. These numbers prove my point, again.
While I still feel that another part of the JOBS Act -- the Regulation A+ Mini-IPO -- is a better law and gives a company more bang for their buck because they can raise up to $50 million rather than being capped at $1 million, the early report card is encouraging for Title III and it appears that the law will be a success despite the legal limitations it imposes. If we can just get Congress to fix those remaining issues with the law, most notably removing the unnecessary marketing restrictions, Regulation CF has a chance to fulfill its original promise.
A special thanks to one of the pioneers of the JOBS Act, Sherwood Neiss at Crowdfund Capital Advisors for putting together these numbers. And a special thanks to the American public and to risk-taking entrepreneurs everywhere for proving that equity crowdfunding can truly be a game-changer for small businesses and an evening of the playing field that democratizes the investment process for all of us.
Originally Published at Entrepreneur.com on June 30, 2016
Image credit: Shutterstock
Regulation A+ is the portion of the JOBS Act that allows a company to raise up to $50 million in new capital through an online “Mini-IPO.” It came roaring into the investment world a year ago with the promise of changing the way small businesses get funded. The law allows companies to economically raise funds from the “crowd” and let everyday people, not just the rich and powerful, invest in small private companies for the first time in 80 years. One of the ways Congress and the Securities and Exchange Commission (SEC) made this law affordable was by exempting companies from having to comply with state Blue Sky laws. Those are state by state securities laws that require a company to register and often undergo extensive merit review by each state’s securities regulators.
imagine the legal bills of going to the 50 different states to file extensive paperwork, have a securities regulator review and request changes, then make sure those changes were okay with 49 other state regulators who also were requesting their own changes. This would be a process that took months, cost hundreds of thousands of dollars, and effectively make Regulation A+ unusable.
Kudos for Congress and the SEC for not requiring those burdensome restrictions and creating a law the right way. But despite the seemingly universal appeal of this law, Montana and Massachusetts felt otherwise. Their securities regulators were upset that Congress and the SEC took away their ability to get paid fees from companies they could drag through expensive Blue Sky compliance. They were so upset, they filed a federal lawsuit against the SEC to have Regulation A+ nullified.
Yes, Massachusetts and Montana thought that this game-changing law, destined to help companies raise capital and grow, create new jobs and provide access to investments for the general public, was a bad idea because it did not “protect investors” in their states. "Protect investors" should be read to mean "took away the ability to change money to companies in exchange for putting the company through hell in order to sell securities in their state!"
The good news is, the justice system worked, and the SEC prevailed over the states' attempts to gut the groundbreaking law. In an opinion released June 14, 2016, the United States Court of Appeals for the DC Circuit ruled unanimously that Regulation A+ will stand and continue to provide small companies with the opportunity to raise new capital without Montana, Massachusetts, or any other state being able to force the company to comply with their expensive state Blue Sky laws.
At the heart of the state’s rejected argument was a term used in the law -- “qualified purchaser.” The JOBS Act states that certain Regulation A+ securities may only be sold to a “qualified purchaser” and that the SEC should define that term however it saw fit. The SEC, wanting to be sure that Regulation A+ would allow companies to raise capital as easily as possible, defined the term “qualified purchaser” to mean anyone who wanted to buy the securities. In other words, according to the SEC, a “qualified purchaser” was everybody, not just rich and powerful folks.
Massachusetts and Montana argued that in order to be a “qualified purchaser,” the SEC must limit the people who could purchase Regulation A+ stocks to wealthy people, or must impose some other limitation. That effectively took away the promise of this law that regular people could buy shares of the next Facebook or Google at an early stage in the company's development, when the potential for a greater return on investment would be the highest.
In an extremely well-reasoned opinion, Judge Karen LeCraft Henderson rejected the states' argument and found that Congress had given the SEC the right to define “qualified purchaser” as it saw fit, and that the SEC’s definition was legal, reasonable and in line with the intent of the JOBS Act itself. Final scoreboard: SEC Wins! Small business wins! Everyday investors win! States that wanted to ruin a great law lose!
See, the justice system does work the way it's supposed to... sometimes.
As a result, Regulation A+ lives on. Companies can still use this remarkable law to raise up to $50 million in capital. The Average Joe has a chance to invest a small amount of money in small companies at a stage that was never allowed before. Unless Massachusetts and Montana can convince the United States Supreme Court to hear an appeal, which is very unlikely, the law remains on the books.
The bad news for Massachusetts and Montana is that they can’t drag a Regulation A+ company through their Blue Sky laws and take fees from the company at a stage where the money is most needed to operate and grow. The states will have to find another way to “protect investors” in their state. One thing is for sure: Massachusetts will continue to "protect" their citizens by extracting as much money as possible from them in wonderful investments (note sarcasm) their citizens can benefit from: lottery tickets and blackjack tables.
Originally Published at Entrepreneur.com on May 12, 2016
Image credit: Thomas Barwick | Getty Images
On May 16, 2016 the long awaited (four years, five months and six days after the law was signed by the president, but who’s counting) JOBS Act equity crowdfunding law goes into effect allowing startups and small businesses to raise new capital up to $1,000,000 online through an equity crowdfunding portal. Entrepreneurs can now legally raise money from “the crowd” by giving everyday people a chance to own a part of their business. For the crowd, the chance to invest a small amount of money online in a new or growing young company, opens a new world of opportunity that was never available before.
I am frequently asked in my law practice: “Is my company a good fit for crowdfunding?” While nearly any U.S. or Canadian based company can use this groundbreaking law, there are businesses that are a near-perfect fit. Before we get to those, there are a few basics and statistics to ponder.
For the past several years, rewards-based crowdfunding sites like Kickstarter have prospered allowing an entrepreneur to raise money by giving away a reward, but no equity or ownership in their company. This is a great way to raise some money for new products that can be pre-sold and for art, music and film projects. If you can raise money without giving away part of your company -- do it.
But rewards-based crowdfunding has severe limitations that equity crowdfunding does not have. The number of people who are willing to “donate” money to a company in exchange for a “reward” (but no equity and a subsequent share of the company’s profits) is limited. The latest statistics available on Kickstarter reveal that 84 percent of the successful campaigns on their site raise less then $20,000. A staggering 97 percent of successful campaigns on Kickstarter raise less then $100,000.
Good luck opening a new business with $19,999.99.
The number of people willing to invest in a company, and possibly own a small part of a profitable business, is much larger. In 2015, 48 percent of Americans have invested money in stocks already. That’s a pool of more than 150,000,000 potential investors, far outnumbering the 10.8 million who have donated to a Kickstarter campaign since their launch in 2009.
The most important factor to consider in successful crowdfunding campaigns, both rewards and equity-based, is the ability to market the campaign and reach “the crowd” of potential supporters or investors. Small businesses such as these below have a unique opportunity to reach a local crowd through geo-targeted marketing in an economic manner, and also have the ability to get local media coverage to assist in their equity crowdfunding campaign. This combination of factors makes these small businesses a great fit for the new equity crowdfunding laws.
1. Restaurants.
Millions of people dream of opening a restaurant, but very few can afford to do it. According to a recent survey, the median cost to open a restaurant is $275,000, and if owning the building is figured into the amount, the median cost rises to $425,000. The ability to raise up to $1 million with the new equity crowdfunding law allows a restaurateur to satisfy the cravings of local foodies by giving them the opportunity to invest a small amount and fulfill their dream of restaurant ownership. Better yet, these hundreds of small investors will become brand ambassadors who bring their friends and family to eat at “their restaurant.”
2. Small office or retail buildings.
While not as sexy as owning a restaurant, owning part of a local office or retail building is an easy sell to a small investor. Who doesn’t drive by a building or strip center, see all the cars parked outside, and think that someone is making a good living owning that property and renting it out to others? A great example of this recently closed using the equity crowdfunding law’s bigger and better looking cousin: the Regulation A+ the Mini IPO, which works very similarly but allows a company to raise up to $50 million for a local business. Using this similar law, a Portland, Oregon company raised $750,000 from the local crowd to build a funky office building. How did they market this? Their website proudly offered investors the chance to “own a piece of your neighborhood” and get an 8 percent return on the investment.
3. Franchises.
If you own a successful franchise, and need the funds to expand to a second or third location, why not sell a part of your expansion to the customers who already patronize your business, and those in the community who know your name and recognize your success? Equity crowdfunding creates an opportunity to expand and scale your business (and, like with the restaurant above, have hundreds of investors advertising your business to everyone they know -- for free) that cash flow concerns may otherwise prevent.
4. Local investment real estate.
Real estate crowdfunding is a huge industry already. In 2015, a reported $483 million was invested (mostly by rich “accredited investors”) through real estate crowdfunding. Now, this investment opportunity is available to everyone. People inherently understand the value in buying a house, or investing in land. In addition to office buildings, investments like owning a vacation rental property or purchasing a house to renovate and flip for a profit, are now within the reach of everyone thanks to the new equity crowdfunding laws.
Originally Published at Entrepreneur.com on March 3, 2016
Bernie Sanders’ presidential campaign has demonstrated exactly why equity crowdfunding under the JOBS Act will work, when done properly.
Image credit: Juli Hansen | Shutterstock
Before anyone accuses me of displaying my political leanings in this story, please understand one thing: if I decide to vote for a bald, white, Jewish guy from Brooklyn, I’ll write in Larry David.
That being said, I admire that Bernie Sanders has done exactly what equity crowdfunding under the JOBS Act allows small companies to do: take small amounts of money from large numbers of people to fund something, all the while thumbing one's nose at the rich, powerful and elite. The parallels between his campaign funding, and equity crowdfunding under the JOBS Act, are remarkable.
1. His campaign has truly been funded by the crowd.
By the end of 2015, Bernie Sanders’ campaign had raised more than $73 million from 2,513,665 donations. Unlike most presidential campaigns, small contributions make up the vast majority of funds Sanders has raised. The average donation to Sanders during the last three months of 2015 was $27.16.
This is a perfect illustration as to how crowdfunding works. Look at the one of the first hugely successful rewards-based crowdfunding campaigns: the Kickstarter campaign for the Pebble Watch, in which 68,929 members of the crowd pledged $10,266,845 to bring the Pebble Watch to life. According to Kickstarter, the most common amount donated on their site for all campaigns is $25, almost exactly the average donation to Sanders' campaign.
2. His campaign has catered to the populace.
According to the web site OpenSecrets.org, 99.9 percent of the money Sanders has raised came from donations directly to his candidate committee, not from Super PACs or other leadership political action committees. Contrast this with candidates. A good examples is Jeb Bush. Only 22 percent of donations to Bush’s $150 million campaign war chest came from individual donations. And look at where all of that big money got JEB!
Equity crowdfunding will work the same way. Most companies using the new JOBS Act laws to raise capital need to both raise funds to grow and build a clientele for their business. The companies that get the general public excited about their product or their company will be the most successful. That can translate into large numbers of small investments from a huge number of people, most of whom then become brand ambassadors, social media promoters and eventually paying customers of the company they invested in.
3. His campaign has thumbed its nose at Wall Street.
The Sanders campaign has been extremely critical of Wall Street and the banking world. At the end of 2015, he had accepted donations totaling only $55,000 from donors in the “securities and investment” sector. Contrast this with his primary rival, Hillary Clinton, who accepted millions from Wall Street and related parties during the same period.
Equity crowdfunding has been called the democratization of the investment process, in no small part because most companies that will use Title III of the JOBS Act, or the Regulation A+ Mini-IPO, to raise capital are not far enough along for Wall Street or venture capital groups to back. Startups in particular are often run by a management team that has tapped out their credit cards, have no more friends and family to go to for financial help and cannot possibly get a bank to loan them money. Rather than futilely attempting to get funding from high-end banking and investment sectors, these companies can now go straight to the crowd to get financed, and be in a better position as they get to later rounds to negotiate with the Wall Street and VC types.
4. His campaign is focused on young people new to the process.
NBC reported that in the New Hampshire primary, Sanders received 79 percent of the votes of women aged 18-29. He also reportedly received 78 percent of all votes from first-time voters.
Ever try explaining crowdfunding to your grandmother? Tell most people 70 or older that they need to send you money for something you have not made yet, but in six months you will send them something you are hoping to create, and you will probably be laughed at. Crowdfunding is a young person’s game. Studies have shown that between 60-65 percent of donors on Kickstarter and Indiegogo are under the age of 35.
Related: The SEC Just Approved Rules Opening Up Equity Crowdfunding to the General Public In a 3-1 Vote
5. His campaign has been largely funded online.
During his victory speech after winning the New Hampshire primary, Sanders made this request of his supporters: “Please help us raise the funds we need, whether it’s 10 bucks, 20 bucks or 50 bucks.” Almost immediately, the overwhelming response crippled his campaign website. During the next 24 hours, his campaign raised $6.5 million, almost all of it online.
Let’s go back to grandpa again. Ask him to go online, watch a video, then invest money through a website, and he will probably smack you down with his cane. On the other hand, the younger demographic use their computers and smart phones every day, and the concept of investing online in a startup business is not intimidating to an age group who order everything through Amazon and who no longer communicate with others except through social media.
Who would have thought that this crazy Presidential election would actually teach us something? I guess if you look hard enough, there is always something to learn in every situation.
Originally Published at Entrepreneur.com on November 20, 2015
Image credit: Shutterstock
Ever since Regulation A+ became the law in June, I have been inundated with calls from companies excited about the prospect of raising up to $50 million in new capital online through a Mini IPO (initial public offering).
Potential clients I speak to understand that Regulation A+ offerings need approval from the U.S. Securities and Exchange Commission (SEC) and require an investment of legal, compliance and accounting fees. But when I explain to them that committing to a full-blown marketing plan is likely required to raising significant capital, I usually get blank stares. Once the silence subsides, I generally hear something like this:
“Why do I need a marketing budget? Can’t I just put my Mini IPO online and people will invest?”
With a Mini-IPO, unlike full-blown IPOs, there is no Goldman Sachs or Merrill Lynch instructing thousands of their brokers to push the IPO stock out to clients. With a Regulation A+ offering, nobody is promoting the stock to potential investors except the company raising money, and whoever they hire to market the offering. Without a marketing effort, chances are few people will find out the company is raising capital.
To the general public, a Regulation A+ Mini IPO listed on Bankroll or any other online funding website will look and act like a rewards-based crowdfunding campaign on Kickstarter. A lesson learned from rewards-based crowdfunding campaigns is that the highly successful ones require pre-planning, significant time investment in marketing and often the investment of significant funds on ads, public relations, social media and traditional media outreach.
A Mini-IPO will require the same kind of planning and marketing to be successful. A similar marketing approach to those that allowed the Coolest Cooler and the Pebble Watch to raise millions through rewards-based crowdfunding, will be required to raise tens of millions through a Mini-IPO.
Most people have no idea how much money is spent to market high-end rewards-based crowdfunding campaigns. To give some perspective, I met Steve Lebischak when a spoke about the JOBS Act and equity crowdfunding at the Wharton Innovation Summit in Washington, D.C .a few months ago. Lebischak's company successfully raised $648,691 from 1,296 backers on Kickstarter in a rewards-based crowdfunding campaign for the 1964|ADEL line of earphones that deliver richer sound while minimizing risk of hearing loss. Steve told me that they spent $65,575 in marketing, video production, advertising and public relations to market their successful Kickstarter campaign.
This is not an unusual story. And according to Kickstarter, only 128 campaigns to date have raised $1,000,000 or more, which is about one-tenth of 1 percent of all successful campaigns. Crowdfunding experts know that the grand majority of those high-end campaigns had significant marketing budgets, or they never would have raised the money they did.
The same will hold true of Regulation A+ Mini IPOs. A company has to drive people to the online campaign and get potential investors excited about their company in order to bring in significant investment dollars. When people get excited, they tell other people, they share on social media and they drive more traffic to the offering, and therefore more investments to the company.
The marketing experts who actually help people raise money through crowdfunding agree. Joy Schoffler, founder of Leverage PR who works with crowdfunding campaigns says that companies wanting to effectively use Regulation A+ need to develop the right marketing strategy. In her white paper, Schoffler suggests that well before launching their funding campaigns, companies need to take steps to ensure management is committed to the marketing plan and has dedicated time and resources for editorial opportunities, content creation and brand development.
Roy Morejon of Command Partners is one of the top crowdfunding marketers in the world and has an 85 percent success rate of campaigns reaching their goal, more than double the average success rate on Kickstarter and eight times the average success rate on Indiegogo. Morejon says that Regulation A+ offerings will need to be marketed very much like a high-end Kickstarter campaign.
"The goal is to get your investment opportunity to a large, but targeted, percentage of the general public," Morejon notes. "You simply cannot just rely on word of mouth. You need to use tried and true public relations and marketing methods to drive that traffic to the Mini IPO offering in order to raise millions."
Economical solutions also exist. For example, companies like Krowdster help affordably market online funding campaigns. Josef Holm, Krowdster's founder and a pioneer in marketing Regulation A+ offerings, says Krowdster provides marketing tools to quickly building a targeted crowd on Twitter and offers access to media lists from a database of more than 23,000 journalists in 170 crowdfunding categories, all in an affordable web app as an alternative to expensive crowdfunding consultants.
The bottom line is that marketing will be an essential part of every Regulation A+ campaign, just as it has been for rewards-based crowdfunding.
Originally Published at Entrepreneur.com on November 2, 2015
Image credit: 401(K) 2012 | Flickr
The SEC has finally released rules for Title III of the JOBS Act, the equity crowdfunding law. Nearly three years and seven months after the potentially game-changing bill was first signed into law, equity crowdfunding will be available to startups and small companies in 180 days. Yes, we get to wait another half a year before anyone can actually use equity crowdfunding, but at least now we know it will happen.
For those who have run out of Ambien, the hundreds of pages of new rules will provide a welcome sleep aid. But for professionals who plan to use these rules to help companies raise new capital, it is required reading. Bring on the Red Bull.
Related: The SEC Just Approved Rules Opening Up Equity Crowdfunding to the General Public In a 3-1 Vote
What does this mean for entrepreneurs? Will startups be able to actually use this law? Let’s take a look at what the new SEC rules say about key provisions, to answer those questions:
1. The JOBS Act says a company can raise up to $1,000,000 with Title III equity crowdfunding. Did the SEC expand this?
Despite the hopes of many of us that the SEC would pull a regulatory rabbit out of a hat and raise the ceiling to $5 million, the limit on what a company can raise through Title III equity crowdfunding remains at $1 million. If a company wants to raise more, there is always equity crowdfunding’s prettier cousin, a Regulation A+ mini-IPO to consider.
2. What can members of the “crowd” invest?
The law limits investors to (a) the greater of $2,000 or 5 percent of the lesser of their annual income or net worth, if either the annual income or the net worth of the investor is less than $100,000 and (b) 10 percent of the lesser of their annual income or net worth, if both the annual income and net worth of the investor is equal to or more than $100,000.
In both cases, Investors may not invest more than an aggregate amount of $100,000 in one year. The SEC actually tightened up the amounts that can be invested by each individual, which is not good news for entrepreneurs.
3. What happens if a company does not raise its goal amount?
Like many rewards-based crowdfunding campaigns and Regulation A+ mini-IPOs, if a company using the new equity crowdfunding law does not raise the full amount of their funding goal, they do not get to keep any of the money raised, and they lose the out-of-pocket up-front costs. This important provision means setting a realistic goal will become an important part of the equity crowdfunding process for entrepreneurs.
4. Can companies afford to use Title III equity crowdfunding?
The biggest news from the new SEC rules is that the proposed requirement of a full financial audit has been dropped by the SEC for companies using the equity crowdfunding law for the first time. Requiring a startup to spend tens of thousands of dollars on an audit made no sense. The SEC removed that burden, and now a company using the law for the first time must only have reviewed financials to raise more than $100,000, and lesser financial disclosures when raising less than $100,000.
There are still substantial costs, however. Legal fees, compliance costs, funding portal fees, broker-dealer fees and marketing expenses can add up. Without entrepreneurial minded attorneys offering affordable services and innovative businesses offering compliance services for a reasonable cost, equity crowdfunding would still be out of reach for most young companies. Luckily for startups and small businesses, both of the above exist, and will make this law affordable to use for most entrepreneurs.
Related: 4 Financing Tips for Female Entrepreneurs
5. What information has to be disclosed?
A company has to disclose to investors, and file with the SEC, the price of the securities, the method for determining the price, the target offering amount, the deadline to reach the target and whether the company will accept investments in excess of the target.
Companies also must provide a discussion of the company’s financial condition, a description of the business and the use of proceeds from the offering, information about officers and directors and owners of 20 percent or more of the company and annual financial statements.
6. What liability will a company and its officers have under equity crowdfunding?
Equity crowdfunding involves the sale of securities, and not just pre-selling a gadget like on Kickstarter. There are federal and state laws that govern the sale of securities, and if you do something wrong, your company (and its officers and directors) can be sued, and in some cases, could go to jail.
The bottom line is simple: Tell the truth. Under most securities laws including the equity crowdfunding law, being 100 percent truthful and not making misrepresentations of any kind are the keys to not having to bang out license plates in the prison yard with Bernie Madoff.
7. Are the shares sold through equity-crowdfunding liquid?
No. Much like most shares sold through private placements, the shares of stock sold in equity crowdfunding cannot be sold (in most circumstances) for at least one year. There is no marketplace or exchange for these shares, and in all likelihood, never will be unless a company registers with the SEC and becomes a public company.
Will equity crowdfunding work under the new SEC rules? Some may disagree, but I believe there is a workable model here that startups will be able to use to raise capital.
Like every new law, how usable it will be depends on a number of factors. But the reality is that an opportunity like this for startups to raise capital has never existed before, and rather than criticize the law's shortcomings, some of us will work within the laws and rules to find ways to help companies raise funds online in a way they never could before.
Originally Published at Entrepreneur.com on October 15, 2015
Image credit: Shutterstock
Regulation A+ went into effect on June 19, 2015, with the promise that small companies could raise up to $50 million in new capital through an online mini-IPO with investments from anyone in “the crowd” and not just from wealthy accredited investors. By giving access to the general public, this section of the JOBS Act promised to be a game changer for the American economy, and for small businesses everywhere.
So why, three months after this law went into effect, is very little being heard about anyone raising money under the new law?
One requirement of the SEC filings is that your company’s financial records are in order and that the last two years of financial statements need to be audited by an independent CPA or auditing firm for the SEC to approve a Regulation A+ offering. Not surprisingly, few small businesses were ready for this requirement when the law went into effect, and many are still trying to get these records in order and audits completed to file their mini-IPO offering for SEC approval.
Related: 5 Finance Tips All Business Owners Should Follow
Having financials ready for SEC review is a luxury most small businesses were not prepared for when the mini-IPO law became a reality and now are playing catch-up. Craig Denlinger of Artesian CPAis one of the accountants at the forefront of the Regulation A+ movement. I asked Denlinger for some tips to pass along to help facilitate the process of a Regulation A+ filing.
“Initial filings are taking a lot more time than I think people anticipated, from both legal and accounting side,” Denlinger says. “As the industry builds out, framework and templates time and costs will go down.”
In the meantime, Denlinger suggested the following:
1. Preparation for the audit.
Companies should get a strong accountant in place, preferably a CPA with SEC experience, prior to the audit. The SEC requires a company to follow Regulation S-X, Article 2, for all financials filed with a mini-IPO offering. Denlinger says that Regulation S-X “requires the company raising funds to prepare the financial statements, so companies cannot rely on the auditor for full preparation. Audit firms must take a more hands-off approach than is typical under AICPA independence rules.”
2. No disclaimers allowed.
Denlinger says that opinion disclaimers in the audit are not acceptable under to Regulation S-X. “If a company is an inventory-based business, satisfying the audit requirement can prove difficult since the auditor is unable to observe the inventory counts for the past two years that are required to be audited,“ Denlinger says. “This doesn’t necessarily preclude companies with inventory from a Reg A+ offering, but it is something that should be discussed very early in the process to ensure the auditor will be able to issue an opinion that the SEC will consider an acceptable audit.”
Related: 10 Best Accounting Websites for Startups
3. Experience counts.
The Regulation A+ rules create for a hybrid between public company and private standards for financial reporting, so the auditor’s SEC experience is important to understand the additional requirements to meet the financial reporting standards.
4. What are the actual audit requirements?
There is a lot of confusion as to audit requirements of Regulation A+. While it has been commonly reported that a company must have two years of audited financials to attempt to raise up to $50 million in a mini-IPO, there is not much guidance as to what the SEC actually requires. What happens if your business, for example, is less than 2 years old?
For example, Denlinger says that a company with a calendar year-end filing with the SEC in February of 2016 would need to present audited financial statements for the years ended Dec. 31, 2013 and 2014, and unaudited financial statements as of a date not sooner than June 30, 2015.
It gets even more confusing if more than three months have passed since the company’s year end. This is why you need a good accountant. A number of early Regulation A+ filings were reportedly rejected without review based on the incorrect financials being included. Another reason you need a good accountant.
Regulation A+ can be an incredible capital funding tool, but there are a lot of accounting hoops to jump through and roadblocks to avoid.
Did I mention that you need a good accountant?
Related: 7 Tips on How to Do Accounting For a Kickstarter Campaign
Originally Published at Entrepreneur.com on September 30, 2015
Regulation A+ became law in June with the promise of small businesses having the ability to raise $50 million through an online mini initial public offering. The novel concept of a young company being funded by the general public and having “the crowd” -- not just accredited investors -- invest online could revolutionize the capital-formation process in America.
As an attorney whose practice revolves around obtaining funding for small businesses, potential clients ask me every day if Regulation A+ is a good fit for their business. The answer is always that it depends.
To help explain, I called upon a man at the forefront of the Regulation A+ industry, Scott Purcell. Purcell is the founder and CEO of FundAmerica Technologies, which provides a bevy of services to those who make a business of online capital formation pursuant to JOBS Act equity crowdfunding.
Related: Regulation A+ Is Not the Savior of Cash-Seeking Startups
Regulation A+ “is best suited for those companies who want or need non-accredited investors," Purcell says. "It could be just a way to raise capital, or, more appropriately, it could be part of a larger branding and marketing plan. For everyone else, it probably makes more sense to stick with Regulation D.”
That being said, let’s go through some of the typical reasons companies give me for wanting to use Regulation A+:
1. “I need funding for my startup.”
Raising funds through Regulation A+ is not cheap. While a Reg A+ mini IPO could be a financial bonanza for a startup, there are legal fees, compliance fees, regulatory fees, accounting fees and broker-dealer fees to pay. This is not a Kickstarter campaign. This is selling securities, and the SEC has to approve your offering, which costs money. Also, you must have a budget to market the offering or in all likelihood the offering will not raise much money.
While there certainly are exceptions, and entrepreneurial-minded attorneys and accountants can help lower costs, most companies can expect to pay a minimum of $100,000 to cover these necessary expenses and plan on three or four months of time to prepare and file the regulatory forms before you can start fundraising. That puts it out of reach for most startups.
2. “I want to raise $50 million.”
Regulation A+ lets you raise up to $50 million online, but you can do the same thing with a private placement (or even raise more, as those securities offerings are not capped at $50 million) under Section 506(b) or 506(c) of Regulation D for far less money in a far quicker timeframe and with far less hassle. The problem with private placements is you lose access to the masses as potential investors and you are mostly limited to raising money from wealthy accredited investors.
Related: To Encourage Crowdfunding, Change the Definition of an Investment Company
3. “I want my securities to be liquid and tradable.”
Regulation A+ securities are freely tradable, but at this time there really isn’t a marketplace where they can easily be listed. However, we are close to seeing alternative exchanges come to fruition where investors will be able to sell and buy Regulation A+ securities.
You can list your Regulation A+ securities on OTC or NASDAQ, but Purcell notes, “You need to get a CUSIP number, get your securities DTC qualified, go through the steps to get your securities listed on the desired exchange, find market makers and research coverage for your securities and to commit to additional reporting and costs in addition to your SEC and state obligations.”
“Do I need a broker-dealer to do this, or can we do it on our own?"
While the JOBS Act itself does not mandate the need for a broker-dealer for a mini IPO, there are other laws and rules that would put a company in potentially hot water if it does not utilize a broker-dealer to sell Regulation A+ securities, even to investors who come from a company’s own marketing efforts.
“Securities issued via Regulation A+ tier 2 are exempt from state blue sky (laws that regulate the offering and sale of securities) review," Purcell says. "This, to issuers and investors, is one of the best features of the new rules. However many states are very unhappy about it.”
Purcell is referring to the fact that while state officials are angry they no longer have blue sky review of securities sold in their states, each state still has the right to decide who is allowed to sell securities to their residents. While there is no national uniformity, we know that many states will require the agents of companies raising funds in Regulation A+ offerings to register as brokers and to have appropriate securities licenses. What happens if a company sells securities in one of these states without being licensed?
“Ouch,” Purcell says. “States have tools in their arsenal to make life miserable for issuers and to levy fines and force rescissions of completed offerings if the sales are made through anyone other than a licensed broker-dealer.”
Related: Why Kickstarter and Indiegogo Won't Go Into Equity Crowdfunding
Originally Published at Entrepreneur.com on June 4, 2015
Image credit: Sam Chadwick / Shutterstock.com
Rather than spending large sums of money to roll out a mini-IPO with hopes of raising up to $50 million, a company can use a revolutionary provision of Regulation A+ from the Jumpstart Our Business Startups Act (JOBS Act) to “test the waters” before hitting the market. In other words, a company can legally gauge interest from prospective investors before spending more than $100,000 to see if there is sufficient interest in their stock offering to move forward.
Before the JOBS Act was enacted in 2012, companies and their representatives were generally prohibited from talking to prospective investors until they had filed their IPO documents with the SEC. Most securities lawyers also understood federal law to restrict companies from soliciting offers or even indications of interest for an IPO, even after the initial documents were filed with the SEC, until the company filed a preliminary prospectus with an estimated offering price range with the SEC. As a result, hundreds of thousands of dollars had to be spent on legal fees, compliance, due diligence and accounting before a company could talk to the people who might invest.
Investment bankers used to skirt these laws and regulations by holding thinly veiled “education meetings” with potential large investors where, legally, the only talk allowed was general discussions about the company, its industry and other general business matters. But there was a very strict prohibition on soliciting interest from possible investors or asking investors about what price they might be willing to pay for the company’s stock.
That all changes with the JOBS Act.
Now, a company relying on Regulation A+ (and before that others who used the new JOBS Act IPO rules) to raise capital can file certain documents with the SEC, and then communicate with prospective investors (both accredited investors and those in the general public) to see how much interest exists in the potential Mini-IPO. While there are other technical requirements to follow, the basic pitfalls a company has to avoid while “testing the waters” is to not solicit or accept a binding order to purchase the proposed securities, and to be certain the communications with the proposed customer are free of material misrepresentations or omissions.
Basically, this means a company can’t bind anyone to buy or mislead anyone when they test the waters.
Should your company use this more affordable method of gauging interest before diving in with the full cost associated with a Regulation A+ offering? Most securities lawyers will advise that a company testing the waters limit the communications to prospective investors to nothing outside of the information that is going to be included in the final offering documents that will be filed with the SEC. It will also likely be a good practice to be sure all materials (written or otherwise) used to test the waters are filed with the SEC. Also, the SEC requires specific “legends” or disclaimers to be given to the prospective investor in every case.
Outside of the legal requirements, companies should consider several factors from a marketing or business perspective. On the upside, testing the waters can give valuable insight to a company about the attractiveness of their offering to prospective investors. It can “warm the market” and create marketing buzz that could be beneficial once the offering is live.
On the downside, companies need to be extremely careful to not overstep the legal bounds of the testing the waters provisions, so a carefully controlled plan needs to be put into place. Some in the marketplace may view testing the waters as a lack of confidence in the offering.
Overall, testing the waters is a more affordable method for a startup or young company to decide whether to partake in a Regulation A+ offering. I believe, with the $50 million upside of Regulation A+, testing the waters will become a fairly common practice for companies on the fence before investing in the mini-IPO process.
Image credit: Shutterstock | Enhanced by Entrepreneur
Originally Published at Entrepreneur.com on April 10, 2015
The SEC has opened the doors to JOBS Act equity crowdfunding with the recent passage of Regulation A+. In less than 60 days, this revolutionary new capital raising law will allow a small business to raise up to $50 million per year from both accredited and non-accredited investors.
Sounds simple, doesn’t it? Go online, create a Regulation A+ crowdfunding campaign, and then start cashing millions of dollars in checks.
Not so fast.
The SEC has 453 pages of rules and regulations to follow. This is not as simple as logging into Kickstarter, shooting a cool video, writing a pitch and posting a crowdfunding campaign. Regulation A+ involves the sale of securities in your company. As a result, there are a lot of laws and rules to follow.
Let’s start with the six things you should do now to be ready to use Regulation A+ to raise money from the tens of millions of potential investors in “the crowd” that were off-limits to small businesses before this part of the JOBS Act became law.
1. Incorporate or form an LLC.
Individuals cannot raise money under Regulation A+, only companies can. If you have not formed a company, then you do not have stock or ownership interests to sell.
2. Make sure you have the proper structure for your company.
It is important that your company is set up correctly to be able to sell equity to investors. There will be many different ways to do this, such as setting up a special class of shareholders, for a Regulation A+ offering. There are also numerous legal pitfalls that can occur if you do not do this correctly, so you will want to consult with an experienced attorney.
3. Pick which “tier” you are going to use.
There are two “tiers” under which you can raise capital in Regulation A+. Under tier 1, you can raise up to $20 million in a mini-IPO and there is no requirement of audited financial statements, no limit on amounts to be raised from non-accredited investors and in most cases, no ongoing reporting to the SEC. Here’s the downside to tier 1: you have to comply with the “blue sky” laws of every state in which you plan to raise money. Complying with 50 state securities regulators makes tier 1 unattractive to anyone trying to raise capital from the national crowd of non-accredited investors.
Tier 2 allows you to raise up to $50 million, with no state blue sky-law compliance. Sounds perfect, doesn’t it? But wait, the SEC added the requirement that any company attempting a tier 2 offering must have two years of audited financial statements, which can be extremely expensive. Also, in a tier 2 offering, non-accredited investors can only invest 10 percent of income or net worth. And to top it all off, there will be ongoing reporting requirements to the SEC after your raise the funds.
Tier 1 may makes sense for a business that is only raising money in a contained geographic area and does not need to comply with more than one or two state securities laws. Other than that, I believe most companies will use tier 2. The major expense of tier 2, the audited financials, will likely not be as expensive as people believe for startup and younger companies without significant financial history.
4. Get your financials in order.
As I mentioned before, if you plan to use Tier 2, you will need to have two years of audited financial statements, and the audits must be done by an independent CPA according to generally accepted auditing standards. Even if you are using tier 1, you will have financial disclosure requirements, so making sure your books are in order now is a must.
5. Make sure you have no “bad actors” on your team.
The SEC requires all officers, directors and major shareholders of your company to undergo a “bad actor” background investigation. If you have members of your team who have been in trouble with the law, had securities regulatory issues in the past, or fall into one of the many “bad actor” categories, you may need to replace those individuals.
6. Get your IP in order.
Regulation A+ requires you to disclose a great deal of information about your company to the public. You do not want someone to steal your ideas. If you have patentable technology or business processes, you should have your patents in place, or at least have filed a provisional application. Before you expose your trade name, logo, product or service to the masses, be sure you have secured trademarks where available.
Originally Published at Entrepreneur.com on March 25, 2015
The SEC on Wednesday approved game-changing final rules in the implementation of Title IV of the JOBS Act, known as “Regulation A+,” which will allow small businesses and startups to raise up to $50 million from "the crowd."
As I reported more than a year ago, this little-known provision of the JOBS Act will allow a startup company or emerging business to hold a “mini IPO” from the general public, not just accredited investors, and should be a complete game-changer for the way businesses are funded.
When Congress passed the JOBS Act in April 2012, Regulation A+ was an attempt to fix Regulation A, a rarely-used provision of federal law that allowed companies to raise up to $5 million in a public offering. Regulation A was a bust because it required the company to register its offering in each state where it was to be sold. The cost of complying with each state’s “Blue Sky Law” was exorbitant, compared to more commonly used laws such as Regulation D that allowed a company to raise the same amount of money, or more, without having to pay for expensive state-by-state compliance.
Under the SEC’s new rules for Regulation A+, the amount that could be raised increases to $50 million and the need for state compliance has been eliminated. More importantly, Regulation A+ allows those funds to be raised from the general public, not just accredited investors like with Regulation D offerings.
The question that had everyone in the crowdfunding world holding their collective breath was simple: Would the SEC keep their proposed rules intact when its leadership voted, or would they succumb to the pressure of state securities regulators who were adamantly opposed to lessening of restrictions for their own selfish financial reasons? The answer is that the SEC stuck by their guns and allowed companies to raise Regulation A+ without having to go to each state and spend a fortune registering their offerings.
Another important issue the SEC decided involved who can invest in these offerings. The JOBS Act limited Regulation A+ offerings to "qualified investors" which led some to argue that only "accredited investors" would be allowed to invest. Accredited investors are those individuals who earn more than $200,000 per year or have a net worth of greater than $1,000,000. However, the SEC broadly defined the term "qualified investors" under Regulation A+ to allow anyone to invest, albeit with some limitations as to the amount.
For those worried about protecting investors from fraud, Regulation A+ only allows investors to invest 10 percent of the greater of their annual income or net worth in these securities. The SEC has also implemented other strong investor protections such as "bad actor" background checks on the companies offering the securities, and disclosure of the company's financial information as part of the offering.
The Regulation A+ rules can be read in full here. There are hundreds of pages, so get ready for a long read or a fast way to bore yourself to sleep. Having read the entire thing, I can tell you with confidence as a crowdfunding attorney that Regulation A+ has a chance to dramatically change the way small and emerging businesses raise capital in America.
The rules released by the SEC today now have to be published in the Federal Register before they become law, which takes about 60 days. As soon as that happens, entrepreneurs will have the ability to raise millions of dollars from "the crowd" in a simplified and comparatively affordable offering using Regulation A+.