Twin Cities Tech Attorneys Weigh In On The New SEC Crowdfunding Rules

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sec-sealThe U.S. Securities and Exchange Commission (SEC) has finally pulled the trigger on Title III of the JOBS Act, intended to expand funding options for startups by easing various securities regulations.

Last week, they announced the adoption of rules for non-accredited investors to participate in securities-based crowdfunding by lifting what is commonly known as the ‘general solicitation’ ban.

Equity crowdfunding transcends common means of reward-based campaigns found on Kickstarter, Indigogo, etc. — whereby supporters receive some value other than ownership.  The overall premise with equity crowdfunding is startups can legally solicit actual cash investment from the general public in due time and with proper registration.  This is promising for those ventures that want an option to raise outside the tradtional angel / venture path.

Not to be confused with the similar forthcoming intrastate crowdfunding initiative MNvest, this nationwide exemption applies equally to companies and investors from across the country.

Under the SEC’s new rules, a non-accredited investor with an annual income less than $100,000 can invest up to $2,000 or 5 percent of gross income annually, while one with an income of over $100,000 per year can invest up to 10 percent of gross income. There’s an absolute annual limit of $100,000 per investor to all crowdfunding ventures.   Additionally, they voted to propose amendments to existing Securities Act rules to facilitate intrastate and regional securities offerings (more on that later).

The rules are supposed to go into effect 180 days after they’re published in the Federal Register, whenever that may be?  As equity crowdfunding takes a big step closer to reality, we checked in with a few locally known tech attorneys for their take on the situation — posted in aphabetical order by last name:

 

Attorney Doug Ramler – Gray Plant Mooty

 

What do you conceptually think of equity crowdfunding exemptions in general?

Overall, this is a very positive development for startup and small businesses as well as non-accredited investors. It is often very difficult for small companies to raise capital, particularly companies that have not generated revenues. However, based on the very small number of Rule 506(c) offerings which permit public solicitation of accredited investors, I question whether crowdfunding will take off. Crowdfunding will also be good for non-accredited investors.

Access to good seed and early-stage investment opportunities is limited to accredited investors organized into groups and small funds. Because most early stage companies fail, investors need to make 10 investments in order to generate meaningful returns. My sense is that most crowdfunding investors are not thinking this way.

Ultimately, crowdfunding will be successful only if the companies that utilize crowdfunding are successful. The key is attracting good companies to crowdfunding that could raise capital from a variety of sources, not just companies that are having trouble raising capital from angels and funds.

What is your initial impression of the recommended rules and proposed amendments set forth by the SEC last week?

Like most SEC rules they are longer and more complicated than they need to be. Also, it is very clear from reviewing the release and the regulations that the SEC is very concerned about investors being taken advantage of by unscrupulous companies and entrepreneurs. There are numerous safeguards built into the regulations designed to protect investors. The question is whether those safeguards will make crowdfunding less useful or less attractive.

What specifically stands out to you as the good, the bad, or the ugly?

Good: (i) a legitimate source of capital for pre-revenue companies; (ii) audited financial statements are not required for certain smaller initial offerings; (iii) existence of portal obligations to ensure deals are legitimate.

Bad: reporting requirements – before, during and after. That’s a lot of paperwork.

Ugly: investment limitations – it will increase the number of investors in a deal but decrease the dollar amount invested. Some limitations are reasonable, but they have gone a bit too far.

In what scenario do you think equity crowdfunding will be ideal for Minnesota tech Startups?

1) Companies that can or will be able to develop or take advantage of an existing community of supporters. Similar to non-equity crowdfunding, companies with a following of enthusiastic and loyal customers and supporters will have the most success.

2) Companies that do not generate revenues will benefit from crowdfunding. Even angel investors these days are reluctant to invest in pre-revenue companies.

3) Companies that identify and utilize successful funding portals should have success. Finding the right funding portal will make a huge difference in the success of a crowd fundraising. Some funding portals will focus on particular industries or other limitations. I expect that these funding portals will find the most fundraising success.

When do you think it will actually be usable on a federal level?

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What advice would you have for an entrepreneur considering the path of equity crowdfunding once it’s available?

Understand the downside:

-up-front expenses, compliance challenges, large numbers of unsophisticated investors, ongoing reporting requirements, heightened scrutiny.

-There is no guarantee that the money sought will be raised.

-Understand that you are selling securities and disclosure is the key to avoiding legal problems.

-Work with a successful and reputable financing portal.

…and for investors?

Understand that most startups fail and that you need to invest in 10 deals to generate a reasonable return.

-Picking and choosing one deal may be lucky on occasion, but will consistently be a failed strategy.

-Do some due diligence investigation. Understand the business and the industry.

-Securities purchased are not freely-tradable. You cannot sell them like public shares.

-Bet on the jockey not the horse. Good managers seem to find a way to be successful.

What is the best way to reach you for more information?

E-mail: doug.ramler@gpmlaw.com -or Phone: 612.632.3000

 

Attorney Jeffrey Robbins – Messerli & Kramer

 

What do you conceptually think of equity crowdfunding exemptions in general?

The concept is terrific: it’s appealing for start-up companies to raise development and growth capital from the masses, who can share in the company’s profits. However, just as with current non-equity Kickstarter-style campaigns, success is all about generating broad consumer interest in a project. I predict that winners in equity-based crowdfunding will only be a small percentage of those who try. Odds are that companies seeking funding to develop and market a consumer-oriented physical product, rather than software or services, will stand a better chance of garnering investor support.

What is your initial impression of the recommended rules and proposed amendments set forth by the SEC last week?

Frankly, I think many start-up companies will still be bewildered by the upfront financial statement and disclosure requirements, the artificial limitations imposed on marketing fundraising campaigns to the public and the ongoing annual reporting obligations. And I’m concerned that the rules invite the securities litigation bar to target crowdfunding portals and their principals in fraud lawsuits, regardless of the true merit.

What specifically stands out to you as the good, the bad, or the ugly?

The good: it’s finally a reality. The Great Experiment can begin.

The bad and ugly: Even with slightly relaxed final regulations, many start-ups will find it difficult to put together a compliant investment package without outside legal assistance. Except the first time around, companies raising over $500,000 must have audited financial statements. Mandated discussion of financial matters is more detailed than required for some full-blown IPOs. The investment limits per investor, per company and across all equity-based crowdfunding campaigns apply equally to wealthy “accredited investors” and poor folk. And I worry that the regulatory scheme for crowdfunding portals is overkill.

In what scenario do you think equity crowdfunding will be ideal for Minnesota tech startups?

I think that equity crowdfunding will be most successful for the same types of companies that have raised rewards-based crowdfunding in Kickstarter campaigns.

When do you think it will actually be usable on a federal level?

Regulation Crowdfunding from the SEC should be effective in May 2016, 180 days following near-term expected publication in the Federal Register. FINRA, which already regulates stock brokers and now will also register and regulate crowdfunding portals, has published its proposed rules to take effect before the SEC rules. It’s not yet clear if FINRA will approve any portals to go live simultaneously with the SEC effective date.

What advice would you have for an entrepreneur considering the path of equity crowdfunding once it’s available?

Seriously assess whether your product is easily understood and has mass appeal. Develop a marketing campaign before incurring expenses for financial and disclosure compliance. Consider whether it is better to wait and see what types of equity-based programs truly resonate with small investors before jumping in.

…and for the investor?

There’s no assurance you’ll profit from an investment. Don’t invest dollars you can’t afford to lose. Confirm that the company has procedures to manage a large number of investors, who can divert management’s attention and adversely impact future fundraising.

What is the best way to reach you for more information?

Call or email me to chat: jrobbins@messerlikramer.com or (612) 672-3706.

 

Attorney Zach Robins – Winthrop & Weinstine

 

What do you conceptually think about the notion of equity crowdfunding exemptions?

The ability for small and growing business to source funds from non-accredited investors is the future of seed stage capital raising.

What is your initial impression of the recommended rules and proposed amendments set forth by the SEC?

While more restrictive than MNvest and other intrastate offering exemptions, Regulation Crowdfunding is a welcome addition to the panoply of funding options for businesses.  Is it a silver bullet to solve all needs? No.  Depending on the needs of each Issuer, Rule 506(c), Reg A+, MNvest, or even SCOR may be a better alternative than Regulation Crowdfunding.

What specifically stands out to you as the good, the bad, or the ugly?

Bad:

  • The investment limits per non-accredited investors with income/net worth below $100k are too low, plus the cap applies to all offerings in a given year, versus a per offering cap.
  • The ongoing issuer reporting requirements may be cumbersome.
  • Funding Portal Registration with FINRA may be costly initially and from an ongoing compliance standpoint.
  • Intermediary communication channels could provide for chatroom-like trolling and pumping of stock value

Good:

  • There is finally a nationwide infrastructure to raise funds from non-accredited investors
  • There is no risk of “integration” for preceding, concurrent, or subsequent offerings.
  • The “shareholder count” of investors will not count towards the “holder of record” count under the Exchange Act.
  • Verification of investor income or net worth is not required.

In what scenario do you think this will be ideal for the Minnesota tech startup?

The barriers to funding have been lowered.  More businesses will have the opportunity to legally raise capital from their own network, as well as strangers.

When do you think it will actually be usable (intrastate or domestic)?

MNvest: Early 2016; Reg CF: Mid-2016

What advice would you have for an entrepreneur considering the path of equity crowdfunding  when it becomes available?

  • Affiliate with an experienced securities attorney, portal operator, accountant, and marketing firm able to assist with crowdfunding offerings.

…and for the investor?

  • Conduct due diligence, make contact with the company to address open questions, and share offering documents with your advisors.

What is the best way to reach you for more information?

@zjrobins

Comments

  • Zach Robins

    Jeff – thanks for covering this subject. We are entering a new era of investing and I’m excited to see what the future holds!

  • http://paulprins.net Paul Prins

    Very interesting. It will be interesting to see companies choosing between platforms and between rewards/equity.

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