This is a guest blog post by Douglas Ellenoff of Ellenoff Grossman & Schole, LLP. Don’t miss Douglas’ panel discussion:
? 12/07/2016 4:00 pm
Panel Discussion Legal Pitfalls in Crowdfunding
As I reflect on the last five years of my involvement in the crowdfunding industry, I am surprised both by how much we have accomplished and by how few people actually know about their online capital formation and investing options. This is precisely why conferences like the Crowd Invest Summit are so important to get the word out into all of our communities. While many of us in the crowdfunding industry have been laboring feverously for years to establish the foundation of this evolving market, our work in many ways has just begun. Now is the time to share the opportunity even more broadly and make the case for how and why crowdfunding is a valuable and viable option for entrepreneurs to raise much-needed funding to grow their businesses. Equally important is making available to individual investors the opportunity to learn about those entrepreneurial endeavors and about how to possibly invest in and support those entrepreneurs. It is always important to note that securities crowdfunding, which is why we will be attending the Summit, has evolved from the various provisions of the JOBS Act, and should not to be confused with the rewards, donations or pre-order arrangements done on well-known sites, like Kickstarter, Indiegogo, and GoFundMe. Those sites, while they may have certain vague similarities to securities crowdfunding, are not offering any securities to the public; this may only be done pursuant to a qualified securities transaction. Any financing where the public is contributing funds in exchange for an ownership interest, profits participation, revenue sharing or just loaning money should be presumed to be an offering of securities under both Federal and State law. Obviously, I would highly recommend that you confer with an experienced lawyer in this area of practice since this type of financing transaction is regulated. As you listen to the different speakers at the Summit, you may get bombarded by never-ending legalese and securities jargon BUT learning and knowing the differences is critical and will have very practical import on why certain crowdfunding provisions may be appropriate for you or a complete waste of your time and money. We don’t deliberately want you to be lost in a sea of confusing terms and all of the speakers are committing their time to the Summit to facilitate your education—if you don’t understand something then approach the speakers and ask, we are genuinely interested in helping you. It helps you and helps the industry.
In order to be somewhat prepared for the Summit, you need to appreciate that crowdfunding is a catch-all word for what is actually several different pathways for an entrepreneur to seek capital. The oldest of these provisions, which went into effect in 2013 is Title II, also known as 506C and crowdfunding for accredited investors (i.e. wealthier investors) and permits entrepreneurs to raise unlimited funding by generally soliciting investors and marketing to them online through a funding platform or off, so long as the investors are all actually accredited. This may be done through a funding platform, but doesn’t have to be, and with reasonably limited required financial and legal disclosure and for not much money. Thousands of entrepreneurs over the last few years have more efficiently and expeditiously raised many of millions of dollars, actually over a billion dollars, using this new law, for venture deals and real estate deals alike. With very limited and contained legal and/or regulatory issues, Title II/506C has proven that online capital formation works and works well. Investors have been given the opportunity to review deal flow that has never been this readily available to them. This addressed the resentment that many investors have about being left out of all of the more interesting tech related investments. In many of the real estate deals and some of the corporate deals, investors have enjoyed cash on cash returns in excess of what their banks would have offered. This isn’t to say that crowdfunding of all kinds isn’t risky, it is, and investors need to assess their suitability for such investments and their ability to sustain an entire loss of investment should the opportunity crap out, which must be fully appreciated by investors prior to participating.
After Title II/506C went into effect, Title IV, also known as Regulation A+, went into effect in June of 2015. Regulation A+ has witnessed considerable attention and nearly 150 companies have sought to raise funds through this new securities law channel. By rule, Regulation A+, which requires a substantial disclosure filing with the SEC, for its review and comment, permits an issuer to raise up to $50,000,000. Remember, that simply because the Form 1-A permits an issuer to raise that amount of funding doesn’t magically make it happen. For many issuers that have sought this approach, it was simply a costly and time-consuming mistake. You must analyze whether Regulation A+ is appropriate for you or are you too early in your maturity as a company or that you don’t have enough social currency to approach enough investors and raise sufficient or any necessary money. Regulation A+ is intended to facilitate fundraising by the issuer by directly approaching its audience of supporters, customers, and consumers and to use social media to create awareness for your offering. Both accredited and unaccredited investors may participate in the offering once the SEC has qualified the offering. The SEC has promptly qualified nearly ½ of all submitted Regulation A+ submissions. A SEC qualification should not be confused as any form of endorsement of the deal or its investment worthiness. Fewer than 10 of the qualified Regulation A+ entrepreneurs have successfully raised their desired funds. Nonetheless, Regulation A+ remains a very viable option for the properly profiled issuer. Also, with all of the social media and digital agencies that are focused on advising issuers on how to be better prepared for their social media campaigns than we have seen thus far in 2016, I am confident that there will be much greater levels of success over the next year.
The last provision of the JOBS Act which has applicability to crowdfunding and the one most identified as true crowdfunding is Title III or Regulation CF, which enables any US incorporated entity to raise up to $1,000,000 in any twelve month rolling period, but only through a FINRA approved crowdfunding portal. Since May 16, 2016, there have been nearly 150 companies that have sought to raise funding through Title III/Regulation CF and more than 40 of them have had an initial closing. Our view is that Title III/Regulation CF is already off to an impressive and responsible start. No doubt in 2017, there will be many more FINRA approved Title III funding platforms and substantially more entrepreneurs using the services of these platforms to assist them raise capital.
As I said earlier, these are the basics which you need to appreciate as you look forward to joining us this December. Thanks for taking the time, much appreciated.