Raising Capital

The New Crowdfunding Rules: What They Mean For Entrepreneurs

Sherwood Neiss | November 6, 2015

Facebooktwittergoogle_plusredditlinkedinmailFacebooktwittergoogle_plusredditlinkedinmail

The SEC hath delivered the rules, and they are good! They are also voluminous: the final Regulation Crowdfunding rules adopted by the S.E.C. last week spanned 685 pages. We asked Sherwood (Woodie) Neiss, a principal at Crowdfund Capital Advisors and a leader of the securities-based crowdfunding movement, to help us sort through the rules and analyze what they mean for entrepreneurs, investors, and crowdfunding portals. In the first of a three-part series, Woodie looks at what entrepreneurs need to know. 

After spending two and a half days to read and digest the Securities and Exchange Commission’s final rules for Regulation Crowdfunding (also known as Title III of the JOBS Act), a few things are clear. One, this is a very structured approach to how startups and small businesses will be able to raise funds from the crowd. Two, it comes with a fair share of work on everyone’s (issuers, portals and even investors) part. And three, compliance with the rules are key! 

For entrepreneurs (aka issuers), the new rules deliver on the promise of the JOBS Act to open up new pools of capital. For the first time in 80 years, you’ll be able to ask those closest to you—people who might not be rich but who know you, your business and your track record—to back you. 

However, before you get started there are two critical things. First, spend some time educating yourself about the process so you fully understand the magnitude of what you are about to embark on. (Raising money is no easy task, all crowdfunding does is facilitate the process using technology. You still have to do all the heavy lifting to put your offering together and reach out to your crowd). Second, you need to wait about 180 days from when the final rules are published in the Federal Register before this goes live. That effectively puts off any fundraising to the 2nd quarter of 2016.

Companies can raise up to $1 million on websites run by broker-dealers or funding portals, a new kind of intermediary allowed by the SEC. You’ll need to have financials that not only pass the muster of the crowd, but very likely an independent public accountant as well. In some cases, you may need a full audit of your financials, but the SEC has waived that requirement for first time offerings and those under $500,000. (As many industry participants had pointed out, it makes little sense to make a startup to go through an expensive financial audit). If you seek to raise more than that you’ll need an independent public accountant review.

Cost

If you think it’s going to be cheap, you are mistaken. You’ll need to budget for portal fees, legal fees to prepare forms, annual compliance filings, and accounting expenses. The SEC estimates that it will cost anywhere from $6,727 to $11,727 to raise up to $100,000;  $33,577 to $52,743 to raise up to $500,000; and from $74,593 to $118,343 for first time issuers to raise up to $1 million. But then again, it costs money to raise money.

SEC-Cf-Costs

Disclosure and Compliance

Before, during and after your offering, Form C will become one of your best friends. This form lets the SEC know when you’ve filed your offering, if/when you closed on it, any changes you made to it, your annual filing requirements, and if/when you chose to stop your annual filing.  You can find this form here.  Compliance is critical. This includes filing an annual report with the SEC within 120 days after the end of your fiscal year and posting a link to the report on your website. You must keep your investors informed annually of what’s happening in your business and file this update with Form C annually as well.

Read more coverage of Crowdfunding and Raising Capital

The rules require you to provide certain offering documents and information to potential investors on your intermediary’s website. These include a business plan, names of officers and directors, details on how you plan to spend the money you raise, the valuation for the security you are offering, and financial statements, among other things. Your safest bet is to be transparent and disclose as much as possible.  If you hide or omit something, and anything goes wrong, your investors may have a legal claim against you for not disclosing it.

This also goes for any material changes to your business after your offering goes up. As soon as you know something, you need to let everyone know—that means the SEC (via Form C) and your investors.

Intellectual property

If you have intellectual property you wish to protect, you should seek IP protection before you crowdfund. All of your company’s information will be available to the public, and you don’t want to lose some important intellectual property just because you needed to raise a few dollars.

Cap Tables

You’ll also have to become familiar with things like “cap tables” that track who your investors are, what they have purchased, and the unique terms of their equity or debt.  This can be tricky, so you can pay a third party to track it for you, such as a broker-dealer or transfer agent. If you choose to do it yourself, you’ll have to prove to your intermediary that you can handle it.

Advertising

The rules allow you to advertise your offering, as long as your advertisement only mentions limited information about your offering and directs potential investors to the intermediary to find out more information. The last thing the SEC (or the industry) wants to see is an issuer promoting their offering as a “guaranteed win,” “amazing return opportunity,” or any other such characterizations.

Promotion and Intermediary Selection

Don’t have a very big crowd? You can hire someone to help you promote your offering, as long as you fully disclose that you are paying them and the terms of your agreement so that investors know it is paid promotion.

The type of intermediary you choose makes a difference, too. Funding portals are limited on how they can promote a campaign. They cannot highlight specific campaigns as the “investment of the day” because this is considered investment advice and the rules do not allow funding portals to offer investment advice. However, issuers will be able to categorize their campaigns based on objective criteria like location, gender of founder, sector/vertical, etc.

If you feel you need the promotional boost, you may be better off with a broker-dealer, since these more regulated intermediaries are not restricted from making recommendations and giving investment advice. But broker-dealers cost more, and if your deal is small, they may turn you away (small deals may be too time consuming and generate too little profit for broker-dealers).

Sherwood Neiss
Sherwood Neiss

Bottom Line

At the end of the day, this is a BIG win for America’s entrepreneurs, innovators and job creators. It will give them access to capital that might have been available before but untouchable to them. The rules, while intense, offer a structured approach to seed, early stage and growth capital from individuals who choose to submit themselves to background checks and the scrutiny of the crowd. 

Not everyone will be successful. But those that take the time to educate themselves on all the rules and use technology to facilitate the entire process, rather than trying to do it on their own, will stand a better chance. While this might add incremental costs, as more tech companies come into the market and increase competition, prices will drop.  In five years time, Regulation Crowdfunding will just become another “standard” part of the capital stack and one of the first stopping grounds for entrepreneurs seeking capital.

Learn more about Crowdfunding in our guide for Entrepreneurs.

Sherwood Neiss is a principal of Crowdfund Capital Advisors, a crowdfunding advisory, implementation and education firm.

Facebooktwittergoogle_plusredditlinkedinmailFacebooktwittergoogle_plusredditlinkedinmail

Tags: , , , , , , ,

Comments

  1. Sherwood, my compliments on an excellent article. You have netted out the most important elements in this new ruling. I agree, this is big news with major ramifications to the capital stack. Let me comment on a few of your comments. My company, Crudefunders.com, is an equity-crowdfunding portal specifically for the Oil & Gas industry.

    COST: yes, this capital has a cost like all capital, but it can be highly competitive. At CrudeFunders.com, our costs are generally far below other alternatives. DISCLOSURE, COMPLIANCE & CAP TABLES: with our portal, under development, refinement & perfection since the original JOBS Act 3.5 years ago, all of this is handled automatically, seamlessly, and in full compliance. IP: this is easily addressed on a project-by-project basis with our portal. Company IP is not exposed. PROMOTION & ADVERTISING: all done seemlessly and effortless through our portal.

    CrudeFunders.com is 3.5 years ahead of this new SEC ruling and we are open for business. Again, we are specific to Oil & Gas investing, and currently restricted to Texas under intrastate exemption, but this all changes in the 1st Qtr. of 2016 when we will open up nationally under the new SEC rules!

  2. Sherwood, my compliments on an excellent article! You have netted out the most important elements in this new ruling. I agree, this is big news with major ramifications to the capital stack. Let me comment on a few of your comments. First let me say that my company, Crudefunders.com, is an equity-crowdfunding portal specifically for the Oil & Gas industry.

    COST: yes, this capital has a cost like all capital, but it can be highly competitive. At CrudeFunders.com, our costs are generally far below other alternatives…as low as 2%. DISCLOSURE, COMPLIANCE & CAP TABLES: with our portal, under development, refinement & perfection since the original JOBS Act 3.5 years ago, all of this is handled automatically, seamlessly, and in full compliance. IP: this is easily addressed on a project-by-project basis with our portal. Company IP is never exposed. PROMOTION & ADVERTISING: all done seamlessly and effortless through our portal. We currently have 1000’s of registered investors and expect to accumulate 10’s of 1,000’s over the next few months. The response to equity-crowdfunding for Texas Oil & Gas has been impressive.

    CrudeFunders.com is 3.5 years ahead of this new SEC ruling and we are currently open for business. Again, we are specific to Oil & Gas investing, and currently restricted to Texas investors and Texas companies under intrastate exemption, but this all changes in the 1st Qtr. of 2016 when we will open up nationally under the new SEC rules! Equity-crowdfunding is a game-changer for the Oil & Gas industry and this type of investment for the non-accredited (and accredited) “crowd” is perfectly suited for Oil & Gas projects…..especially with current low oil prices!

  3. No one is more knowledgeable about crowdfunding rules than you (and your associates–hello Jason et al) and thank you for distilling SEC regulations in a way that Main Street small businesses can benefit from.

  4. Great article Sherwood !
    We also red the 686 page Final Regulation Crowdfunding, not once but three times.
    There are a few surprises compared to the Preliminary Regulations, came out on Oct. 23rd. in 2013. The most shocking is the reversal of “Whichever is more” to “whichever is less”. Whit it, the industry lost 80% of the funds would been available for equity crowdfunding. It also eliminated almost everyone under 30, without inherited net worth.
    Lets take an MBA making $140,000 a year. Their net worth may be their laptop and some equity in their BMW, totals $50,000. So the most they are allowed to invest is $2,500 yearly. Yes, most of them buying homes, but the primary residence does not count towards net worth.
    However, by waiving the auditing requirements for first time users, did help us to increase the pool of issuers.

    As you probably well aware, our Trading Platform was completed before and was ready for Beta. Now we have to make quite a few changes to it to comply with the Final Regulations.
    Wishing you a Happy New Year, from the West Coast.
    Ted
    founder
    CyberIssues, LLC.
    @CyberIssuesIPOs, also on CrunchBase.

Leave a Reply

Your email address will not be published. Required fields are marked *