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