Crowdfunding Overview

Investor Protection vs Capital Raising

Crowdfunding

Era of legalizing things that prior generations thought were bad ideas

The gateway to crowdfunding = beer

Crowdfunding

New registration exemption under Section 4 of the Securities Act

Intended to allow capital raising – from a large number of people– with relatively small investment amounts– typically through the internet and social media

No final rules yet; no stated deadline for final rules either

Exemption

May not exceed $1 million in any 12 month period Limited purchases per investor:

– greater of $2,000 or 5% of annual income or net worth (if investor annual income or net worth is below $100,000)

– 10% of the annual income or net worth of the investor, up to a maximum of $100,000

Sales conducted through registered broker or funding portal; limited advertising or promotion

Specific disclosure requirements

Intermediaries

Must register with the SEC and applicable self-regulatory organization (FINRA)

Provide disclosure required by SEC Ensure investors review disclosure materials and confirm

their understanding of investment risk Take certain measures to reduce the risk of fraud,

including limited background checks on officers, directors and 20% shareholders

Allow 21 day review period Ensure offering and investor minimums Protect privacy of investors

Funding Portals

May not:– Offer investment advice – Solicit purchases, sales or offers– Compensate employees, agents or others for solicitation

or based on the sale of securities– hold, manage, possess or otherwise handle investor

funds

Disclosure

Directors, officers and 20% owners Business plan Financial condition

– income tax return for last year and financial statements certified by PEO (for offers of $100,000 or less)

– financial statements reviewed by independent public accountant (for offers of $500,000 or less)

– audited financial statements (for offers over $500,000)

Use of Proceeds

Disclosure (continued)

Target offering amount and deadline Ownership and capital structure of the issuer

– terms of offer and terms of other classes of issuer securities

– rights of principal shareholders and impact on purchasers of securities being offered

– information regarding shareholders owning more than 20% of any class of the issuer’s securities

– current and future valuation methodology

Annual financial statements and reports of results of operations

Restricted Securities

Securities purchased in crowdfunding offering may not be transferred for one year, unless transferred:– to the issuer– to an accredited investor– pursuant to a registration statement– to a family member in connection with death or divorce

Securities sold in crowdfunding offering will be considered “covered securities” exempt from blue sky registration requirements

Public Co. threshold exemption

Securities acquired in crowdfunding offerings will not count towards the determination of whether a company is a “public” company by virtue of having 2,000 shareholders of record (or 500 unaccredited shareholders)

Things to think about

Thoughtful initial structure and internal controls are important (act like a public company)

Shareholder Agreements and other reasonable restrictions should be considered

Anticipate annual meetings and other shareholder communications

Some VCs think this is a good litmus test for emerging companies who will seek VC financing

Will VCs and similar types of investors effectively “regulate” the negative space