Crowdfunding. The JOBS Act and the SEC s Missing Rules. Jeanne R. Solomon Matthew Zucker Maura Gallagher. April 2013

Transcription

1 Crowdfunding The JOBS Act and the SEC s Missing Rules Jeanne R. Solomon Matthew Zucker Maura Gallagher April 2013

2 Overview What is crowdfunding? Types of crowdfunding Crowdfunding around the world US crowdfunding sites, past and present JOBS Act deadline and some provisions Political climate (SEC, FINRA) JOBS Act s SEC mandate Potential benefits of crowdfunding rules Potential challenges of crowdfunding rules SEC March 2013 no action letters SEC JOBS Act FAQ guidance as to crowdfunding 2

3 What is Crowdfunding? Raising money in relatively small amounts from a large number of people, including through social media and other online platforms (in some cases no need for an intermediary like a bank or underwriter) Anyone who can convince the public he or she has a good business idea can become an entrepreneur, and anyone with a few dollars to spend can become an investor Modeled in part on campaign donation approach (politicians have been collecting small donations from the general public for decades) Amounts raised can be small (e.g., $25,000 total) or large (many millions) Another route to funding (venture capitalists reject 98% of business plans, according to 11/6/12 Forbes article; tightening bank loan criteria in a recession) JOBS Act of 2012 requires the SEC to adopt equity crowdfunding rules 3

4 Types of Crowdfunding Reward / Pre-Purchase Model Investor obtains non-financial reward (e.g., get T-shirt from clothing co.) Examples: Kickstarter, IndieGoGo, RocketHub Lending Model (peer to peer lending, peer to business lending) Repayment expected (sometimes with interest, sometimes without) Examples: SoMoLend (partnership with Gate Global Impact, broker-dealer that allows investments by accredited investors), Lending Club, Zopa, Prosper, RebuildingSociety.com, Kiva and Zidisha (each microfinance) Donation Model Nothing in return, can fund for-profit or not-for-profit Give2Gether, Global Giving, Fundraise.com, CauseVox, Fundly Equity Model (the topic of this presentation) Allows individuals to invest in newly forming and established small businesses, while realizing a return on their contribution Financing that bigger investors/lenders often unwilling/unable to provide 4

5 Crowdfunding Around the World General despite US concerns about widespread fraud, non-us experience does not appear to bear that out so far Worldwide includes Crowd Valley (infrastructure for third parties to set up startup or investment platforms, 300+ private label crowdfunding platforms) European Union proposal to legalize equity crowdfunding by fall 2013 UK - competing claims as 1 st UK equity crowdfund platform (Seedrs (Financial Services Authority (FSA) authorized May 2012) vs. CrowdCube (FSA auth d Feb. 2013)); FundTheGap (equity), BankToTheFuture (unclear) Australia Australian Small Scale Offerings Board (ASSOB) combines peer-to-peer investment with VC approach, promotes capital raising campaigns of up to $5 million (Australia s only facility for secondary sales of unlisted issued securities); others plus non-equity including Pozible Netherlands Symbid Scandinavia (Norway/Sweden/Finland) - FundedByMe Israel Ourcrowd (VC funding for accredited investors in startups) 5

6 US Crowdfunding Sites, Past and Present Failed US crowdfunding sites (premature) ProFounder: Started Aug for equity crowdfunding in US, shut down June 2011 due to lack of regulatory support, encouraged people to push for legalizing crowdfunding at Entrepreneurs applied, uploaded pitch and created term sheet, ProFounder facilitated compliance ProFounder gave businesses page to invite various investors to make investments directly on the site, charged 5% of public raise +/or flat $1,000 for private raise MoxyVote: Launched 2009, closed July 2012 (individual investorfocused proxy voting platform, wanted individual investors to have same opportunities as institutional investors, crowdfunding would support that) BoostFunder: Introduced 2012 then turned into conventional Silicon Valley incubator, citing regulatory red tape 6

7 US Crowdfunding Sites, Past and Present (cont d) Current US: Equity crowdfunding sites include: Operative (traditional exemption using online platform) CircleUp (CA based formed fall 2012, accredited investors only, arrangement with WR Hambrecht + Co. to handle investments) TheFundersClub.com (CA based, angel investing online) Waiting for SEC rules - EarlyShares (Miami based, educational guides online) - packages investors into single-entity corporations to fund registering businesses, 60% established companies <$5M revenue, 50,000 investors/2000+ companies registered in preparation for legalized crowdfunding Other players include: Crowdfunding Professional Association (trade group) Crowdfund Capital Advisors (consulting firm helping professional investors, governments, NGOs, others leverage crowdfunding) WeFunder (standard broker-dealer) CrowdTilt (CA-based, free technology, allows money-pooling/collection) Gate Technology (broker-dealer, back end crowdfunding platform) 7

8 JOBS Act Deadline and Some Provisions Signed into law on April 5, 2012 JOBS Act Title III, Section 4(a)(6) requires SEC to adopt crowdfunding rules Deadline for adopting rules was December 31, 2012 (missed) Proposed rules not issued, no official SEC timeline for adopting them (rumored to have been drafted already, subject to review) Private estimates of rules by late in 2013 or early 2014 (could slip) New Section 4(6) under Securities Act to be added JOBS Act provisions include: Express cause of action against issuer for material misstatements or omissions Definition of issuer includes director or partner of issuer and principal executive officer, principal financial officer and controlling or principal accounting officer (and persons occupying similar status or performing similar function) who offers or sells a security exempt under Section 4(6) 8

9 Political Climate (SEC, FINRA) Political climate SEC personnel changes (including at Chair level) have added to delays Mary Shapiro (SEC Chair from Jan to Dec. 2012) rumored to oppose crowdfunding, delayed issuing rules saying not feasible within JOBS Act deadline (delay possibly intentional) Elisse Walter (SEC Interim Chair Dec until Apr. 2013, lame duck starting Jan. 2013) insider speculation that she would quickly push through crowdfunding (didn t happen) Mary Jo White (SEC Chair as of April 10, 2013, nominated Jan. 24, 2013), unclear what White s nomination means for crowdfunding FINRA January 2013 invitation to prospective crowdfunding portals to submit information to FINRA as to proposed business models, operations (relevant because JOBS Act requires portals to be FINRA members) Commentary on rules/status Ironic that SEC being asked to adopt rules when lack of SEC responsiveness to small business needs triggered mandate 9

10 JOBS Act s SEC Mandate Limits Each company may raise no more than $1 million/year Each investor may invest: Up to greater of $2,000 and 5% of investor s annual income or net worth, if investor s annual income or net worth is less than $100,000 10% of investor s annual income or net worth (up to $100,000 maximum), if investor s annual income or net worth is greater than $100,000 Disclosure requirements depending on funding amount: Most recent tax return, CEO/CFO certify financials accuracy (raises up to $100K) Financial statements reviewed by certified public accounting firm (raises between $100K and $500K) Audited financial statements (raises between $500K and $1M) (No other offering exemption requires certified or audited financial statements) Distribution method issuers must use services of intermediary registered with SEC and FINRA as either a broker or a funding portal Broker or funding portal acting as crowdfunding intermediary will be subject to SEC authority, may not act as crowdfunding intermediary until SEC rulemaking complete Portal may not offer investment advice, solicit purchases/sales/offers, manage/ handle investor funds/securities or compensate anyone for solicitation or based on securities sales through website or portal 10

11 Potential Benefits of Crowdfunding Rules Benefits to issuers May allow startups to retain more initial value (VC and angel firms traditionally extract and keep value from startups) May allow startups to retain more control compared to VC/other larger investors May give startups more leverage in negotiating with larger investors Crowdfunding alternative presents more populist fundraising option that was not previously available May be good public relations for more established companies that crowdfund Benefits to smaller investors Can more easily get a piece of the startup market May be able to invest in first wave with established companies that crowdfund Benefits to larger investors Opening up a crowdfund may help gauge possible market for an issuer Experienced firms may find useful entry points in crowdfunding market 11

12 Potential Challenges of Crowdfunding Rules $1M annual limit may be too restrictive compared to Regulation D Managing hundreds/thousands of direct investors could substantially impact investor relations function, record-keeping/transfer agent function Portals may offer to help with some of these tasks Risks/costs of compliance may be challenging JOBS Act allowance for claims against directors/officers who fit issuer definition (and misstatement/omission claims) could scare off companies Financial disclosure requirements could be challenging to meet Corporate self-drafting to save on costs could heighten legal risks Many startups fail in first year, raising risk of disgruntled investors Risks to intermediaries (brokers or funding portals) Later VCs, angel investors might not want to invest in a crowdfunded company Risk of inadvertent 1934 Act reporting company status (subsequent purchasers of crowdfunded securities may each count as shareholders of record for determination purposes notwithstanding that initial purchasers exempted) Section 4(2) exemption likely to remain popular (partial repeal of ban on general solicitation and advertising for certain offerings exempt by Rule 506 also makes exemption more attractive) 12

13 SEC March 2013 No Action Letters SEC's Division of Trading & Markets granted no action relief to accredited investor crowdfunding sites that do not register as broker-dealers: FundersClub (March 26, 2013 at online venture capital firm, accredited investors help fund startups in exchange for equity No enforcement if engages in described activities without broker-dealer registration (funds kept in separate custodial accounts for each startup, so not technical crowdfunder but VC advisor that raises funds online) No commissions earned on securities sales (carried interest received, which pays out if fund returns its capital contributions); no management fee taken SEC seemed to bless argument that only receives money if successful in creating value (i.e., traditional investment adviser compensation is not transaction-based compensation earned by broker-dealer) AngelList LLC (March 28, 2013 at registered investment advisor, accredited investors only, internet-based platform No enforcement action if engages in described activities without registering as broker-dealer 13

14 SEC JOBS Act FAQ Guidance FAQs issued May 7, 2012 ( Registration (Intermediary must register with SEC as such and be subject to SEC rules; Portal must become member of an Exchange Act Section 15A registered national securities association (currently that means FINRA)) Portals may not offer investment advice, solicit purchases, manage investor funds or compensate for solicitation or based on securities sales through its portal Crowdfunding brokers/funding portals have significant JOBS Act duties including to: make available to investors/sec issuer-provided disclosures 21+ days pre-sale ensure that each investor reviews materials/understands risks take steps to protect privacy of investor-collected information take measures to reduce fraud risk, including obtaining background/securities enforcement regulatory history check on each D, O and 20%+ equity holder of issuers being crowdfunded ensure that offering proceeds only provided to issuer when aggregate capital raised from all investors is equal to or greater than target offering amount, and allow investors to cancel their investment commitments make efforts to ensure that annual investor limits are not exceeded 14

15 Contact Page Jeanne R. Solomon Senior Associate Phone: (212) Matthew Zucker Associate Phone: (212) Maura Gallagher Associate Phone: (212)