Crowdfunding
Equity Crowdfunding Update
David Menard
860.240.6047 (Hartford) | 617.457.4105 (Boston)
dmenard@murthalaw.com
Rajesh Patel, Ph.D.
rajesh@redacre.com
January 21 and 22, 2014
Crowdfunding Explained
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Aggregating funds from a broad donor/investor base
toward a common goal
Breaks down two key barriers:
• Communication
– investors finding companies and vice versa
• Money
– allowing pool of money to come from all types of investors, not just
sophisticated wealthy investors
Crowdfunding (cont’d.)
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Four Types
• Microfinance / Microloans
– ex. Kiva.Org – minimum loan is $25; Have handled approx.
$322M in loans since 2005, with numbers increasing rapidly in
the last few years
– Generally no investor returns or very small returns expected.
Crowdfunding (cont’d)
• Peer-to-Peer (P2P) Loans / Social Lending
– Loans from group of lenders without traditional intermediaries (banks) reduces overhead costs
– Strong financial regulations involved – depends on jurisdiction; non-bank
commercial lenders.
– Ex.
» Prosper.Com (US) ($692M in loans since 2006 ($248 since last
year); 2M members (400K increase over 2012)
» See SoMoLend.Com
» Lending circles (ex. FundingCircle.Com (UK) – Approx. €
€201,758,400 (approx €100M over 2012) in loans since 2010;
average net return: 5.7; bad debt – less than 1.3%
Crowdfunding (cont’d)
• Donor/Reward-Based Funding
– Generally creative and culture-based (technology,
movies, television, art and music) as well as
philanthropic endeavors
– No financial return on investment, but may get physical
reward (final copy of movie, t-shirt, stage prop, etc.) or
offered a unique experience (walk-on part in movie).
– Ex. Kickstarter.com (over $943M funded);
IndieGoGo.com; RocketHub.com
A Few Light Statistics
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Gartner – Non-equity Crowdfunding expected to
reach $3.3B in 2013
2013CF Crowdfunding Industry Report – expects
actual non-equity total will have been $5.1B in 2013
(81% increase over 2012)
As of 2012: US non-equity CF platforms -191; UK –
44; EU over 100 more; total worldwide – est. 536
Average time frame for current equity CF campaigns
(worldwide): 8.2 weeks
• versus donor/reward campaigns: 10-10.2 weeks
Equity Crowdfunding
• Equity Crowdfunding
– Securities (equity, debt or revenue share) for funding.
– Prior to JOBS Act, this type of funding generally violated securities
rules for private placements.
– What is the downside? Fraud.
» Kickstarter has had less than 4 cases of possible reported fraud,
less than 0.01% of their total offerings. Expect more fraud in
equity CF, but how much more is the question?
– World Bank predicts worldwide Equity CF market to exceed $93B by
2025..
Why is Equity Crowd Funding
Important
• Restrictions on sales of securities – all sales must be
registered or exempted from registration on both
federal and state levels;
• 4(2) private sale exemption; Reg. D safe harbors;
• The more sophisticated the investor, the less
protection/information needed.
• The barriers broken down by CF (communication,
money) are anathema to the purpose of the SEC.
Status in United States
•
WHERE WE ARE NOW
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Reg D. General Solicitation Changes effective Sep. 23.
New equity CF proposed rules came out Oct. 23. Still subject to comments and
revisions (90 day comment period, and then 90-120 day SEC review period)
FINRA releases proposed CF Portal registration form – Jan 8. 2013.
Many companies were lining up to become crowd funding portals – including
IndieGoGo, Crowdfunder, Circle UP, SoMoLend. Some companies are in a
holding pattern until the regulations are finalized, some are focusing on debtbased crowd-funding in the meantime. BoostFunder, intended to be a portal, now
a traditional start-up incubator. Another portal, ProFounder, ceased doing
business, while Earlyshares has already acquired a potential competitor portal.
SoMoLend founder suggests debt-based crowd funding may have more impact
on banking industry than equity-based crowd funding will have on securities
markets.
Reg D. 506 Rule Change
• Breaks down the communication barrier
(money barrier still in place)
• Can now use general solicitation (advertising)
to reach audience of accredited investors.
Reg D. (cont’d.)
• New Additional Requirements for General Solicitation Offering:
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Submit Form D 15 days prior to first sale (used to be 15 days
after first sale)
Disclose:
• # and type of accredited investors, and how verification was
made (enhanced verification requirements)
• Copies of offering/solicitation materials (and whether such
materials were disclosed to FINRA)
• Website address; use of proceeds; legends
Proposed U.S. Equity CF Rules
• Basics of U.S. CF Rules:
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Crowd Funding must take place through SEC (or SEC designee)
regulated online portals or brokers – portals must participate in
registration regime.
Unlimited # of investors, including foreign investors, may invest,
in the aggregate, up to $1M in a company’s securities in a 12month period (limitation only applies to securities sold in CF
offering – but also applies to affiliate companies)
Investors with net worth of $100K or less may invest no more
than the greater of $2,000 or 5% of net worth / annual income;
Proposed CF Rules (cont’d.)
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Investors with net worth of more than $100K may invest no more
than the lesser of $100,000 or 10% of net worth / annual income;
How to determine when an investor has hit limit? SEC leaves
this up to the Portal to determine.
Certain resale restrictions on securities for no less than one year
after purchase (unless sold to accredited investor, death/divorce,
in public offering).
Companies will having varying requirements with respect to
disclosures and financial statements depending on amount of
investment being sought (e.g., audited returns for companies
seeking $500,000 or more in crowdfunded investments).
Proposed Equity CF Rules
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Sample disclosures:
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20% or greater stockholders;
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Business and business plan;
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Use of proceeds;
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Target offering amount and deadline;
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How investors can cancel an investment commitment;
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How offering price was determined;
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Other offerings by issues in past 3 years;
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Related party transactions
Proposed Rules (cont’d.)
• Reporting continues until company goes public,
liquidates or all securities purchased in the offering are
sold to a third party.
• Limits on advertising, which must direct the reader to the
appropriate Portal.
• CF offering not allowed if any “bad actors” are involved,
which includes directors, officers and 20% stockholders.
CF Portals
• Register with SEC as a broker or Portal
• Portal, directors, officers and partners cannot have direct financial
interest in any issuer that uses Portal’s services
• Must provide investors with educational materials
• Must take steps to reduce fraud risk: have reasonable basis to
believe an issue is in compliance with regs and keeps accurate
records; and must deny access to any offering that presents a
potential risk of fraud.
• Must perform background and regulatory checks on issues and
related parties.
CF Portal (cont’d.)
• Portal must ensure no investor exceeds limits (allowed to
rely on investor representation), and allow investors to
cancel investment commitment.
• Portal must provide for communication between
investors and between investors and issuer.
• If Portal provides for secondary market, it must register
as a securities exchange or alternative trading system.
• Must protect investor privacy.
US Equity CF Thoughts
• Liability has started to land where expected: on the Portals.
• Communication among investors – now regulated.
• Possible concerns:
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Company disclosure requirements:
• Ongoing audited financials (compare to Reg. A $5M Offering
• Ongoing nonfinancial disclosure
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Portals getting short shrift: liability, unable to participate, cannot
prohibit issuer from participating based on qualitative or
subjective factors (advantage to broker; curation)
Foreign Crowd Funding
• Currently permissible in:
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Australia (ex. Pozible, ASSOB),
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UK (See Next Slide); and
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Sweden (ex. FundedByMe).
• Canada: intra-state exemption first adopted by Saskatchewan in
December 2013. Ontario looking for general exemption first quarter
of 2014. More legislative effort remains for general equity CF.
• In each case, governed by government regulations and monitored
by government agencies.
Foreign Crowd Funding (cont’d)
•
4 UK Crowd Funding portals: CrowdCube (equity focused); Abundance
Generation (energy-focused); Seedrs (equity focused); and
BankToTheFuture.com (supported by Richard Branson).
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In one widely-cited example, in 2012 CrowdCube helped a web-based
company Escape the City obtain £600,000 in funding; £100K over goal
– in 13 days! ETC had turned down an offer from a top London VC firm
citing a desire to remain independent.
In first year and a half of operation CrowdCube has funded 85
businesses to the tune of £16,488,270.
In interesting meta-CF example; Seedrs is raising £500,000 for its own
expansion in to mainland Europe
UK expected to raise £1.6B in Crowdfunding in 2014 (Nesta Study)
Equity Crowdfunding for
Entrepreneurs/Startups
•
Should you do it?
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Cons:
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Ongoing reporting requirements (audited financials and other
disclosures)
VCs and Angels may not want to invest in a crowdfunded company
Too many shareholders make corporate governance and logistics very
difficult
Funding Limits – $1M in any given 12 month period
Skill assessment – are you ready to manage this type of company
without outside assistance?
Equity Crowdfunding for
Entrepreneurs/Startups
• Pros:
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It does work – much more capital available for companies
It can possibly be cheaper and quicker than traditional equity
fundraising
Better deal terms for founders – on average: give up smaller
percentage of Company; non-voting shares; no additional
information, registration or management rights given to investors
Equity Crowdfunding for
Entrepreneurs/Startups
•
How to Prepare for Equity Crowdfunding/Considerations
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Build your audience – your customers may be your investors
Have good internal recordkeeping – be ready for financial and other
reporting requirements
Know your market, and how to communicate with them. Consider
whether a PR/Advertising specialist is needed. Crowdfunding of any
type is a sales campaign.
Learn how to be a CEO – use growth advisors, accelerators and
incubators to learn the skills necessary to deal with many shareholders
and a rapidly growing company.
• It’s ok not to know how, but it’s not ok to not educate yourself.
What makes a successful
crowdfunding campaign?
•
From GoGetFunding.Com (Dec. 13, 2013):
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Successful campaigns receive an average 193 likes and 57 tweets
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Best tools for converting a finder to a funder: email (53%); facebook (12%); twitter (3%)
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Once you’ve raised 40% of funds – visitors stay on page 31% longer and are 22% more
likely to donate
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If a campaign reached its goal, 78% received more than goal
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Campaign with personal video raises 105% more than one without
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Projects with word count between 300 and 500 words raise the most money
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Most successful campaigns generally last between 20 and 40 days
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Campaigns with teams raise 38% more;
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Campaigns with day-to-day marketing plans raise 180% more
Mr. Menard is a Partner in the firm's corporate law practice, where he represents both
private and public companies. He practices in the areas of general corporate law, private
equity and venture capital investments, mergers and acquisitions, and securities law. In
the private equity and venture capital area, Mr. Menard has represented both companies
and investors in debt and equity offerings, and has provided both pre and post-investment
general corporate law guidance to companies in the high tech, bio-science,
manufacturing, audio and video, steel and retail industries.
DMenard@murthalaw.com | 860.240.6047
Rajesh Patel. Ph.D., is the Managing Director of RedAcre Investments. Prior to Red
Acre, Rajesh was a Member of Technical Staff with the Massachusetts Institute of
Technology, (MIT) Lincoln Laboratory where he analyzed the strategic value of emerging
technologies to enhance the capabilities of the U.S. Military. Rajesh holds a Ph.D. in
Applied Physics from the University of California, Davis, a Master's in Environmental
Science from Rice University and bachelors degrees in both Physics and English from the
University of Connecticut.
Disclaimer
This information is educational material that provides an
overview of the issues described. It does not deal with every
issue, and does not deal with every exception to this information.
This information does not constitute legal advice.
Please contact your attorney or a Murtha Cullina attorney if you
would like legal advice which would be best for your particular
circumstance.
© 2013 Murtha Cullina LLP