Crowdfunding: Is It Really Worth It?
CDs Saved: Sonic Youth Two-Pack! A Thousand Leaves and Murray Street
CD Recipient: Kyle Anderson
The recent passage of crowdfunding provisions in the JOBS Act has been hailed in the press as a game changer for startups seeking to raise funds. These provisions are not yet effective as the SEC has yet to promulgate definitive rules related to the legislations. But even a quick look at the Act itself shows that crowdfunding's potential benefits are accompanied with a heavy burden.
Startups generally raise money through what's known as a Rule 506 Regulation D offering. Under US securities laws, companies are required to register an offering of securities, an expensive and lengthy process. Rule 506 of Regulation D exempts companies from the registration requirements if they offer securities in a private offering exclusively to "accredited investors," that is, investors of a high net worth.
There is relatively little paperwork in a Rule 506 offering. The securities purchase agreement will be signed and a Form D will be filed with the SEC. The downside is that the offering cannot be a "general solicitation": startup founders would need to know a sufficient number of "accredited investors."
Crowdfunding seeks to remedy these hardships. Startups using the crowdfunding exemption from registration are permitted to offer securities to non-accredited investors. These offerings can be made public using an online "intermediary." (Those interested in setting up an intermediary can read the SEC's recent FAQ on the subject.)
On the downside, crowdfunded offerings impose requirements on startups not present in the typical Reg D offering. The press widely reported about the monetary limitations of the amounts raised in crowdfunded offerings and limitations on the amounts invested by individual investors in such offerings. Rule 506 Regulation D offerings have no such limitations. (For the rest of this post, "Regulation D" will be shorthand for "Rule 506 Regulation D offering.")
Perhaps more onerous are the lesser known burdens described below:
Disclosure documents:
Crowdfunding. An issuer of a crowdfunded offering is required to provide to the investors with certain disclosures, describing risks relating to minority ownership in the issuer, additional share issuances, a sale of the issuer and transactions with related parties. The SEC generally requires issuers to provide risk factors tailored to the specific offering and issuer. While this better protects investors, it means added legal costs to an issuer.
Regulation D. None required. There are benefits to preparing a disclosure document, but in the tech startup world, none is usually prepared.
Fraud reduction measures:
Crowdfunding. Issuers are required to take measures to reduce the risk of fraud, including background and securities enforcement regulatory checks on its officers, directors and 20% shareholders.
Regulation D. None required.
Pre-Offering Filings:
Crowdfunding. No later than 21 days before the first day on which the securities are sold to any investor, the issuer must make available to the SEC and to potential investors any information to be provided by the issuer.
Regulation D. None required.
Non-Financial Disclosures:
Crowdfunding. Issuers must provide investors: (a) its name, legal status, physical addres and website address; (b) names of its directors, officers and 20% shareholders; (c) a description of its business and anticipated business plan; and (d) a description of the ownership and capital structure of the issuer.
Regulation D. None required.
Financial Disclosures:
Crowdfunding. Issuers must provide, among other things: (a) a description of its financial condition and intended use of proceeds; (b) the target offering amount, the deadline to reach the target and regular updates regarding progress; and (c) how the offered securities are being valued, and examples of methods for how the issuer may value its securities in the future.
Regulation D. None required.
Financial Documentation:
Crowdfunding. For offerings that, together with all other crowdfunding offerings by the issuer in the past 12 months, have, in the aggregate, target offering amount of: (i) $100,000 or less, the issuer must provide tax returns for its most recently completed year and financial statements certified by the principal executive officer; (ii) more than $100,000 but less than $500,000, the issuer must provide financial statements reviewed by a public accountant that is independent of the issuer; and (iii) more than $500,000, the issuer must provide audited financial statements.
Regulation D. None required.
Post-Closing Financial Disclosures:
Crowdfunding. At least once a year, crowdfunding issuers must file with the SEC and provide to investors its financial statements and reports of its results of operations, as per rules to be adopted by the SEC.
Regulation D. None required.
Opportunity to rescind:
Crowdfunding. Before each sale, each investor in a crowdfunded offering must be provided in writing the final price and all required disclosure, with a reasonable opportunity to rescind its purchase commitment.
Regulation D. None required.
...And these are only some the requirements set forth in the Act itself: the SEC rules which will be released in a few months will likely contain more hoops to jump through.
Such obligations may very well be necessary to protect mom and pop investors. But it is clear that despite the promise of greater availability of capital, startups contemplating crowdfunding need to seriously assess whether it is worth the monetary and administrative costs.
Bonus fact!: CROWDFUND is an acronym for "Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure Act of 2012."
CD's Saved: Sonic Youth Two-Pack! I got into Sonic Youth a few years too late, after I got into a conversation with Thurston Moore at a Beck show (celeb name drops!). As with all SY releases, the songs on these albums alternate between mellifluous melody and stabbing, cacophonous feedback. Standout Karen tracks: "Karen Koltrane" and "Karen Revisited"
Congrats Kyle Anderson! Sweet two-pack tune-age heading your way!
[After recently marrying and moving into a tiny apt with the wife, I've been tasked with reducing my personal possessions. Rather than relegate my carefully curated CD collection to neglect on the shelves of a thrift shop, I've decided to give it away, one by one. Listen with care.]