As of March 14, 2021, the Securities and Exchange Commission amended its private offering rules to harmonize an overly complex set of rules for smaller offerings. Many of the changes will apply directly to our smaller and medium-sized clients looking to raise equity capital in 2021. This includes seed capital for start-ups and growth capital for established companies.
In our world, the biggest changes are:
- An increase in the offering limit for Rule 504 private offerings under Regulation D from $5 million to $10 million in a 12-month period.
- Rule 504 is the most flexible exemption for private offerings under Regulation D. Historically, it has been the right exemption for small, more informal offerings. However, with the increased cap now at $10 million, Rule 504 will become the preferred exemption for a wide variety of capital raises.
- The offering limit for “crowdfund” offerings will be increased from $1.07 million to $5 million.
- This change is already reverberating in the venture capital community as some VC funds have added a crowdfund component to their equity raises and commentators generally are talking about how this change will open doors for companies struggling to find investment capital. We like Crowdfund raises as long as they are managed in a way that does not interfere with (or even cut off) future follow-on capital raises.
- Generally, “Crowdfunding” is a form of capital financing where businesses use qualified internet crowdfund platforms to raise capital through investments, potentially from a large number of investors where most of them will be “micro-investors” contributing small amounts. The structuring exercise for these offerings is to formulate offering terms that enable the company to manage a large number of micro-investors going forward.
- New Rule 148 creates clarity and provides guidelines for acceptable communications at certain investment events where opportunities for investment are presented publicly. We are frequently asked about what can be presented by a company conducting a private offering where the company is invited to speak about the investment opportunity and potential investors will be present. Rule 148 gives us clarity in responding to these questions.
Why Consider a Crowdfund
Our opinion – companies that can attract professional venture capital investors generally should prefer that sort of investment over a crowdfund. The reason is that with a professional investor or fund, you also get allies and connections for future raises. You get the benefit of their experience, contacts, knowledge and problem solving capability. They may want more control than “retail” crowdfund investors.
If your company has high growth potential – meaning it is an appropriate business for venture capital financing as opposed to traditional financing – and you are not having success attracting a professional VC, think about a crowdfund. This option is much more attractive at the new $5 million offering limit.
We have a couple of thoughts.
- You do not have to follow all of the recommended documentation promoted by the crowdfund sites. For example, we have seen documentation that is overly complicated and provides investor rights that are cumbersome and not necessarily compelling to crowdfund investors. The platforms generally will accept your structure for shareholder rights and limitations if they are straightforward easily explained.
- The idea that you can fill in some on-line forms, upload pictures and then you have a crowdfund offering is (a) a myth and (b) not a good idea. Companies doing crowdfund offerings are offering securities to the public and filing with the SEC. The SEC prescribed offering document is quite comprehensive. Our preference is to do the offering documents ourselves (a collaboration with our client) so that we have a deliberate process that ensures accuracy. Regardless of the platform, documents that you use to offer securities are subject to the securities laws and can carry liability for misstatements.
- Control the voting by your new “crowd” of shareholders. There are a number of ways to do that. You do not want to take away voting, but you can manage how it is done and by whom. In general, managing a potentially large number of micro-investors takes some planning.
- If you do not build structural controls into your crowdfund offering, you may find that future professional investors who can bring much more money to your company are turned off by your cap table and the prospect of dealing with a large number of micro-investors.
Who Invests in a Crowdfund?
Thinking about who is likely to invest helps a company decide whether they should consider a crowdfund program.
- First and foremost, consider your existing network, including family, friends, customers and current shareholders. Studies have suggested a local bias for investing in companies in close proximity to on-line investors. Does your company have a public persona? Does it have a following of some kind?
- Investors in equity crowdfunds may have motivations other than pure financial return. They may be interested in social, environmental and other policy impacts. Does your company offer those things?
- Investors may be attracted by something like an early release of a product or rewards that are available only to investors.
- Studies suggest that a large number of investors in crowdfunding platforms are non-professionals following the investment decisions of the largest number of investors. They are following a crowd. As a result, momentum can help propel an offering.
Can you Make it Compelling?
Companies that have CEOs who are good speakers and products or services that lend themselves to a visual presentation have an advantage in the crowdfund world. But, you do not have to be a rock star. You do need to be trustworthy, highly committed and make sense. If you believe in what you are doing, that is likely to come across.
We’ve never met a business owner or CEO who could not use more working capital.
Jon Gardner and Danielle Fahey focus their practices in the areas of corporate and securities law and business law generally. They can be reached at:
