When it Comes to Investment Crowdfunding—Compliance Matters!

When it Comes to Investment Crowdfunding—Compliance Matters!

What to Know Before You Take the Plunge

The investment crowdfunding marketplace is growing faster than ever before, and is projected to grow by $196.36 billion from 2021 to 2025.

Unfortunately, industry watchers have observed an alarming level of non-compliance with the most basic rules of Regulation Crowdfunding by both companies raising capital and the platforms hosting the campaigns.

Non-compliance can result in regulatory enforcement action and/or investor lawsuits.  So if you’re considering dipping a toe into the crowdfunding world, compliance should be at the top of your list.

In 2016, the SEC completed its rulemaking process for Regulation Crowdfunding.  It suddenly became possible for a business to list an investment offering on a platform, and anyone in the United States could invest in the offering.  But before doing that, the business, as well as the platform, must comply with some basic rules of the road.

According to a recent analysis, only a small minority of offerings listed on Regulation Crowdfunding platforms are compliant!  

 

Crowdfunding compliance—what to watch for 

To offer securities under Regulation Crowdfunding, you must complete a federal Form C (also known as the offering statement).  The form takes about 60+ hours to properly complete and is designed to provide all the information investors need before deciding whether to invest.  Without this documentation, investors would essentially be going in blind.

A properly prepared Form C protects the business that is raising funds from future lawsuits from investors who claim they did not receive the information that was supposed to be disclosed.

In addition to the Form C, there are requirements for additional reports after you complete your raise.

Failure to comply with these requirements can result in private litigation—all of the investors in a non-compliant offering are entitled, at a minimum, to rescission.  In a rescission, the company must return the proceeds of the investment to the investor and pay interest.  The company may also be subject to enforcement actions by federal and state regulators.

If you fail to comply with all of the regulations, you create a potential liability for your company which would have to be disclosed to all future potential investors.

The effort of making sure you are compliant on the front end is well worth avoiding the potential nightmare scenarios if you don’t!

 

What to expect from a regulation crowdfunding platform

With compliance top of mind, it’s essential to seriously examine the level of compliance and transparency your platform of choice is practicing. 

At a minimum, here are a few helpful questions any investor or entrepreneur should ask before choosing a crowdfunding platform:

  1. What efforts are they taking to meet the regulatory requirements?
  2. Do they prepare the Form C for the companies that list on their platform?  If so, what is the training of the person that prepares it (is that person a lawyer)?
  3. If the platform prepares your Form C and it is found to be deficient, does the platform cover the resulting litigation and other expenses?

Compliance isn’t optional—it’s a must

As investment crowdfunding continues to grow, so do the concerns surrounding regulation and compliance and the likelihood that private lawsuits and public enforcement actions will become commonplace.

If you’re interested in connecting with one of our team members to discuss how we can support you with planning and implementing a compliant fundraising campaign, complete our Interest Form.

Three Keys to Escape the Bootstrap Trap

Three Keys to Escape the Bootstrap Trap

You may have been bootstrapping for a while now—using your personal resources to fund your business and hoping that eventually you will be able to break even and start paying yourself and buying the things your business really needs. 

The symptoms of being in the bootstrap trap include:

  • using personal credit cards to pay for business expenses
  • doing side gigs to earn extra money
  • wearing all the hats in your business because you can’t afford to get high-quality help
  • not being able to provide a top-quality customer experience due to lack of funding
  • not paying yourself a salary anywhere close to what a CEO should earn

Going for too long with too few resources is a leading cause of business failure. So how do you finally get off the hamster wheel of bootstrapping?  Here are the keys to get on the right path:

Realistically evaluate your options and commit to the best one for you.  

If you are in the bootstrap trap, you have three options:

1) Continue as you are and keep hoping that you finally get enough revenues to be able to do all the things you want with your business. This can work for some—if you hustle hard enough you may be able to reach that revenue goal. But if you have been trying to reach that goal for a while and you keep falling behind, it is time to acknowledge that a lack of resources is making it impossible for you to create sustainable revenue. You are in a vicious cycle!  Without upfront resources, you can’t buy what you need to create a business that generates sustainable revenue.

2) Give up on your business and get a job.

3) Bring outside resources into your business—also known as Other People’s Money (OPM). I want to be very clear about what OPM is. It is not money that you are personally liable to pay back (like a credit card, home equity line of credit, or personal loan from a family member). That kind of money keeps you in the bootstrap trap. OPM is money that is invested in your business and does not put your personal finances at risk.

If you choose option 3, you owe it to yourself to commit and do what it takes to get that funding!

If you choose to raise funding for your business, learn about all the options for doing that.

There are numerous ways to bring in outside funding for your business.  It is not necessary to be a high growth tech startup to raise funding from investors.  Be sure you understand all the options so you can choose the one that fits your business best.

Create your plan.

Spending some time up front to create a well thought out plan will save you time, effort, and regrets on your fundraising journey.  You need to customize your plan to your particular goals, projections, and values so that you don’t waste time chasing funding sources that are not a good fit for you or, even worse, get funding that requires you to sacrifice what you love the most about your business.

We want to help you get clarity on your path for escaping the bootstrap trap.  We are offering a limited number of sessions with our team members who can help you pinpoint your strategy.  To schedule a complimentary session, click here.

What could possibly go wrong? Using due diligence to make investment decisions

What could possibly go wrong? Using due diligence to make investment decisions

Due diligence, a fancy term for doing reasonable research, is a key component in the process of evaluating any investment opportunity. While there are no set rules for the due diligence process, due diligence is expected to be conducted by investors and can be a wonderful learning experience. It’s common practice for due diligence to include review of issuers’

  • Management Team
  • Financial Projections
  • Product / Service / Technology
  • Market Opportunity
  • Go-to-Market Strategy
  • Competitive Analysis

Although issuers expect potential investors to perform due diligence, the degree to which an issuer is prepared and organized enough to facilitate the process varies widely. Entrepreneurs who are launching or managing businesses and raising money simultaneously are often spread thin with little time to spare. Lucky for investors considering investments through a FINRA approved portal for Regulation Crowdfunding (Reg CF), much of the document collection and anti-fraud verification is already complete!

Among the many benefits of Reg CF raises is the transparency and ease of access to the issuer’s business documents. FINRA approved Reg CF portals like Crowdfund Mainstreet collect the issuer’s pitch deck, executive summary, financial documents, legal documents, term sheet, and projected use of proceeds and post them on the crowdfunding page along with a link to Form C —the Securities and Exchange Commission’s (SEC’s) required disclosure form.  These can all be easily reviewed at any time during the raise. 

Some investors take what is colloquially called the “spray and pray” approach to investing.

What’s more, the SEC relies on Reg CF portals to shoulder anti-fraud responsibilities in the form of background checks and securities enforcement regulatory history checks for each issuer and its officers, directors, and owners of 20% or more of the voting equity in the company. Because the portals have already done the work of document collection and background checks, potential investors in Reg CF raises have a head start in the due diligence process and are able to save time and effort. 

Because Reg CF raises have relatively low minimum investment thresholds, combined with the required checks by the portal, some investors take what is colloquially called the “spray and pray” approach to investing. They make many investments across various opportunities without performing due diligence and hope their investments that have returns do well enough to cover the losses of the other investments and, on the average, they come out on top. While the spray and pray approach is common, I recommend a more empowered approach: performing due diligence to at least a degree that reflects the risk and, even better, teaming up with friends to conduct due diligence together. Not only will you be able to share the workload, everyone will benefit from the diverse perspectives offered by various members of the team.

As the Community Manager for Angels of Main Street, I’ll be coordinating a due diligence team for Traipse: My Local Token, an issuer currently raising funds on the Crowdfund Mainstreet portal. Everyone is welcome to join regardless of interest level in this specific issuer. Everyone has something to offer and due diligence is a team sport.  Contact Amy@JennyKassan.com to be notified of upcoming meetings.  Note:  You do not need to be an Angels of Main Street member to join this due diligence group.

The Angel Capital Association 2021 Summit—is there any hope?

The Angel Capital Association 2021 Summit—is there any hope?

 

Have you ever attended a conference and felt so at home—like the attendees are really your people?  When I go to the Angel Capital Association conference, I feel exactly the opposite!  Most of the people I meet there don’t understand why anyone would be concerned about the impact of their investments beyond the impact of making the angel investors rich.  Most of the talk is bragging about that 47x exit that they got (i.e. they got a return of 47 times their original investment).  

I went ahead and applied to speak at the conference about “alternative” investment models because it is my mission to spread the word about non-extractive, sustainable ways to invest.  I was shocked when my proposal was accepted!  I decided not only to attend the panel I was on, but to attend the whole conference and try to keep an open mind.  Maybe the world of angel investing was starting to evolve?

When I looked at the agenda, I noticed that almost 20% of the sessions had the word “exit” in the title.  This, and the content of most of the sessions, confirmed that most active angel investors continue to rely on “exits” (via acquisition or IPO) to get paid.

The session I was invited to speak at was called “The Art of the Deal: Alternative Deal Structures.”  I decided to be honest about my opinion of the sacred cows of angel investing. 

Here are some excerpts of what I said:

“When we talk to angel investors about ‘alternative structures,’ there is an assumption that alternative structures are debt and that equity has to be structured using the typical angel/VC style term sheet. . .There are many ways to structure equity.”

“I wonder about the wisdom of relying on a big exit as the only way to get paid.”

“The model where you push for an exit is not appropriate for 99.9% of businesses in our country.  And that doesn’t mean those businesses are “lifestyle businesses” or not investable.  They could go huge.  Only 6% of fortune 500 are venture backed.”

“Women are less likely to found companies that are on the high growth path.  If you want to diversify your portfolio, focusing on that one structure may not be consistent with that.”

As you can imagine, my comments did not go over well.  Here is what some of the attendees said:  

“We need to keep deal structures pretty standard, especially if future institutional funding is expected.  Using the standard terms on the National Venture Capital Association’s website has been very helpful.”

“I believe the great majority of angel investors want to help grow companies to a successful exit.”

“Most angel investors want to invest in companies that will have an exit.”

“In MOST cases exit is the right path.”

“A lot of complex “creative” deal structures don’t really help . . . the reason the VC route happens over and over is because so many lawyers have a basic understanding.”

“I would argue that if the entrepreneur doesn’t want to drive to an exit, we shouldn’t have invested in the business in the first place.”

 

We did get a few supportive comments acknowledging that there is, in fact, a category of business that can be successful and grow big without having an exit.  Unfortunately, this seemed to be very much a minority view among the attendees of the conference.  My hope is that I might have planted some seeds that will bear fruit some day as more investors become increasingly open minded about investment structures that support a livable, prosperous, and sustainable world for all.

You don’t have to sell your company for your investors to exit!

You don’t have to sell your company for your investors to exit!

When you raise money from investors, many of them will want to know how they may someday get their money back out of your company.

When people invest in public companies, it is very easy to exit from one investment to another—they just tell their online broker to sell Apple and buy Google.  

But with investments in private companies, the exit may not be so easy.  If you offer debt to investors, the way they will exit someday is spelled out in your promissory note.  At some point, you will pay your investors back their initial investment (principal) plus interest.

What if you offer an equity investment, however?  In the venture capital model, used for high growth tech startups, the exit from an equity investment usually happens when the company is acquired by another larger company.  But what if you don’t want to focus all your energy on that kind of exit?  When you know your investors are expecting you to sell your company to the highest bidder as quickly as possible, you may be forced to do things that are not in alignment with your goals, values, and how you want to live your life.

What if your investors could exit without you having to sell your company?  Well, they can!  There are a few ways this can happen, but in this article, I will focus on redemptions.  A redemption is when you buy equity back from your investors.  You can build this into your investment terms right from the start so that both you and your investors are clear on how they may someday exit.

Your investor’s ability to redeem his or her stock will depend on the exact language you put in your legal documents.  Our clients usually offer the ability for their investors to request a redemption at a certain predetermined price.  If your company is unable to honor the request due to insufficient cash for operations and reserves, you can delay or refuse the redemption or can pay the redemption in the form of a promissory note.  You can also offer a “mandatory redemption right” that requires the company to redeem the equity whenever the investor wants (this right often doesn’t kick in for several years after the initial investment).  Keep in mind though that there is really no such thing as a truly mandatory redemption right.  If your company does not have enough cash to meet its obligations to its creditors, it cannot legally redeem investor equity.

To learn more about all the ways that your investors can exit without you having to sell your company, consider joining our Capital on Your Terms Community—this is a great way to get literate about fundraising and make sure you know all your options for raising money on terms that will be sustainable for you and your business.

It’s Official!

It’s Official!

Things just got a lot easier for you if you are looking to invest or raise money via Investment Crowdfunding. The following is a summary of changes that went into effect on March 15 and will improve Investment Crowdfunding for both companies and investors:

  • The maximum amount that companies can raise each year is $5M, up from $1.07M.
  • The investment cap no longer applies to accredited investors. They are free to invest any amount they choose.
  • The formula for determining the investment cap for non-accredited investors has improved. If an investor has income or net worth below $107,000, the investment cap is the greater of $2,200 or 5% of the higher of income or net worth. If the investor has income and net worth above $107,000, they may invest up to 10% of the greater of income or net worth, up to $107,000.
  • A new ‘Test the Waters’ rule allows companies to solicit interest in an offering prior to the filing of the mandatory Form C.
  • The use of Special Purpose Vehicles is now permitted. This will be useful for companies that are concerned about having a large number of investors on their cap table.
  • The temporary relief measure allowing companies to raise up to $250,000 without the need for reviewed financials has been extended to offerings started before August 28, 2022.
  • The SEC has clarified that offline oral communications with investors are permitted providing the communications are compliant.
  • Communications about the terms of the offering may now include progress (% of goal reached, for example) in addition to the amount of securities being offered; the type of security being offered (debt or equity); the price of the securities; and the closing date of the offering. All communications must include a link to the campaign.