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The Evolution of Investment Crowdfunding, and Where We Go from Here

The Evolution of Investment Crowdfunding, and Where We Go from Here

In 2009, I got together with Janelle Orsi to cofound a new nonprofit called Sustainable Economies Law Center (SELC).  The mission of SELC was to bring legal knowledge and support to those who are working to make our economy regenerative, healthy, just, and sustainable.

One of the very first things we tackled was securities law.  Having worked with many small businesses that lacked access to capital, we knew that a change to the law that would make it easier for small businesses to raise funding from their communities, customers, and fans could have a major positive impact for our small disadvantaged businesses.

We wrote a petition to the Securities and Exchange Commission in 2010 which got the attention of small business advocates, members of Congress, and eventually, the White House.  Amazingly enough, a new law was passed by Congress and signed into law by President Obama in 2012 that legalized investment crowdfunding at the national level.

It took four years for the Securities and Exchange Commission to adopt rules so that this new law could actually be used. 

We were hopeful that this was the silver bullet we had been waiting for to finally move significant funding into the hands of Main Street businesses and social ventures, especially those owned and run by entrepreneurs who have been almost completely locked out of mainstream finance (e.g. women, people of color, etc.).

The results so far have been mixed.  There is still a lot more that needs to be done for federal investment crowdfunding to fulfill its promise as an equalizer of opportunity.

Check out my talk on this topic at SuperCrowd22.

Building a Strategy to Fund Your Business On Your Terms

In this video, The Kassan Group founder Jenny Kassan outlines six important steps to designing your fundraising strategy.

Funding is an essential element of starting a business, but figuring out the best way to acquire it can be challenging, especially for mission-driven entrepreneurs who don’t want to give up their values to get their business off the ground.

In this video, Kassan Group founder, Jenny Kassan discusses her six-step process for raising capital without selling your soul. According to Jenny and her team, “The way you raise money should be consistent with what’s important to you and your business.”

These six pillars will lay down the proper foundation for your business to succeed while keeping your mission intact. This process consists of defining your goals and values; identifying your ideal investors; designing your offer; choosing your legal compliance strategy; creating an effective investor enrollment strategy; and addressing potential obstacles. Learn more about building the six pillars of your fundraising strategy in the following video.

The Kassan Group is planning a three-day virtual training to take a deep dive into these steps. If you’re looking for guidance on building a fundraising plan for your business in a way that meets your values, join us! Register for the event November 2-4 at JennyKassan.com/FundIt

 

Legal Compliance Options for Raising Capital

Legal Compliance Options for Raising Capital

To choose the right legal compliance strategy for your raise, you need to ask yourself four questions:

  1. Do I want to be able to publicly advertise the fact that I’m looking for investors?
  2. Do I want to include everyone as potential investors or limit myself to accredited investors?
  3. Do I want to be able to raise from all over the country or just one or a few states?
  4. How much do I want to raise?

With answers to these questions, it will be easier to narrow down the options that may be right for you.

Do you need a cheat sheet on the options you can choose from when raising investment capital to make sure your offering is compliant?  Check ours out here.

What Businesses and Investors Can & Can’t Discuss: Six Guidelines for Business-Investor Conversations

What Businesses and Investors Can & Can’t Discuss: Six Guidelines for Business-Investor Conversations

By Jenny Kassan and Michael H. Shuman

What kinds of conversations can a business owner have with potential investors without breaking the law? Over the past year many local investment advocates and practitioners have sought our advice in answering these questions, and this blog attempts to provide some answers.

The law has been rapidly changing in this area, so not all our answers are crystal clear. But below is our best effort to summarize what’s permissible for individuals or groups that wish to have conversations about the possibility of investments in person or online. (We do not cover here new rules that apply to “pitch sessions” before groups of investors.)

(1) Public Conversations Unrelated to Investment – Green Light

The First Amendment protects free speech, including conversations between businesses and supporters. If you’re a fan, customer, or mentor for a business, you can freely talk about anything unrelated to investment.

Once the conversation shifts to investment, however, caution is needed because such conversations are regulated under state and federal securities law. Securities regulators consider any conversations between businesses and potential investors about potential investments, whether one-on-one, in group conversations, or via public platforms, to be an offering of securities. And unless or until you jump through the appropriate legal hoops for a securities offering, you cannot have such conversations.

If you run a web site encouraging conversations between businesses and supporters—say a mentorship platform—you might want to post disclaimers that the conversations should not touch on any potential investment opportunities. Better still, you might actively facilitate the conversations to prevent any violations.

(2) Private Conversations on Investment – Yellow Light

If a business has an informal conversation with a potential investor about a potential investment, this conversation may fall under the definition of a securities offering. A private conversation like this is often legal without the need to do any particular filings or make any particular disclosure. However, the details of what is required vary quite a bit depending on various factors such as what state the potential investor is in, what is being offered, and the potential investor’s wealth and income. Before actually offering an investment opportunity, even privately, it’s important to work with an attorney to determine what rules apply.

Does this mean that any conversation that even mentions an investment opportunity would be considered a regulated securities offering? Not necessarily. A conversation in which an entrepreneur mentions the possibility of raising funding in the future and does not mention any details about the investment offering (e.g. the size, the terms, the timing) is less likely to be considered a securities offering. Unfortunately, the line between an unregulated conversation and a securities offering is not well-defined under the law. Hence the yellow light.

(3) Social Mixers Involving Businesses and Investors – Green Light

Unstructured social gatherings among potential investors and business owners are fine as long as specific investment opportunities are not discussed. The original conception of LION, the Local Investment Opportunity Network of Port Townsend, Washington, was to deepen relationships between local investors and local businesses, to facilitate the possibility of future investments.

(4) Investment Clubs – Yellow Light

Groups of investors are welcome to come together, form a club, and collectively invest. They can have robust conversations about potential investments among fellow investors (but not potential investees). The presumption also is that members do not pitch one another to invest in their own businesses.

As soon as the club enters conversations with outside businesses about potential investments, the federal and state rules apply.

(5) Open, Online Conversations About Potential Investments – Red Light

Generally, an online public platform cannot host free-wheeling conversations between businesses and potential investors. This is regarded as facilitating general solicitation. And the host might be considered a broker-dealer, which would mean that it would have to register with the Securities & Exchange Commission (SEC), or under state law, as a broker. Some states are very strict about what constitutes a broker-dealer. One business was shut down by the state of California for hosting a platform that did nothing more than facilitate private investments for a flat fee.

But the next point offers a potential exemption for platforms that wish to help businesses “test the waters” (TTW) with potential investors.

(6) “Testing the Waters” Conversations in Preparation for an Investment Crowdfunding Campaign – Yellow Light

The SEC recently announced a new Rule 206 that permits businesses planning to raise money through investment crowdfunding to “test the waters” with potential investors. Participating businesses effectively must announce their interest in crowdfunding, agree to various disclaimers, and then conversations can begin.

But there’s a catch: If you meet a potential investor through public testing the waters activities, and then decide not to do a crowdfunding campaign, you may not be able to ask that person privately to invest in your business later. Thanks to little-appreciated rules around “integrating” separate offers, you cannot engage in general solicitation now, meet a bunch of new people, and then pitch them with a private offering later.

It’s important to point out here the difference between public and private offerings. Public offerings, like investment crowdfunding, allow you to advertise to the general public. Private offerings can only be made privately through one-on-one conversations. One of the virtues of the LION approach is that it is a legal way of developing relationships with people who you might be able to approach privately about a potential investment.

So if you’re a business seeking capital, the only way you can transform an investor you met through a public TTW discussion (a precursor for a public offering under Regulation Crowdfunding) into a private investor is by developing a substantial relationship with him or her after the public solicitation round. If someone you met online becomes your best fishing buddy, for example, you might be able to pitch him privately.

The good news is that if you only are pitching accredited (that is, wealthy) investors after your crowdfunding campaign, you can use Rule 506(c) to pitch them. Under this rule, public advertising is permitted and all investors must be accredited and their wealth or income status must be carefully established. If you want to also pitch unaccredited investors and include people you met through public solicitation, you will have to stick with investment crowdfunding going forward.

There’s one other possible opening that’s useless now but could be useful later—and that’s the newly announced Rule 241. It’s like Rule 206—permission for public “testing the waters” conversations with appropriate disclaimers—except that businesses do not need to announce that they are only interested in crowdfunding. All kinds of investment options, public and private, could be discussed. The problem is that the SEC did not preempt state laws that mostly prohibit such conversations. If you want to lobby your state to harmonize its laws with Rule 241, then this option could be helpful—especially to community investment groups having preliminary conversations with local businesses.

We should say, finally, that we are explaining the law, not defending it. Whether these legal rules are sensible is another blog for another day.

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.

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.