Crowdfunding Survives a Crucial Legal Challenge Few Know About

Originally Published at Entrepreneur.com on June 30, 2016

Image credit: Shutterstock

Regulation A+ is the portion of the JOBS Act that allows a company to raise up to $50 million in new capital through an online “Mini-IPO.” It came roaring into the investment world a year ago with the promise of changing the way small businesses get funded. The law allows companies to economically raise funds from the “crowd” and let everyday people, not just the rich and powerful, invest in small private companies for the first time in 80 years. One of the ways Congress and the Securities and Exchange Commission (SEC) made this law affordable was by exempting companies from having to comply with state Blue Sky laws. Those are state by state securities laws that require a company to register and often undergo extensive merit review by each state’s securities regulators.

imagine the legal bills of going to the 50 different states to file extensive paperwork, have a securities regulator review and request changes, then make sure those changes were okay with 49 other state regulators who also were requesting their own changes. This would be a process that took months, cost hundreds of thousands of dollars, and effectively make Regulation A+ unusable.

Kudos for Congress and the SEC for not requiring those burdensome restrictions and creating a law the right way. But despite the seemingly universal appeal of this law, Montana and Massachusetts felt otherwise. Their securities regulators were upset that Congress and the SEC took away their ability to get paid fees from companies they could drag through expensive Blue Sky compliance. They were so upset, they filed a federal lawsuit against the SEC to have Regulation A+ nullified.

Yes, Massachusetts and Montana thought that this game-changing law, destined to help companies raise capital and grow, create new jobs and provide access to investments for the general public, was a bad idea because it did not “protect investors” in their states. "Protect investors" should be read to mean "took away the ability to change money to companies in exchange for putting the company through hell in order to sell securities in their state!"

The good news is, the justice system worked, and the SEC prevailed over the states' attempts to gut the groundbreaking law. In an opinion released June 14, 2016, the United States Court of Appeals for the DC Circuit ruled unanimously that Regulation A+ will stand and continue to provide small companies with the opportunity to raise new capital without Montana, Massachusetts, or any other state being able to force the company to comply with their expensive state Blue Sky laws.

At the heart of the state’s rejected argument was a term used in the law -- “qualified purchaser.” The JOBS Act states that certain Regulation A+ securities may only be sold to a “qualified purchaser” and that the SEC should define that term however it saw fit. The SEC, wanting to be sure that Regulation A+ would allow companies to raise capital as easily as possible, defined the term “qualified purchaser” to mean anyone who wanted to buy the securities. In other words, according to the SEC, a “qualified purchaser” was everybody, not just rich and powerful folks.

Massachusetts and Montana argued that in order to be a “qualified purchaser,” the SEC must limit the people who could purchase Regulation A+ stocks to wealthy people, or must impose some other limitation. That effectively took away the promise of this law that regular people could buy shares of the next Facebook or Google at an early stage in the company's development, when the potential for a greater return on investment would be the highest.

In an extremely well-reasoned opinion, Judge Karen LeCraft Henderson rejected the states' argument and found that Congress had given the SEC the right to define “qualified purchaser” as it saw fit, and that the SEC’s definition was legal, reasonable and in line with the intent of the JOBS Act itself. Final scoreboard: SEC Wins! Small business wins! Everyday investors win! States that wanted to ruin a great law lose!

See, the justice system does work the way it's supposed to... sometimes.

As a result, Regulation A+ lives on. Companies can still use this remarkable law to raise up to $50 million in capital. The Average Joe has a chance to invest a small amount of money in small companies at a stage that was never allowed before. Unless Massachusetts and Montana can convince the United States Supreme Court to hear an appeal, which is very unlikely, the law remains on the books.

The bad news for Massachusetts and Montana is that they can’t drag a Regulation A+ company through their Blue Sky laws and take fees from the company at a stage where the money is most needed to operate and grow. The states will have to find another way to “protect investors” in their state. One thing is for sure: Massachusetts will continue to "protect" their citizens by extracting as much money as possible from them in wonderful investments (note sarcasm) their citizens can benefit from: lottery tickets and blackjack tables.

4 Local Businesses Perfect for the New Equity Crowdfunding Law

Originally Published at Entrepreneur.com on May 12, 2016

Image credit: Thomas Barwick | Getty Images

On May 16, 2016 the long awaited (four years, five months and six days after the law was signed by the president, but who’s counting) JOBS Act equity crowdfunding law goes into effect allowing startups and small businesses to raise new capital up to $1,000,000 online through an equity crowdfunding portal. Entrepreneurs can now legally raise money from “the crowd” by giving everyday people a chance to own a part of their business. For the crowd, the chance to invest a small amount of money online in a new or growing young company, opens a new world of opportunity that was never available before.

I am frequently asked in my law practice: “Is my company a good fit for crowdfunding?” While nearly any U.S. or Canadian based company can use this groundbreaking law, there are businesses that are a near-perfect fit.  Before we get to those, there are a few basics and statistics to ponder.

For the past several years, rewards-based crowdfunding sites like Kickstarter have prospered allowing an entrepreneur to raise money by giving away a reward, but no equity or ownership in their company. This is a great way to raise some money for new products that can be pre-sold and for art, music and film projects. If you can raise money without giving away part of your company -- do it.

But rewards-based crowdfunding has severe limitations that equity crowdfunding does not have. The number of people who are willing to “donate” money to a company in exchange for a “reward” (but no equity and a subsequent share of the company’s profits) is limited.  The latest statistics available on Kickstarter reveal that 84 percent of the successful campaigns on their site raise less then $20,000. A staggering 97 percent of successful campaigns on Kickstarter raise less then $100,000.

Good luck opening a new business with $19,999.99.

The number of people willing to invest in a company, and possibly own a small part of a profitable business, is much larger. In 2015, 48 percent of Americans have invested money in stocks already. That’s a pool of more than 150,000,000 potential investors, far outnumbering the 10.8 million who have donated to a Kickstarter campaign since their launch in 2009.

The most important factor to consider in successful crowdfunding campaigns, both rewards and equity-based, is the ability to market the campaign and reach “the crowd” of potential supporters or investors. Small businesses such as these below have a unique opportunity to reach a local crowd through geo-targeted marketing in an economic manner, and also have the ability to get local media coverage to assist in their equity crowdfunding campaign. This combination of factors makes these small businesses a great fit for the new equity crowdfunding laws.

1. Restaurants.

Millions of people dream of opening a restaurant, but very few can afford to do it.  According to a recent survey, the median cost to open a restaurant is $275,000, and if owning the building is figured into the amount, the median cost rises to $425,000. The ability to raise up to $1 million with the new equity crowdfunding law allows a restaurateur to satisfy the cravings of local foodies by giving them the opportunity to invest a small amount and fulfill their dream of restaurant ownership. Better yet, these hundreds of small investors will become brand ambassadors who bring their friends and family to eat at “their restaurant.”

2. Small office or retail buildings.

While not as sexy as owning a restaurant, owning part of a local office or retail building is an easy sell to a small investor. Who doesn’t drive by a building or strip center, see all the cars parked outside, and think that someone is making a good living owning that property and renting it out to others? A great example of this recently closed using the equity crowdfunding law’s bigger and better looking cousin: the Regulation A+ the Mini IPO, which works very similarly but allows a company to raise up to $50 million for a local business. Using this similar law, a Portland, Oregon company raised $750,000 from the local crowd to build a funky office building. How did they market this? Their website proudly offered investors the chance to “own a piece of your neighborhood” and get an 8 percent return on the investment.

3. Franchises.

If you own a successful franchise, and need the funds to expand to a second or third location, why not sell a part of your expansion to the customers who already patronize your business, and those in the community who know your name and recognize your success? Equity crowdfunding creates an opportunity to expand and scale your business (and, like with the restaurant above, have hundreds of investors advertising your business to everyone they know -- for free) that cash flow concerns may otherwise prevent.

4. Local investment real estate.

Real estate crowdfunding is a huge industry already. In 2015, a reported $483 million was invested (mostly by rich “accredited investors”) through real estate crowdfunding. Now, this investment opportunity is available to everyone. People inherently understand the value in buying a house, or investing in land. In addition to office buildings, investments like owning a vacation rental property or purchasing a house to renovate and flip for a profit, are now within the reach of everyone thanks to the new equity crowdfunding laws.

Equity Crowdfunding's Unlikely Proof of Concept: Bernie Sanders

Originally Published at Entrepreneur.com on March 3, 2016

Bernie Sanders’ presidential campaign has demonstrated exactly why equity crowdfunding under the JOBS Act will work, when done properly.

Image credit: Juli Hansen | Shutterstock

Before anyone accuses me of displaying my political leanings in this story, please understand one thing: if I decide to vote for a bald, white, Jewish guy from Brooklyn, I’ll write in Larry David.

That being said, I admire that Bernie Sanders has done exactly what equity crowdfunding under the JOBS Act allows small companies to do: take small amounts of money from large numbers of people to fund something, all the while thumbing one's nose at the rich, powerful and elite. The parallels between his campaign funding, and equity crowdfunding under the JOBS Act, are remarkable.

1. His campaign has truly been funded by the crowd.

By the end of 2015, Bernie Sanders’ campaign had raised more than $73 million from 2,513,665 donations. Unlike most presidential campaigns, small contributions make up the vast majority of funds Sanders has raised. The average donation to Sanders during the last three months of 2015 was $27.16.

This is a perfect illustration as to how crowdfunding works. Look at the one of the first hugely successful rewards-based crowdfunding campaigns: the Kickstarter campaign for the Pebble Watch, in which 68,929 members of the crowd pledged $10,266,845 to bring the Pebble Watch to life. According to Kickstarter, the most common amount donated on their site for all campaigns is $25, almost exactly the average donation to Sanders' campaign.

2. His campaign has catered to the populace.

According to the web site OpenSecrets.org, 99.9 percent of the money Sanders has raised came from donations directly to his candidate committee, not from Super PACs or other leadership political action committees. Contrast this with candidates. A good examples is Jeb Bush. Only 22 percent of donations to Bush’s $150 million campaign war chest came from individual donations. And look at where all of that big money got JEB!

Equity crowdfunding will work the same way. Most companies using the new JOBS Act laws to raise capital need to both raise funds to grow and  build a clientele for their business. The companies that get the general public excited about their product or their company will be the most successful. That can translate into large numbers of small investments from a huge number of people, most of whom then become brand ambassadors, social media promoters and eventually paying customers of the company they invested in.

3. His campaign has thumbed its nose at Wall Street.

The Sanders campaign has been extremely critical of Wall Street and the banking world. At the end of 2015, he had accepted donations totaling only $55,000 from donors in the “securities and investment” sector. Contrast this with his primary rival, Hillary Clinton, who accepted millions from Wall Street and related parties during the same period.

Equity crowdfunding has been called the democratization of the investment process, in no small part because most companies that will use Title III of the JOBS Act, or the Regulation A+ Mini-IPO, to raise capital are not far enough along for Wall Street or venture capital groups to back. Startups in particular are often run by a management team that has tapped out their credit cards, have no more friends and family to go to for financial help and cannot possibly get a bank to loan them money. Rather than futilely attempting to get funding from high-end banking and investment sectors, these companies can now go straight to the crowd to get financed, and be in a better position as they get to later rounds to negotiate with the Wall Street and VC types.

4. His campaign is focused on young people new to the process.

NBC reported that  in the New Hampshire primary, Sanders received 79 percent of the votes of women aged 18-29. He also reportedly received 78 percent of all votes from first-time voters.

Ever try explaining crowdfunding to your grandmother? Tell most people 70 or older that they need to send you money for something you have not made yet, but in six months you will send them something you are hoping to create, and you will probably be laughed at. Crowdfunding is a young person’s game. Studies have shown that between 60-65 percent of donors on Kickstarter and Indiegogo are under the age of 35.

Related: The SEC Just Approved Rules Opening Up Equity Crowdfunding to the General Public In a 3-1 Vote

5. His campaign has been largely funded online.

During his victory speech after winning the New Hampshire primary, Sanders made this request of his supporters: “Please help us raise the funds we need, whether it’s 10 bucks, 20 bucks or 50 bucks.” Almost immediately, the overwhelming response crippled his campaign website. During the next 24 hours, his campaign raised $6.5 million, almost all of it online.

Let’s go back to grandpa again. Ask him to go online, watch a video, then invest money through a website, and he will probably smack you down with his cane. On the other hand, the younger demographic use their computers and smart phones every day, and the concept of investing online in a startup business is not intimidating to an age group who order everything through Amazon and who no longer communicate with others except through social media.

Who would have thought that this crazy Presidential election would actually teach us something? I guess if you look hard enough, there is always something to learn in every situation.

Raising Capital Through Regulation A+? You Still Need to Market Your Socks Off.

Originally Published at Entrepreneur.com on November 20, 2015

Image credit: Shutterstock

Ever since Regulation A+ became the law in June, I have been inundated with calls from companies excited about the prospect of raising up to $50 million in new capital online through a Mini IPO (initial public offering).

Potential clients I speak to understand that Regulation A+ offerings need approval from the U.S. Securities and Exchange Commission (SEC) and require an investment of legal, compliance and accounting fees. But when I explain to them that committing to a full-blown marketing plan is likely required to raising significant capital, I usually get blank stares. Once the silence subsides, I generally hear something like this:

“Why do I need a marketing budget? Can’t I just put my Mini IPO online and people will invest?”

With a Mini-IPO, unlike full-blown IPOs, there is no Goldman Sachs or Merrill Lynch instructing thousands of their brokers to push the IPO stock out to clients. With a Regulation A+ offering, nobody is promoting the stock to potential investors except the company raising money, and whoever they hire to market the offering. Without a marketing effort, chances are few people will find out the company is raising capital.

To the general public, a Regulation A+ Mini IPO listed on Bankroll or any other online funding website will look and act like a rewards-based crowdfunding campaign on Kickstarter. A lesson learned from rewards-based crowdfunding campaigns is that the highly successful ones require pre-planning, significant time investment in marketing and often the investment of significant funds on ads, public relations, social media and traditional media outreach.

A Mini-IPO will require the same kind of planning and marketing to be successful. A similar marketing approach to those that allowed the Coolest Cooler and the Pebble Watch to raise millions through rewards-based crowdfunding, will be required to raise tens of millions through a Mini-IPO.

Most people have no idea how much money is spent to market high-end rewards-based crowdfunding campaigns. To give some perspective, I met Steve Lebischak when a spoke about the JOBS Act and equity crowdfunding at the Wharton Innovation Summit in Washington, D.C .a few months ago. Lebischak's company successfully raised $648,691 from 1,296 backers on Kickstarter in a rewards-based crowdfunding campaign for the 1964|ADEL line of earphones that deliver richer sound while minimizing risk of hearing loss. Steve told me that they spent $65,575 in marketing, video production, advertising and public relations to market their successful Kickstarter campaign. 

This is not an unusual story. And according to Kickstarter, only 128 campaigns to date have raised $1,000,000 or more, which is about one-tenth of 1 percent of all successful campaigns. Crowdfunding experts know that the grand majority of those high-end campaigns had significant marketing budgets, or they never would have raised the money they did. 

The same will hold true of Regulation A+ Mini IPOs.  A company has to drive people to the online campaign and get potential investors excited about their company in order to bring in significant investment dollars.  When people get excited, they tell other people, they share on social media and they drive more traffic to the offering, and therefore more investments to the company.

The marketing experts who actually help people raise money through crowdfunding agree. Joy Schoffler, founder of Leverage PR who works with crowdfunding campaigns says that companies wanting to effectively use Regulation A+ need to develop the right marketing strategy. In her white paper, Schoffler suggests that well before launching their funding campaigns, companies need to take steps to ensure management is committed to the marketing plan and has dedicated time and resources for editorial opportunities, content creation and brand development.

Roy Morejon of Command Partners is one of the top crowdfunding marketers in the world and has an 85 percent success rate of campaigns reaching their goal, more than double the average success rate on Kickstarter and eight times the average success rate on Indiegogo. Morejon says that Regulation A+ offerings will need to be marketed very much like a high-end Kickstarter campaign.

"The goal is to get your investment opportunity to a large, but targeted, percentage of the general public," Morejon notes. "You simply cannot just rely on word of mouth. You need to use tried and true public relations and marketing methods to drive that traffic to the Mini IPO offering in order to raise millions."

Economical solutions also exist. For example, companies like Krowdster help affordably market online funding campaigns. Josef Holm, Krowdster's founder and a pioneer in marketing Regulation A+ offerings, says Krowdster provides marketing tools to quickly building a targeted crowd on Twitter and offers access to media lists from a database of more than 23,000 journalists in 170 crowdfunding categories, all in an affordable web app as an alternative to expensive crowdfunding consultants.

The bottom line is that marketing will be an essential part of every Regulation A+ campaign, just as it has been for rewards-based crowdfunding.

What the New Equity Crowdfunding Rules Mean for Entrepreneurs

Originally Published at Entrepreneur.com on November 2, 2015

Image credit: 401(K) 2012 | Flickr

The SEC has finally released rules for Title III of the JOBS Act, the equity crowdfunding law. Nearly three years and seven months after the potentially game-changing bill was first signed into law, equity crowdfunding will be available to startups and small companies in 180 days. Yes, we get to wait another half a year before anyone can actually use equity crowdfunding, but at least now we know it will happen.

For those who have run out of Ambien, the hundreds of pages of new rules will provide a welcome sleep aid. But for professionals who plan to use these rules to help companies raise new capital, it is required reading. Bring on the Red Bull.

Related: The SEC Just Approved Rules Opening Up Equity Crowdfunding to the General Public In a 3-1 Vote

What does this mean for entrepreneurs? Will startups be able to actually use this law? Let’s take a look at what the new SEC rules say about key provisions, to answer those questions:

1. The JOBS Act says a company can raise up to $1,000,000 with Title III equity crowdfunding. Did the SEC expand this?

Despite the hopes of many of us that the SEC would pull a regulatory rabbit out of a hat and raise the ceiling to $5 million, the limit on what a company can raise through Title III equity crowdfunding remains at $1 million. If a company wants to raise more, there is always equity crowdfunding’s prettier cousin, a Regulation A+ mini-IPO to consider. 

2. What can members of the “crowd” invest?

The law limits investors to (a) the greater of $2,000 or 5 percent of the lesser of their annual income or net worth, if either the annual income or the net worth of the investor is less than $100,000 and (b) 10 percent of the lesser of their annual income or net worth, if both the annual income and net worth of the investor is equal to or more than $100,000.

In both cases, Investors may not invest more than an aggregate amount of $100,000 in one year. The SEC actually tightened up the amounts that can be invested by each individual, which is not good news for entrepreneurs.

3. What happens if a company does not raise its goal amount?

Like many rewards-based crowdfunding campaigns and Regulation A+ mini-IPOs, if a company using the new equity crowdfunding law does not raise the full amount of their funding goal, they do not get to keep any of the money raised, and they lose the out-of-pocket up-front costs. This important provision means setting a realistic goal will become an important part of the equity crowdfunding process for entrepreneurs.

4. Can companies afford to use Title III equity crowdfunding?

The biggest news from the new SEC rules is that the proposed requirement of a full financial audit has been dropped by the SEC for companies using the equity crowdfunding law for the first time. Requiring a startup to spend tens of thousands of dollars on an audit made no sense. The SEC removed that burden, and now a company using the law for the first time must only have reviewed financials to raise more than $100,000, and lesser financial disclosures when raising less than $100,000.

There are still substantial costs, however. Legal fees, compliance costs, funding portal fees, broker-dealer fees and marketing expenses can add up. Without entrepreneurial minded attorneys offering affordable services and innovative businesses offering compliance services for a reasonable cost, equity crowdfunding would still be out of reach for most young companies. Luckily for startups and small businesses, both of the above exist, and will make this law affordable to use for most entrepreneurs.

Related: 4 Financing Tips for Female Entrepreneurs

5. What information has to be disclosed?

A company has to disclose to investors, and file with the SEC, the price of the securities, the method for determining the price, the target offering amount, the deadline to reach the target and whether the company will accept investments in excess of the target.

Companies also must provide a discussion of the company’s financial condition, a description of the business and the use of proceeds from the offering, information about officers and directors and owners of 20 percent or more of the company and annual financial statements.

6. What liability will a company and its officers have under equity crowdfunding?

Equity crowdfunding involves the sale of securities, and not just pre-selling a gadget like on Kickstarter. There are federal and state laws that govern the sale of securities, and if you do something wrong, your company (and its officers and directors) can be sued, and in some cases, could go to jail.

The bottom line is simple: Tell the truth. Under most securities laws including the equity crowdfunding law, being 100 percent truthful and not making misrepresentations of any kind are the keys to not having to bang out license plates in the prison yard with Bernie Madoff.

7. Are the shares sold through equity-crowdfunding liquid?

No. Much like most shares sold through private placements, the shares of stock sold in equity crowdfunding cannot be sold (in most circumstances) for at least one year. There is no marketplace or exchange for these shares, and in all likelihood, never will be unless a company registers with the SEC and becomes a public company.

Will equity crowdfunding work under the new SEC rules? Some may disagree, but I believe there is a workable model here that startups will be able to use to raise capital.

Like every new law, how usable it will be depends on a number of factors. But the reality is that an opportunity like this for startups to raise capital has never existed before, and rather than criticize the law's shortcomings, some of us will work within the laws and rules to find ways to help companies raise funds online in a way they never could before.

4 Things You Need to Know if You Hope to Raise $50 Million With a Regulation A+ Mini-IPO

Originally Published at Entrepreneur.com on October 15, 2015

Image credit: Shutterstock

Regulation A+ went into effect on June 19, 2015, with the promise that small companies could raise up to $50 million in new capital through an online mini-IPO with investments from anyone in “the crowd” and not just from wealthy accredited investors. By giving access to the general public, this section of the JOBS Act promised to be a game changer for the American economy, and for small businesses everywhere.

So why, three months after this law went into effect, is very little being heard about anyone raising money under the new law?

One requirement of the SEC filings is that your company’s financial records are in order and that the last two years of financial statements need to be audited by an independent CPA or auditing firm for the SEC to approve a Regulation A+ offering. Not surprisingly, few small businesses were ready for this requirement when the law went into effect, and many are still trying to get these records in order and audits completed to file their mini-IPO offering for SEC approval.

Related: 5 Finance Tips All Business Owners Should Follow

Having financials ready for SEC review is a luxury most small businesses were not prepared for when the mini-IPO law became a reality and now are playing catch-up. Craig Denlinger of Artesian CPAis one of the accountants at the forefront of the Regulation A+ movement. I asked Denlinger for some tips to pass along to help facilitate the process of a Regulation A+ filing.

“Initial filings are taking a lot more time than I think people anticipated, from both legal and accounting side,” Denlinger says. “As the industry builds out, framework and templates time and costs will go down.”

In the meantime, Denlinger suggested the following:

1. Preparation for the audit.

Companies should get a strong accountant in place, preferably a CPA with SEC experience, prior to the audit. The SEC requires a company to follow Regulation S-X, Article 2, for all financials filed with a mini-IPO offering. Denlinger says that Regulation S-X “requires the company raising funds to prepare the financial statements, so companies cannot rely on the auditor for full preparation. Audit firms must take a more hands-off approach than is typical under AICPA independence rules.”

2. No disclaimers allowed.

Denlinger says that opinion disclaimers in the audit are not acceptable under to Regulation S-X. “If a company is an inventory-based business, satisfying the audit requirement can prove difficult since the auditor is unable to observe the inventory counts for the past two years that are required to be audited,“ Denlinger says. “This doesn’t necessarily preclude companies with inventory from a Reg A+ offering, but it is something that should be discussed very early in the process to ensure the auditor will be able to issue an opinion that the SEC will consider an acceptable audit.”

Related: 10 Best Accounting Websites for Startups

3. Experience counts.

The Regulation A+ rules create for a hybrid between public company and private standards for financial reporting, so the auditor’s SEC experience is important to understand the additional requirements to meet the financial reporting standards.

4. What are the actual audit requirements? 

There is a lot of confusion as to audit requirements of Regulation A+. While it has been commonly reported that a company must have two years of audited financials to attempt to raise up to $50 million in a mini-IPO, there is not much guidance as to what the SEC actually requires. What happens if your business, for example, is less than 2 years old?

For example, Denlinger says that a company with a calendar year-end filing with the SEC in February of 2016 would need to present audited financial statements for the years ended Dec. 31, 2013 and 2014, and unaudited financial statements as of a date not sooner than June 30, 2015.

It gets even more confusing if more than three months have passed since the company’s year end. This is why you need a good accountant. A number of early Regulation A+ filings were reportedly rejected without review based on the incorrect financials being included. Another reason you need a good accountant.

Regulation A+ can be an incredible capital funding tool, but there are a lot of accounting hoops to jump through and roadblocks to avoid.

Did I mention that you need a good accountant?

Related: 7 Tips on How to Do Accounting For a Kickstarter Campaign

Why the Recently Passed Law Allowing Mini IPOs May Not Benefit Your Business

Originally Published at Entrepreneur.com on September 30, 2015

Regulation A+ became law in June with the promise of small businesses having the ability to raise $50 million through an online mini initial public offering. The novel concept of a young company being funded by the general public and having “the crowd” -- not just accredited investors -- invest online could revolutionize the capital-formation process in America.

As an attorney whose practice revolves around obtaining funding for small businesses, potential clients ask me every day if Regulation A+ is a good fit for their business. The answer is always that it depends.

To help explain, I called upon a man at the forefront of the Regulation A+ industry, Scott Purcell. Purcell is the founder and CEO of FundAmerica Technologies, which provides a bevy of services to those who make a business of online capital formation pursuant to JOBS Act equity crowdfunding.

Related: Regulation A+ Is Not the Savior of Cash-Seeking Startups

Regulation A+ “is best suited for those companies who want or need non-accredited investors," Purcell says. "It could be just a way to raise capital, or, more appropriately, it could be part of a larger branding and marketing plan. For everyone else, it probably makes more sense to stick with Regulation D.”

That being said, let’s go through some of the typical reasons companies give me for wanting to use Regulation A+:

1. “I need funding for my startup.”

Raising funds through Regulation A+ is not cheap. While a Reg A+ mini IPO could be a financial bonanza for a startup, there are legal fees, compliance fees, regulatory fees, accounting fees and broker-dealer fees to pay. This is not a Kickstarter campaign. This is selling securities, and the SEC has to approve your offering, which costs money. Also, you must have a budget to market the offering or in all likelihood the offering will not raise much money.

While there certainly are exceptions, and entrepreneurial-minded attorneys and accountants can help lower costs, most companies can expect to pay a minimum of $100,000 to cover these necessary expenses and plan on three or four months of time to prepare and file the regulatory forms before you can start fundraising. That puts it out of reach for most startups.

2. “I want to raise $50 million.”

Regulation A+ lets you raise up to $50 million online, but you can do the same thing with a private placement (or even raise more, as those securities offerings are not capped at $50 million) under Section 506(b) or 506(c) of Regulation D for far less money in a far quicker timeframe and with far less hassle. The problem with private placements is you lose access to the masses as potential investors and you are mostly limited to raising money from wealthy accredited investors.

Related: To Encourage Crowdfunding, Change the Definition of an Investment Company

3. “I want my securities to be liquid and tradable.”

Regulation A+ securities are freely tradable, but at this time there really isn’t a marketplace where they can easily be listed. However, we are close to seeing alternative exchanges come to fruition where investors will be able to sell and buy Regulation A+ securities.

You can list your Regulation A+ securities on OTC or NASDAQ, but Purcell notes, “You need to get a CUSIP number, get your securities DTC qualified, go through the steps to get your securities listed on the desired exchange, find market makers and research coverage for your securities and to commit to additional reporting and costs in addition to your SEC and state obligations.”

“Do I need a broker-dealer to do this, or can we do it on our own?"

While the JOBS Act itself does not mandate the need for a broker-dealer for a mini IPO, there are other laws and rules that would put a company in potentially hot water if it does not utilize a broker-dealer to sell Regulation A+ securities, even to investors who come from a company’s own marketing efforts.

“Securities issued via Regulation A+ tier 2 are exempt from state blue sky (laws that regulate the offering and sale of securities) review," Purcell says. "This, to issuers and investors, is one of the best features of the new rules. However many states are very unhappy about it.”

Purcell is referring to the fact that while state officials are angry they no longer have blue sky review of securities sold in their states, each state still has the right to decide who is allowed to sell securities to their residents. While there is no national uniformity, we know that many states will require the agents of companies raising funds in Regulation A+ offerings to register as brokers and to have appropriate securities licenses. What happens if a company sells securities in one of these states without being licensed?

“Ouch,” Purcell says. “States have tools in their arsenal to make life miserable for issuers and to levy fines and force rescissions of completed offerings if the sales are made through anyone other than a licensed broker-dealer.”

Related: Why Kickstarter and Indiegogo Won't Go Into Equity Crowdfunding

Companies Can Now 'Test The Waters' Before Pursuing a Mini-IPO

Originally Published at Entrepreneur.com on June 4, 2015

Image credit: Sam Chadwick / Shutterstock.com

Rather than spending large sums of money to roll out a mini-IPO with hopes of raising up to $50 million, a company can use a revolutionary provision of Regulation A+ from the Jumpstart Our Business Startups Act (JOBS Act) to “test the waters” before hitting the market. In other words, a company can legally gauge interest from prospective investors before spending more than $100,000 to see if there is sufficient interest in their stock offering to move forward.

Before the JOBS Act was enacted in 2012, companies and their representatives were generally prohibited from talking to prospective investors until they had filed their IPO documents with the SEC. Most securities lawyers also understood federal law to restrict companies from soliciting offers or even indications of interest for an IPO, even after the initial documents were filed with the SEC, until the company filed a preliminary prospectus with an estimated offering price range with the SEC. As a result, hundreds of thousands of dollars had to be spent on legal fees, compliance, due diligence and accounting before a company could talk to the people who might invest.

Investment bankers used to skirt these laws and regulations by holding thinly veiled “education meetings” with potential large investors where, legally, the only talk allowed was general discussions about the company, its industry and other general business matters. But there was a very strict prohibition on soliciting interest from possible investors or asking investors about what price they might be willing to pay for the company’s stock.

That all changes with the JOBS Act.

Now, a company relying on Regulation A+ (and before that others who used the new JOBS Act IPO rules) to raise capital can file certain documents with the SEC, and then communicate with prospective investors (both accredited investors and those in the general public) to see how much interest exists in the potential Mini-IPO. While there are other technical requirements to follow, the basic pitfalls a company has to avoid while “testing the waters” is to not solicit or accept a binding order to purchase the proposed securities, and to be certain the communications with the proposed customer are free of material misrepresentations or omissions.

Basically, this means a company can’t bind anyone to buy or mislead anyone when they test the waters.

Should your company use this more affordable method of gauging interest before diving in with the full cost associated with a Regulation A+ offering? Most securities lawyers will advise that a company testing the waters limit the communications to prospective investors to nothing outside of the information that is going to be included in the final offering documents that will be filed with the SEC. It will also likely be a good practice to be sure all materials (written or otherwise) used to test the waters are filed with the SEC. Also, the SEC requires specific “legends” or disclaimers to be given to the prospective investor in every case.

Outside of the legal requirements, companies should consider several factors from a marketing or business perspective. On the upside, testing the waters can give valuable insight to a company about the attractiveness of their offering to prospective investors. It can “warm the market” and create marketing buzz that could be beneficial once the offering is live.

On the downside, companies need to be extremely careful to not overstep the legal bounds of the testing the waters provisions, so a carefully controlled plan needs to be put into place. Some in the marketplace may view testing the waters as a lack of confidence in the offering.

Overall, testing the waters is a more affordable method for a startup or young company to decide whether to partake in a Regulation A+ offering. I believe, with the $50 million upside of Regulation A+, testing the waters will become a fairly common practice for companies on the fence before investing in the mini-IPO process.

6 Things You Should Do Now If You Want to Raise Funds With Regulation A+

Image credit: Shutterstock | Enhanced by Entrepreneur

Originally Published at Entrepreneur.com on April 10, 2015

The SEC has opened the doors to JOBS Act equity crowdfunding with the recent passage of Regulation A+. In less than 60 days, this revolutionary new capital raising law will allow a small business to raise up to $50 million per year from both accredited and non-accredited investors.

Sounds simple, doesn’t it? Go online, create a Regulation A+ crowdfunding campaign, and then start cashing millions of dollars in checks.

Not so fast.

The SEC has 453 pages of rules and regulations to follow. This is not as simple as logging into Kickstarter, shooting a cool video, writing a pitch and posting a crowdfunding campaign. Regulation A+ involves the sale of securities in your company. As a result, there are a lot of laws and rules to follow.

Let’s start with the six things you should do now to be ready to use Regulation A+ to raise money from the tens of millions of potential investors in “the crowd” that were off-limits to small businesses before this part of the JOBS Act became law.

1. Incorporate or form an LLC.

Individuals cannot raise money under Regulation A+, only companies can. If you have not formed a company, then you do not have stock or ownership interests to sell.

2. Make sure you have the proper structure for your company.

It is important that your company is set up correctly to be able to sell equity to investors. There will be many different ways to do this, such as setting up a special class of shareholders, for a Regulation A+ offering. There are also numerous legal pitfalls that can occur if you do not do this correctly, so you will want to consult with an experienced attorney.

3. Pick which “tier” you are going to use.

There are two “tiers” under which you can raise capital in Regulation A+. Under tier 1, you can raise up to $20 million in a mini-IPO and there is no requirement of audited financial statements, no limit on amounts to be raised from non-accredited investors and in most cases, no ongoing reporting to the SEC. Here’s the downside to tier 1: you have to comply with the “blue sky” laws of every state in which you plan to raise money. Complying with 50 state securities regulators makes tier 1 unattractive to anyone trying to raise capital from the national crowd of non-accredited investors.

Tier 2 allows you to raise up to $50 million, with no state blue sky-law compliance. Sounds perfect, doesn’t it? But wait, the SEC added the requirement that any company attempting a tier 2 offering must have two years of audited financial statements, which can be extremely expensive. Also, in a tier 2 offering, non-accredited investors can only invest 10 percent of income or net worth. And to top it all off, there will be ongoing reporting requirements to the SEC after your raise the funds.

Tier 1 may makes sense for a business that is only raising money in a contained geographic area and does not need to comply with more than one or two state securities laws. Other than that, I believe most companies will use tier 2. The major expense of tier 2, the audited financials, will likely not be as expensive as people believe for startup and younger companies without significant financial history.

4. Get your financials in order.

As I mentioned before, if you plan to use Tier 2, you will need to have two years of audited financial statements, and the audits must be done by an independent CPA according to generally accepted auditing standards. Even if you are using tier 1, you will have financial disclosure requirements, so making sure your books are in order now is a must.

5. Make sure you have no “bad actors” on your team.

The SEC requires all officers, directors and major shareholders of your company to undergo a “bad actor” background investigation. If you have members of your team who have been in trouble with the law, had securities regulatory issues in the past, or fall into one of the many “bad actor” categories, you may need to replace those individuals.

6.  Get your IP in order.

Regulation A+ requires you to disclose a great deal of information about your company to the public. You do not want someone to steal your ideas. If you have patentable technology or business processes, you should have your patents in place, or at least have filed a provisional application. Before you expose your trade name, logo, product or service to the masses, be sure you have secured trademarks where available.

SEC: Startups Can Now Raise $50 Million in 'Mini IPO'

Originally Published at Entrepreneur.com on March 25, 2015

The SEC on Wednesday approved game-changing final rules in the implementation of Title IV of the JOBS Act, known as “Regulation A+,” which will allow small businesses and startups to raise up to $50 million from "the crowd."

As I reported more than a year ago, this little-known provision of the JOBS Act will allow a startup company or emerging business to hold a “mini IPO” from the general public, not just accredited investors, and should be a complete game-changer for the way businesses are funded.

When Congress passed the JOBS Act in April 2012, Regulation A+ was an attempt to fix Regulation A, a rarely-used provision of federal law that allowed companies to raise up to $5 million in a public offering. Regulation A was a bust because it required the company to register its offering in each state where it was to be sold. The cost of complying with each state’s “Blue Sky Law” was exorbitant, compared to more commonly used laws such as Regulation D that allowed a company to raise the same amount of money, or more, without having to pay for expensive state-by-state compliance.

Under the SEC’s new rules for Regulation A+, the amount that could be raised increases to $50 million and the need for state compliance has been eliminated. More importantly, Regulation A+ allows those funds to be raised from the general public, not just accredited investors like with Regulation D offerings.

The question that had everyone in the crowdfunding world holding their collective breath was simple: Would the SEC keep their proposed rules intact when its leadership voted, or would they succumb to the pressure of state securities regulators who were adamantly opposed to lessening of restrictions for their own selfish financial reasons? The answer is that the SEC stuck by their guns and allowed companies to raise Regulation A+ without having to go to each state and spend a fortune registering their offerings.

Another important issue the SEC decided involved who can invest in these offerings. The JOBS Act limited Regulation A+ offerings to "qualified investors" which led some to argue that only "accredited investors" would be allowed to invest. Accredited investors are those individuals who earn more than $200,000 per year or have a net worth of greater than $1,000,000. However, the SEC broadly defined the term "qualified investors" under Regulation A+ to allow anyone to invest, albeit with some limitations as to the amount.

For those worried about protecting investors from fraud, Regulation A+ only allows investors to invest 10 percent of the greater of their annual income or net worth in these securities. The SEC has also implemented other strong investor protections such as "bad actor" background checks on the companies offering the securities, and disclosure of the company's financial information as part of the offering.

The Regulation A+ rules can be read in full here. There are hundreds of pages, so get ready for a long read or a fast way to bore yourself to sleep. Having read the entire thing, I can tell you with confidence as a crowdfunding attorney that Regulation A+ has a chance to dramatically change the way small and emerging businesses raise capital in America.

The rules released by the SEC today now have to be published in the Federal Register before they become law, which takes about 60 days. As soon as that happens, entrepreneurs will have the ability to raise millions of dollars from "the crowd" in a simplified and comparatively affordable offering using Regulation A+.

Should You Consider Hiring a Crowdfunding Consultant?

Originally Published at Entrepreneur.com on March 25, 2015

If you start a crowdfunding campaign, don’t be surprised when you start getting solicited by email from people who want to help you crowdfund successfully. Are these potential donors? Fans of your project who want to help you spread the word because they love what you are doing? Writers or bloggers who could take your campaign to viral status through their vast readership?

Hopefully, these email solicitations come from one (or all) of those people. Unfortunately, many will come from a recent phenomenon that is cropping up in the crowdfunding world: the crowdfunding consultant.

A crowdfunding consultant will, for a fee, advise you on launching, running and promoting your campaign. Some of these crowdfunding consultants are very good and can provide valuable help, particularly for campaigns trying to raise more than $100,000. Others are basically worthless and will take anyone’s money just to repeat things you could learn for free reading my Entrepreneur.com articles.

When it comes to raising money for larger campaigns, Roy Morejon of Command Partners is one of the top crowdfunding consultants in the business. In the past four years, he has helped more than 100 projects successfully crowdfund and has helped raise more than $18 million for his crowdfunding clients.

One of the firm's recent success stories was the Bunch O Balloons Kickstarter campaign that raised nearly $1 million and led to a lucrative licensing deal with one of the largest toy distributors in the world. I asked Morejon to help me reveal the secrets to finding the right crowdfunding consultant for your campaign.

1. Find a consultant with a multidisciplinary team of marketers.

Many crowdfunding consultants are just marketing people or PR firms who will send out an online press release for your campaign. This does little to no good by itself. You not only need someone great with public relations skills, but a consultant with experience with social media and digital marketing. A good consultant understands the crowdfunding landscape, including who to reach out to and how to target media and donors depending on what industry your campaign falls into.

2. Ask to see their track record and check references.

“Anybody can say they are a crowdfunding expert," Morejon says. "Very few can back it up with consistent success and references that will vouch for their value.”

Ask to see the last 10 campaigns the consultant worked on, whether they were successful or not. Pay close attention to the success rate. On Kickstarter, only about 40 percent of all crowdfunding campaigns are successful. On other platforms such as Indiegogo and GoFundMe, the success rate is reportedly only 10 percent.

A crowdfunding consultant should be able to show a higher success rate to justify their fees. Command Partners, for example, has an 85 percent success rate of campaigns reaching their goal.

3. Make sure they are well connected to the media. 

Nothing makes a crowdfunding campaign go viral faster than media coverage. When Morejon consulted on the Trunkster Kickstarter campaign that raised nearly $1.4 million, a big boost came from an appearance on Good Morning America, as well as a story in Travel+Leisure. 

Nearly every crowdfunding consultant will offer press releases as part of their package, but access to actual media contacts and proof that the consultant’s media pitches consistently work is the key. Don’t believe someone who promises to “get you on the Today Show” unless they can show you a track record of other crowdfunding clients sitting next to Matt Lauer.

4. Ask about their fees. 

Fees vary from consultant to consultant, with some charging flat fees up front, others charging a percentage of the money raised, and others a combination of the two. This is a good place to remember the old adage: You get what you pay for. 

Don’t expect someone you pay a one-time fee of $500 to work tirelessly for 30 to 60 days to get your campaign rocking and rolling. Also, as an attorney, I offer one more bit of advice: Get their fee structure in writing, and sign a contract detailing their services if possible, so there are no surprises at any point.

For those trying to crowdfund $1,500 to pay for your dream vacation or a few hundred to get a new set of sub-woofers for your car, a crowdfunding consultant is not for you. But for those who need to raise serious money to start a business or get a product manufactured and to market, a good crowdfunding consultant can be invaluable.

But finding a good consultant is not easy. You need someone with creativity and who is willing to think outside the box of normal marketing practices, and who also has a track record of success. Follow these tips, do your homework, and pick someone that will justify the cost of bringing them onto your crowdfunding team.

Raising Millions With Equity Crowdfunding Will Cost You, But How Much?

Originally Published at Entrepreneur.com on May 20, 2015

Image credit: Brook Ward | Flickr

The recently released Regulation A+ is the first section of the JOBS Act that allows a company to raise capital from the general public. By opening up private company investments to the “crowd,” Regulation A+ promises to be a game changer for how emerging companies are funded. It's the first nationally available form of equity crowdfunding to non-accredited investors.

This will not be as easy as a Kickstarter campaign, however. Raising capital with Regulation A+ will involve more than going online, creating a crowdfunding campaign and watching the money flow in. Regulation A+ involves the sale of equity or debt in your company and is governed by securities laws. This means (cue maniacal laughter) attorneys’ fees, accountants’ fees and compliance costs. Raising $50 million under Regulation A+ is going to require your company to invest money in the process.

The question is: Can Regulation A+ be affordably used by startups and small businesses?

The first thing to understand is that there are two “tiers” of Regulation A+. Tier 1 allows a company to raise between $1 million and $20 million, and there are no limits on the amount that an individual non-accredited investor can invest. Tier 2 allows a company to raise between $1 million and $50 million, but non-accredited investors can only invest 10 percent of their income or net worth in each tier 2 offering. 

There are different rules and costs associated with each tier. Both tiers will have sizeable costs for SEC compliance and legal fees (damn those lawyers). Tier 1 will have costs for compliance with state securities laws or "blue sky laws." While tier 2 doesn’t require you to comply with the blue sky laws for each state, it will have more onerous accounting, auditing and ongoing SEC reporting requirements.

Both tiers have legal fees and SEC compliance costs, so let’s tackle that ugly subject first. When the law becomes effective on June 19, expect most of the big securities law firms and lawyers to quote ridiculously large bills of more than $100,000 in legal fees and compliance costs.

The reality is, there are competent entrepreneurial-minded lawyers who will charge far less, so shop around, but be sure to check credentials and hire someone who knows the JOBS Act and the Regulation A+ process. Also, as time goes on, expect to see legal fees and compliance costs come down, particularly as innovative companies find ways to automate the compliance process, and as lawyers become more comfortable with the new law.

The two remaining factors are the cost of complying with state blue sky laws (in tier 1) and the cost of two years of audited financial statements (in tier 2).

The tier 1 cost of complying with blue sky laws in all 50 states could run in the tens of thousands of dollars. Some big law firms may even quote six-figure fees. Worse than the cost, the time wasted by having to deal with 50 different state securities regulators could make this process akin to having all of your teeth pulled, one at a time, without Novocain. Because of blue sky compliance, tier 1 only makes sense for a business that is raising money in a contained geographic area and does not need to comply with more than one or two state blue sky laws. Other than that, I believe most companies will use tier 2.

The major expense of tier 2, two years of audited financials records, seems like a deal killer for many small businesses. CPA audit costs of more than $25,000 per year are not uncommon for a revenue producing, young business. One CPA I discussed this with says innovators in the accounting industry will find ways to make these audits work.

“If a startup is new, and does not have significant financial history, there is no reason an audit should be so expensive,” says Craig Denlinger, who left a big six firm to start an accounting business geared towards the JOBS Act market.

Denlinger is right. I have seen quotes from entrepreneurial-minded CPA firms willing to do startup audits for as little as $2,500.

So what will the ultimate cost of Regulation A+ be? As a crowdfunding and JOBS Act attorney who has been fielding Regultaion A+ calls non stop for the past month, I suspect that the minimum a company will need to spend at the onset, with the right lawyer, the right accountant and the right compliance company, will be at least $50,000.

While that seems like a lot for a startup to swallow, how often can a company invest $50,000 into something that will allow them to raise $50 million from the general public? The best news is Regulation A+ allows a company to “test the waters” before spending a ton of money. This means you can approach potential investors and gauge their interest before you spend thousands on putting together all of your filings with the SEC.

Before You Crowdfund an Invention, Consider Patent Protection

Originally Published at Entrepreneur.com on February 2, 2015

Crowdfunding has become a successful way for an inventor to raise the money needed to create, manufacture and distribute a new product. You just need to look at the successful crowdfunding campaigns of the Pebble Watch or the Coolest Cooler to see what the power of the crowd can do for a new consumer product. The days of begging friends, family and angel investors to fund a new invention are over for someone with a great new idea and access to "the crowd."

But access to the Internet is a mixed blessing. Millions of people can now quickly see, evaluate and potentially donate to help an inventor get his or her product off the drawing board. But amongst those millions of people are a few bad apples who will see a great idea and try to steal it. Even the great Steve Jobs was once quoted as having said, “We have always been shameless about stealing great ideas.”

As a crowdfunding attorney, I caution excited product creators about one important aspect of the online crowdfunding process: Legally protect your invention, if possible, through the patent process.

InventHelp is one of the industry leaders in helping inventors and entrepreneurs get a product to market. InventHelp’s CEO, Robert Susa, says that inventors should consult with a patent attorney early in the process.

“We use a patent referral system to give our inventors access to patent attorneys who can advise them of the best way to be protected, before they put their product online for the world to see,” he says.

A patent is the best legal means to protect an invention from being sold or used by another person or business, and provides a remedy if an idea is stolen. Patents are very expensive, however, and many product creators will take a far-less expensive step and first file a provisional patent application.

A provisional patent application is a document filed with the U.S. Patent and Trademark Office that establishes an early filing date and gives the inventor one year to file a regular patent application. The provisional application is a shorter, more simplified version of the patent application. Some people mistakenly say that filing this document gives them a “provisional patent” even though no such thing exists. The correct term after filing any patent application, provisional or not, is that the invention is “patent pending.”

Does the “patent pending” label protect the inventor from online thieves and pirates? While filing a provisional application can act as a deterrant that dissuades your competition from stealing your product, it does not provide an enforceable patent that gives you the best protection under the law. However, as a practical matter, filing a provisional patent application can be a valuable advertising tool, and one that helps attract investor capital, whether through crowdfunding or more traditional investor funding.

Susa also notes another benefit to filing the provisional patent application. 

“If an inventor’s goal is to license their product, many large companies often want to see that an inventor has made that effort before they go into business with you,” he says.

The bottom line is simple: Protect your idea the best you can before you put it on display on a crowdfunding platform for the world to see. Talking to an attorney who specializes in patent and intellectual property law is an investment every inventor and product creator should make before diving into the crowdfunding arena.

SEC Delays Equity Crowdfunding Piece of JOBS Act for Another Year

Originally Published at Entrepreneur.com on December 8, 2014

The Securities and Exchange Commission recently released a rulemaking agenda revealing that it plans to finalize the Title III Equity Crowdfunding rules and the Title IV Regulation A+ rules from the JOBS Act by October 2015. Given that these rules will then require 60 days to be published in the federal register and become law, it appears likely that the earliest date small businesses will be able to utilize these JOBS Act provisions to raise capital will be the beginning of 2016.

This announcement comes nearly three years after the overwhelming bipartisan passage into law of the JOBS Act, a historic piece of legislation designed to help small businesses raise funds to launch and grow. The announcement is also a remarkable 700 days past the deadline the law itself contains mandating the date that the final crowdfunding rules were supposed be released by the SEC.

The additional delay will certainly darken the spirits of entrepreneurs who have been patiently waiting to use equity crowdfunding and Regulation A+ to raise millions of dollars to start and grow small businesses.

Under Title III of the JOBS Act, small businesses will eventually be allowed to use an online crowdfunding portal to sell equity in their business to the general public and to raise up to $1,000,000 in capital. Equity crowdfunding under the JOBS Act has been seen as a democratization of the startup and small-business investment process, and one which will put the ability of entrepreneurs to raise capital into the hands of “the crowd” and not just wealthy investors, banks and Wall Street brokers.

Title IV, or “Regulation A+,” holds even more excitement for some, given that it will allow a small or emerging business to raise up to $50,000,000 in capital from “the crowd” through a relatively inexpensive form of a public offering. For now, both appear to be on hold for at least another year.

Most industry insiders expected the final rules on crowdfunding and Regulation A+ to be released in late 2014. As recently as October, SEC Chair Mary Jo White stated in her opening remarks to the SEC’s Investor Advisory Committee, that the agency would “be pushing forward in the near term” on “finalizing our remaining JOBS Act mandates.”

Apparently, “near term” means “next year” to the SEC.

In its recently published rulemaking agenda, the SEC set a target date of October 2015 to adopt final rules regarding the offer and sale of securities through crowdfunding and small and additional issues exemptions under Regulation A+.

Will the SEC actually follow through on these agenda items at or before that time? The SEC has often not met the target dates included in its rulemaking agendas, so the October 2015 target date should not be seen as set in stone by anyone waiting to utilize these valuable funding laws.

Will the SEC Redefine Who Can Be an 'Accredited Investor'?

Originally Published at Entrepreneur.com on October 7, 2014

For years, federal law has only allowed “accredited investors” to invest in most private-securities offerings for startup and growing businesses. This will change to a certain degree with the enactment of equity crowdfunding under the JOBS Act, but there will still be a large number of private investments limited to accredited investors.

This month, the Securities and Exchange Commission will consider revising the definition of who qualifies as an accredited investor. Unfortunately, some of the proposals the SEC is considering would make qualifying as an accredited investor more difficult, and thereby limiting the pool of investment money that presently is available to small businesses.

Currently, an investor is accredited if his or her net worth exceeds $1 million, excluding a primary residence, or if their income is $200,000 or more. Most estimates say there are more than 9 million people in the United States that qualify under this easy-to-verify standard. Of that number, it is estimated that a small percentage actually invest in startups and small businesses.

The theory behind the accredited investor rule is that someone who makes a lot of money, or has a high net worth, is sophisticated enough to determine if an investment is risky or not, and can withstand the loss if the investment goes bad. More than 60 years ago, the U.S. Supreme Court decided that someone who has a lot of money “can fend for themselves” when it comes to investments.

Of course, this reasoning is idiotic. Anyone who hears the horror stories about millionaire athletes or lottery winners who lose everything knows that a high net worth does not equal investing sophistication. But having a simple, income-based definition of accredited investor gives everyone involved in the process certainty that the investor is accredited, thereby avoiding legal troubles when an investment goes bad. 

The reality is, there are millions of financially-sophisticated people who are not able to invest in private offerings because of this rule. Yet, if you are a securities lawyer, an investment banker, a stock broker, a certified public accountant or a tax advisor, but do not have a net worth of more than $1 million, or did not earn $200,000 last year, the SEC does not consider you sophisticated enough to be called an accredited investor.

Think about it. These people can give advice to others about investments, accounting and taxation, but they cannot participate in the investments themselves because they do not meet an arbitrary amount of earnings or wealth.

The Dodd-Frank financial reform law requires the SEC to review the accredited investor standard this year, the first time a review has been done since 1982. The SEC is meeting this week to consider major changes to the definition of accredited investor, a decision that will have far-reaching implications to entrepreneurs in the near future.

What will the SEC decide to do? Here are four possibilities:

1. They could increase the monetary requirements. 

Some people believe that the 30-year-old $200,000 salary and $1 million net worth thresholds are too low, and should be raised. Small businesses will suffer if the already-small number of people who qualify to invest is restricted even more.

The SEC estimates that increasing these numbers to account for inflation since 1982 would exclude 60 percent of those considered accredited investors from being allowed to continue investing in private placements.

2. They could scrap the monetary requirements, and require proof of investment sophistication.

The SEC might allow people with certain professional licenses to automatically be labeled as accredited investors, and for others to provide other demonstrable proof. While this seems like a good idea, having a license to dispense investment advice, for example, does not mean that someone is able to handle the loss of a large investment in a private placement. And how will others be tested or qualified?

3. They could broaden the number of people who are accredited, but limit the amount they can invest.

In the equity crowdfunding provisions of the JOBS Act, there are limitations of how much someone can invest in certain offerings, and these seem reasonable on their face as a way to protect investors from catastrophic losses.

But is it truly fair for the government to tell someone who is a “sophisticated investor” that their investment is limited to some arbitrary percentage of their income? If so, why doesn’t the government prevent anyone, even non-accredited investors, from “investing” as much as they want in slot machines at casinos? Does the government prevent grandma from using her retirement nest egg to buy as many lottery tickets as she wants?

4. They could do some combination of the above. 

This is my best guess of what will happen. I suspect we will see new, slightly higher financial thresholds, a group of licenses or occupations that become accredited investors automatically and, unfortunately, some limitation on the amount certain accredited investors will be allowed to invest.

How to Invest for Equity in a Startup

Originally Published at Entrepreneur.com on September 22, 2014

When making an equity investment in a startup, there are many issues to consider. 

The U.S. Securities and Exchange Commission is expected to release its final JOBS Act equity crowdfunding rules, and entrepreneurs will be allowed to sell equity in their companies through online crowdfunding portals to more than just accredited investors. The law promises to be a game changer for startups. As a result, investors will have easily accessible investment choices at their fingertips.

Here are 10 questions to raise about making an equity investment in a startup company. I pass these along from my personal experience as an investor, as well as my 25-year history as an attorney helping people start and fund businesses:

1. Is the investment for equity or a convertible note?

An investor needs to know what he or she is getting in exchange for the cash infusion. Will it be equity (shares of ownership of the company) or a convertible note? The note means that the investor loaned money to the company with the right to either be paid back or to turn the loan into equity as some later date.

2. How and when does the investor get the money back? 

When an investor buys an equity stake in a startup, usually those shares cannot be sold or traded for several years. If the investment is a convertible debt, figure out the conversion date. This is when the company either pays the money back or the investor can convert the money loaned into equity according to the terms of the convertible note. 

3. How will the business make money?

I am amazed when I see business plans that don't describe a visible means of monetization. If a company has not yet started generating revenue (like most startups), look at how the enterprise plans to make money. If the company has indeed started generating revenue, examine how it's making money. Consider if the model makes sense and is sustainable. Is the model scalable?

Related: 6 Key Factors in Scoring a $1 Billion Valuation for Your Startup

4. How can the investor profit from an investment?

Equity shareholders should find out if they will receive dividends or distributions, how much and when. What happens if the company is sold, merges or goes public? Convertible note holders need to know their interest payment schedules and ask what happens in the case of a sale, merger or IPO.

5. What rights come with an investment?

Investors need to find out if they gain voting rights at the company and of what kind. Can the ownership percentage be diluted? Can the investment be sold or transferred to a third party? If so, how and when?

6. How will the investment money be used?

Research the "use of proceeds" and understand what, why, and how the startup intends to spend the money raised. The use of proceeds offers a good look inside the mind of the business owner. Is the amount being raised enough to reach profitability or is it just enough to arrive a the next financing round? Is everything the company is paying for seem reasonable?

7. Who are the founders and key personnel?

I often pay more attention to this aspect than just about anything else. I like to invest in companies with founders who know how to run a business and who have a track record of success. If the founder has no track record then he or she should surround herself with professionals with experience. A strong management team is no guarantee of success but is an important factor to consider.

8. What are the founders being paid?

I like to see the visionaries behind the business receiving a fair salary so that I know they will be focused on doing the work to make the company successful and not waiting tables at night to make ends meet. I generally make sure no salary seems out of line with market wages.

9. Are the sales projections and profit projections reasonable? 

Nearly every company trying to raise money claims to be the next billion dollar company and usually has sales projections to back up some bold claims. Sales projections for startups are usually created with smoke and mirrors, so take them with a grain of salt. But examine the method of creating the numbers presented. Is there a reasonable basis for the projections?

10. What's the risk associated with investing in the startup?

Investors should not invest money that they cannot afford to lose. Investing in any new business involves risk. But it is really more risky than investing in the “safe” stock market? Ask people who bought Bank of America stock at $82 a share in 2004 how safe their investment was in that bluest of blue-chip stocks, now trading at $17

Want to Make Equity Crowdfunding Legal? 3 Experts Sound Off.

Originally Published at Entrepreneur.com on September 4, 2014

The JOBS Act became law on April 5, 2012, with the promise to open a new world of funding for startup businesses through equity crowdfunding. Entrepreneurs were excited that Congress passed a law creating a Kickstarter-like tool to raise capital by selling stock online. Equity crowdfunding had promised to bring ideas to life, businesses to fruition and the American Dream back into play.

Then, nothing happened.

Almost two-and-a-half years since the law was passed, there is frustration in the entrepreneurial world because the SEC has not released final rules allowing JOBS Act equity crowdfunding to begin.

I don’t blame the SEC being extremely cautious implementing the biggest change in securities law in eight decades. Creating an entirely new method of selling securities requires a great deal of thought and planning. This became obvious when the SEC released 585 pages of proposed rules last October. That’s a lot of thought and planning.

Nobody thought we would be waiting almost a year for the final rules to be released so the law can be implemented. Nobody knows how well the law will work until people try to use it. I have repeatedly argued that the SEC should roll the law out, see how it works and let the collective ingenuity of the American people find creative ways to make the law function as Congress intended.

What can you do to help convince the SEC to release the final rules? Here are some suggestions from crowdfunding industry experts:

1. John Robert Clarke, who runs Midtown Partners, a FINRA registered broker-dealer in New York City, is waiting for the final rules to make his entry into the crowdfunding industry and says people should submit a polite letter to the SEC asking them to release the final rules. Clarke says the SEC will take into account each and every comment letter submitted, and they need to know that funding portals are ready to launch as soon as equity crowdfunding becomes legal.

“I’ve been waiting for the final rules so we can formally launch our funding portal FundItNation and let entrepreneurs raise startup capital from the crowd,” Clarke says. “While some have criticized the proposed rules as being unworkable, we have found ways with our portal to make the JOBS Act work for investors and entrepreneurs. We just need the green light from the SEC to launch.”

You can submit a comment to the SEC online by clicking here.

2. Attorney Anthony Zeoli, one of the top real-estate crowdfunding experts in the country, has clients ready to use Title III crowdfunding as soon as the rules are passed.

"The SEC's desire to protect investors is admirable, but failing to issue the rules hasn't stopped equity crowdfounding," Zeoli says. "It has only succeeded in forcing entrepreneurs and portals to pursue a variety of workarounds to make it happen."

He notes that real-estate crowdfunding is one of the places where entrepreneurs are already implementing crowdfunding despite the lack of final rules.

"You have debt/equity investments being made with very little guidance as to how it should be handled from a legal or a regulatory prospective," Zeoli says. "Only by issuing final rules can experienced crowdfunding professionals begin creating best practices for the equity investments that will truly protect investors."

3. Joy Schoffler, principal of Leverage PR and board member of CFIRA, the crowdfunding industry’s advocacy group, says the SEC and Congress members need to be reminded to ignore the naysayers. The critics who claim that investors are not protected and that equity crowdfunding will not produce “the next Facebook” are missing the point, she says.

“I personally invest in some businesses that will never have a Facebook-type exit," Schoffler says. "They are everyday businesses that have great cash flow and make healthy returns. Enacting Title III of the JOBS Act is about allowing all Americans that same opportunity. If you are a sandwich-shop owner with loyal customers and want to open a second location, why not allow the community a chance to own a piece of the business? They will become even more loyal customers.”

4. And some advice from yours truly. Attend a live crowdfunding event such as the Global Crowdfunding Convention and Bootcamp this October in Las Vegas. Listen to crowdfunding industry leaders speak and get educated about the latest developments and network with others who want to see this law up and running.

There is no better place to collectively pool the resources of those who are passionate about finally being able to use this law to bring investors and entrepreneurs together in a way that could change the American economy.

Potential Game Changer for Funding Awaits Final Approval From SEC

Originally Published at Entrepreneur.com on July 3, 2014

Regulation A+, a little-discussed provision of the JOBS Act, would allow a company to raise up to $50 million selling stock to the general public through a mini-IPO that would not be overly expensive or burdensome from a regulatory perspective. Earlier this year, I boldly predicted that this provision could have a game-changing effect on how new and emerging companies raise capital once it went into effect. 

As the law was written and the rules were proposed by the SEC, it might not cost a company much more to raise $50 million under Regulation A+ than it would cost to raise $1 million under the equity crowdfunding provisions of the JOBS Act.

At the time of my article, the SEC had proposed rules to enact Regulation A+, and the public was allowed to comment on the proposed rules. The public comment period has ended and we are all still waiting for the SEC to release its final rules so we know whether this potentially game-changing law will have the economic bite Congress intended, or whether the SEC will buckle under the pressure of state regulators and make Regulation A+ a virtually useless piece of legislation like its predecessor, Regulation A.

Hopefully, these SEC rules will keep Regulation A+ as a powerful tool for funding small businesses. To do so, I hope we find the following in the final rules when they are rolled out:

1. No state Blue Sky compliance. The SEC got this one right in its proposed rules, but state securities regulators are not happy and have flooded the SEC with comment letters and lobbyists trying to get the SEC to reverse its position. If the SEC changes its mind and requires a startup company to register the Regulation A+ offering in all 50 states, the new law will likely be as worthless as the old law to most companies.

The expense and regulatory nightmare of dealing with 50 states and their securities laws is totally unnecessary, given the SEC's disclosure requirements for any company to use Regulation A+.

2. The ability to sell to the general public. Regulation A+ allows a company to sell stock through a mini-IPO to the general public, with the limitation that each purchaser cannot invest more than 10 percent of their annual income or net worth in a Regulation A+ offering. Some states and other commentators want the purchasers of Regulation A+ offerings to be limited to accredited investors or others who are wealthy and connected.

If the SEC changes its position and limits purchases of Regulation A+ stock to rich folks, the "public" part of the initial public offering would disappear, and there would be little reason for a company to use Regulation A+ instead of Regulation D, the most popular private-equity exemption presently in use. If this happens, Regulation A+ will sit on the shelf collecting dust next to Regulation A, the law it is supposed to replace.

3. A streamlined process. One of the reasons Regulation A has failed to be a viable method of raising capital is that it reportedly takes an average of eight months to go through the SEC process needed to make a Regulation A offering. To make Regulation A+ work, the SEC needs to make the document filing, compliance and other regulatory issues easier by streamlining this process. A startup business cannot wait eight months to do anything, much less raise capital.

4. The law's original intention. The SEC did a fantastic job in its proposed rules of making Regulation A+ a viable model for small businesses to raise money. It apparently took the mandates of Congress seriously by removing Blue Sky compliance, allowing a company to raise up to $50 million, and allowing anyone to be an investor within the income limits proposed.

This law was proposed to give the small business and entrepreneur community a game-changing way to raise money and to give the lower-end IPO market a much-needed boost. When the final Regulation A+ rules roll out, let's hope Congress remembers that this law was created to help small business raise capital, and at the same time, to stop state governments from imposing costly fees and needless repetitive regulations that strangle startups and emerging companies.

Crowdfunding Can Be Really Effective -- If You Know What You're Doing

Originally Published at Entrepreneur.com on June 17, 2014

Most people do not understand crowdfunding. "I built it, but they did not come" is a common complaint. Some people are shocked and unable to understand why nobody donated to their crowdfunding campaign on Indiegogo or GoFundMe.

Crowdfunding is hard work. On many sites, the vast majority of people who try crowdfunding fail to meet their goal. But for those who plan ahead, prepare properly and execute a plan the right way, the chances of success are much greater. 

Many entrepreneurs see rewards-based crowdfunding -- when a perk or a product is provided to a donor as opposed to equity -- as an easy way to raise money. But if you don't have a very good idea or a product that excites people, it's not going to work. 

Here are some important things to understand when trying to raise money through crowdfunding:

1. Make sure you have a product that works for crowdfunding. Campaigns for gadgets, video games and films have a high level of success.

Campaigns centered on causes in the news or that truly touch people's hearts are often successful but raising tens of thousands of dollars for a new nonprofit group supporting an arcane issue is not going to work. Raising a lot of money for a personal need rarely works. Browse through Indiegogo and look for campaigns like yours. If you see a high number of failures for those with ideas similar to yours, take heed.

2. Set a realistic funding goal. According to Kickstarter, only 2 percent of the campaigns that successfully raised funds on the site raised more than $100,000. Compare that to the 73 percent of the successful campaigns that raised $10,000 or less. If you are looking to raise more than $10,000, rewards-based crowdfunding will be a long shot, with very few exceptions. 

3. Plan to spend 30 to 60 days before a crowdfunding campaign launches. That's the time required to hone the project, create a great video, develop compelling rewards, build a following for the launch on social media, reach out to potential supporters who will be ready to donate on Day 1, write and schedule all the social media postings and emails, and contact media sources and bloggers to build rapport for possible public relations opportunities. If you do not take this part seriously, your chances at success may be greatly diminished.

Nearly every successful campaign has about 30 percent of its crowdfunding goal committed through family, friends and a network of close connections before it's launched. Without that initial boost of donations hitting a campaign early, the success rate is very low. 

The overwhelming majority of successful campaigns that raise significant funds involve products that are preordered. Don't try to compare preselling a cool iPhone gadget on Indiegogo with raising money to start an orange juice stand. It's like comparing apples and oranges, pun intended. If you are not preselling a product, do not expect to raise more than $10,000 through rewards-based crowdfunding.

Be prepared to have a second full-time job during the campaign's 30 to 60 days. The campaign will require your constantly being on the phone and promoting online, looking for supporters, dealing with questions, reaching out to the media, fulfilling rewards and handling social media. Imagine how much work it will be, then triple that.

The good news is, when it works, significant amounts of money can be raised. The process can net low-cost publicity and buzz for a product or business. It's possible to test the market for an idea or product without spending much money. Another bonus: You may build a rabid social media following and an excited and vocal base of customers who want the company to succeed.

Crowdfunding Growing at a Startling Rate, New Report Says

Originally Published at Entrepreneur.com on June 14, 2014

Just a couple of years ago, providing answers to some of the most common questions on crowdfunding was based evenly between limited anecdotal evidence and my gut feelings as an attorney with keen business instincts.

But as with any fledgling industry moving towards maturity, more and more data has started to appear that makes answering these questions a bit easier. One recent mountain of data on the crowdfunding world that just arrived contains a plethora of information -- read on as I distill some of it for you.

Barry James and his team at The Crowd Data Center recently released eFunding & The State of The Crowdfunding Nation, a report (which can be purchased for $49) that studied more than 75,000 crowdfunding campaigns for the first quarter of 2014. The report provides a wealth of information about both rewards-based and equity-crowdfunding campaigns. It puts crowdfunding into a whole new perspective.

Those of us in the industry already knew how profoundly the crowdfunding explosion had affected society. But the report puts it into perspective, and one particular fact truly illustrates the explosive nature of the burgeoning industry. Gordon Moore, one of Intel's founders, coined Moore's Law that predicted computing power would grow exponentially for the foreseeable future, doubling every 18 to 24 months.

According to the eFunding report, crowdfunding on a global basis is doubling at nearly 10 times the rate of Moore’s Law.

The report and the infographics accompanying it offer insights into what is happening in crowdfunding worldwide by drawing on a continuous influx of data from live crowdfunding campaigns as well as studying the major funding platforms, pledges and patterns of donors and investors during the first quarter of 2014. Here are some interesting facts and numbers about the global effect of crowdfunding from the eFunding report:

• More than $57,000 is pledged to a crowdfunding campaign somewhere in the world every hour of every day.
• The five most popular categories of successful crowdfunding campaigns are gaming, technology, design, film and music.
• Rewards-based campaigns on Kickstarter successfully fund 42.8 percent of the time. On Indiegogo, the success rate is 14.4 percent.
• The average number of backers of a successful Kickstarter campaign is 255.
• An average of 325 new crowdfunding campaigns launch every day.

These tidbits of information are a great resource for anyone who is looking to crowdfund. For example, being able to look at the statistics that are now available allows interested crowdfunders to know which platforms work and how well. James and his crew are constantly updating the site with more and more research. The site has search tools that let anyone answer almost any data-driven question about crowdfunding, questions that are crucial when someone is considering, planning and launching a campaign.

Until now, getting answers to these could take hours or days of research on many different platforms, trying to compare apples to oranges.

As someone experienced with the field, not only can I now find promising crowdfunding rising stars or rocketing campaigns far before they've become obvious to the world, but I can do so by mining the live-data (registration is required) on active campaigns on a daily or even hourly basis. The site’s analytics can also be used to dig deeper into the data for emerging trends.

While traditionally, investing has been a very closed world with information closely guarded and available at a premium, if at all, one of the things I love about crowdfunding that's transformative is its openness and transparency. Having data such as this available will assist investors and entrepreneurs as the crowdfunding world booms when equity crowdfunding under Title III of the JOBS Act soon becomes a reality.