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1 Equity Crowdfunding Is Awesome! AUGUST 1, 2018 AUTHORS Lou Bevilacqua

Equity Crowdfunding Is Awesome! - Bevilacqua PLLC · for any equity crowdfunding raises undertaken within a period of 12 months. I have a totally contrary opinion. Equity crowdfunding

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Page 1: Equity Crowdfunding Is Awesome! - Bevilacqua PLLC · for any equity crowdfunding raises undertaken within a period of 12 months. I have a totally contrary opinion. Equity crowdfunding

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Equity Crowdfunding Is Awesome!

AUGUST 1, 2018

AUTHORS

Lou Bevilacqua

Page 2: Equity Crowdfunding Is Awesome! - Bevilacqua PLLC · for any equity crowdfunding raises undertaken within a period of 12 months. I have a totally contrary opinion. Equity crowdfunding

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INTRODUCTION Equity Crowdfunding is Awesome! There, I have said it. Most lawyers seem to be against equity crowdfunding under new Regulation Crowdfunding and Title III of the JOBS Act, especially those at big firms. They talk about how investors will get ripped off by shysters and startup companies that have no chance of success. They also complain about the limit of approximately $1 million for any equity crowdfunding raises undertaken within a period of 12 months. I have a totally contrary opinion. Equity crowdfunding has become the new way that legitimate early stage companies and startups raise capital to grow their businesses. Equity crowdfunding is an excellent tool for entrepreneurs seeking capital. It allows an entrepreneur to raise capital from both accredited and non-accredited investors. Since most entrepreneurs don’t have a huge network of high net worth friends who qualify as “accredited investors”, equity crowdfunding allows entrepreneurs to ask for small investment amounts ($100 to $300) from a large number of their friends, families, acquaintances, fans and social media contacts. Entrepreneurs are able to generate interest through online general solicitation and advertising, while also tapping friends and family, networks, affinity groups and others to support their cause. I also believe that investors will be protected because they will receive full disclosure by way of a Form C offering statement and the amount of their investment is limited. Besides, SEC enforcement is always standing by to pounce on the fraudsters. To capitalize on the tools provided by Regulation Crowdfunding, entrepreneurs should work with their counsel to prepare a Form C offering statement and file it with the SEC. Securities may only be sold through one intermediary or funding portal. The funding portal must be a funding portal member of FINRA (here is the list of funding portal members so far) or a registered broker dealer. The Form C offering statement resembles a private placement memorandum. Once the Form C offering statement is close to ready, the entrepreneur will then set up a landing page on the portal using the information from the Form C offering statement and providing other information. Of course, entrepreneurs will want to have a compelling video, pictures and other marketing collateral that they can upload to the portal to make their offering more attractive. Once everything is up on the portal and the Form C is filed with the SEC, entrepreneurs can begin marketing their offering immediately. The SEC does not review the Form C, so there is no delay resulting from an SEC comment and review period. There are certain restrictions on what can be said in the advertising material. For example, an advertisement must either be in the form of a tombstone that has limited information about the terms of the offering or be a general advertisement that does not mention the terms of the offering. Tombstones and general advertisements must refer potential investors to the funding portal. The SEC published an excellent summary of Regulation Crowdfunding called “A Small Entity Compliance Guide for Issuers.” I urge you to review it if you are interested in getting into the details of Regulation Crowdfunding. This White Paper is intended to be a brief summary of Regulation Crowdfunding’s requirements taken largely from the SEC’s guide.

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MAXIMUM AMOUNT OF RAISE The maximum amount that an issuer can raise is $1,070,000 in a 12-month period. The $1,070,000 limit includes securities it has already sold (including amounts sold by affiliates, which is important for private equity funds to keep in mind when using equity crowdfunding to raise capital for their portfolio companies) in reliance on Regulation Crowdfunding during the 12-month period preceding the expected date of sale, plus the amount the issuer intends to raise in reliance on Regulation Crowdfunding in the current offering. INVESTOR LIMITS Individual investors cannot invest more than the following amounts over the course of a 12-month period in equity crowdfunding transactions:

Ø If either of an investor’s annual income or net worth is less than $100,000, then the investor’s investment limit is the greater of: $2,000 or 5 percent of the lesser of the investor’s annual income or net worth.

Ø If both annual income and net worth are equal to or more than $100,000, then the investor’s limit is 10 percent of the lesser of their annual income or net worth.

Ø During the 12-month period, the aggregate amount of securities sold to an investor through

all Regulation Crowdfunding offerings may not exceed $100,000, regardless of the investor’s annual income or net worth.

TRANSACTIONS CONDUCTED THROUGH A PORTAL Each Regulation Crowdfunding offering must be exclusively conducted through one online platform. The portal operating the platform must be a broker-dealer or a funding portal that is registered with the SEC and FINRA. ELIGIBILITY The companies that cannot use Regulation Crowdfunding include:

Ø Non-U.S. companies;

Ø Companies that already are Exchange Act reporting companies;

Ø Certain Investment Companies;

Ø Companies that are disqualified under Regulation Crowdfunding’s disqualification rules;

Ø Companies that have failed to comply with the annual reporting requirements under Regulation Crowdfunding during the two years immediately preceding the filing of the offering statement; and

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Ø Blank check companies, i.e., companies that have no specific business plan or have

indicated their business plan is to engage in a merger or acquisition with an unidentified company or companies.

DISCLOSURE BY ISSUERS Any issuer conducting a Regulation Crowdfunding offering must file its offering statement on Form C with the SEC through the EDGAR filing system (“EDGAR”) and with the portal facilitating the crowdfunding offering. Form C requires disclosure regarding the following:

Ø Information about officers, directors, and owners of 20 percent or more of the issuer;

Ø A description of the issuer’s business and the use of proceeds from the offering;

Ø The price to the public of the securities or the method for determining the price;

Ø The target offering amount and the deadline to reach the target offering amount;

Ø Whether the issuer will accept investments in excess of the target offering amount;

Ø Certain related-party transactions; and

Ø A discussion of the issuer’s financial condition and financial statements.

Form C also has financial statement requirements. The financial statement requirements are based on the amount offered and sold in reliance on Regulation Crowdfunding within the preceding 12-month period:

Ø Raising $107,000 or less: Financial statements of the issuer and certain information from

the issuer’s federal income tax returns, both certified by the principal executive officer.

Ø Raising more than $107,000 but not more than $535,000: Financial statements reviewed by a public accountant that is independent of the issuer.

Ø Raising more than $535,000:

• First time equity crowdfunding raise: Financial statements reviewed by a public

accountant that is independent of the issuer.

• Not the first equity crowdfunding raise: Financial statements audited by a public accountant that is independent of the issuer.

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Amendments to Offering Statement. An issuer can amend its Form C to disclose changes, additions or updates to information. An amendment is required for changes, additions or updates that are material, and in those required instances the issuer must reconfirm outstanding investment commitments within 5 business days, or the investor’s commitment will be considered cancelled. Progress Updates. An issuer must provide an update on its progress toward meeting the target offering amount within 5 business days after reaching 50% and 100% of its target offering amount. These updates will be filed on Form C-U. If the issuer will accept proceeds over the target offering amount, it also must file a final Form C-U reflecting the total amount of securities sold in the offering. If, however, the portal provides frequent updates on its platform regarding the progress of the issuer in meeting the target offering amount, then the issuer will need to file only a final Form C-U to disclose the total amount of securities sold in the offering. Annual Reports. An issuer that sold securities in a Regulation Crowdfunding offering is required to provide an annual report on Form C-AR no later than 120 days after the end of its fiscal year. The report must be filed on EDGAR and posted on the issuer’s website. The annual report requires information similar to what is required in the offering statement, although neither an audit nor a review of the financial statements is required. LIMITS ON ADVERTISING An issuer may not advertise the terms of a Regulation Crowdfunding offering except through either a tombstone type advertisement or a general advertisement that does not mention the offering terms. A tombstone type advertisement can include no more than the following:

Ø a statement that the issuer is conducting an offering pursuant to Section 4(a)(6) of the Securities Act, the name of the portal through which the offering is being conducted, and a link directing the potential investor to the portal’s platform;

Ø the terms of the offering, which means the amount of securities offered, the nature of the

securities, the price of the securities, and the closing date of the offering period; and

Ø factual information about the legal identity and business location of the issuer, limited to the name of the issuer of the security, the address, phone number, and website of the issuer, the e-mail address of a representative of the issuer, and a brief description of the business of the issuer.

An issuer may also publish a general advertisement that does not discuss the terms of the offering. “Terms of the Offering” is described in the second bullet point under tombstone advertisement above. So, as long as you do not mention the terms of the offering and so long as you refer potential investors to the portal that your offering is listed on, you can publish all kinds of information about your company, state that you are undertaking an equity crowdfunding offering and refer investors to the portal. Make sure, however, that there is a basis in fact and that your advertisements are not exaggerated or misleading.

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PAYING PROMOTERS An issuer is allowed to compensate others to promote its crowdfunding offerings through communication channels provided by an portal, but only if the issuer takes reasonable steps to ensure that the promoter clearly discloses the compensation with each communication. RESTRICTIONS ON RESALE Securities purchased in a crowdfunding transaction generally cannot be resold for a period of one year, unless the securities are transferred: (1) to the issuer of the securities; (2) to an “accredited investor;” (3) as part of an offering registered with the Commission; or (4) to a member of the family of the purchaser or the equivalent, to a trust controlled by the purchaser, to a trust created for the benefit of a member of the family of the purchaser or the equivalent, or in connection with the death or divorce of the purchaser or other similar circumstance. ESTIMATE OF COSTS ASSOCIATED WITH A REGULATION CROWDFUNDING OFFERING As you will see from the table below, assuming a $1,070,000 equity crowdfunding offering, the “all-in” cost, including commissions, ranges from about $60,000 on the lower end of the scale (assuming a good amount of DIY work) to about $120,000 on the higher end. The good news is that many of the fees can be deferred until the closing of the offering as many service providers are willing to accept some fees up front and defer the balance until the closing. In most cases, a company will be able to launch an equity crowdfunding campaign for as little as $10,000 to $25,000 with the balance of the fees deferred until capital is raised at the closing.

ITEM COST EXPLANATION

ACCOUNTING $3,000 to $7,000 Many companies that raise capital in an equity crowdfunding offering are startup companies and their financial statements are relatively simple – mostly just expenses. It is likely the first time for companies to raise capital in an equity crowdfunding offering. Therefore, an audit is not required even if the company raises $1.07 million. This cost is eliminated altogether if the company is raising $107,000 or less. The cost noted is for a review of financial statements for a typical startup. Of course, if the company is more complex or not a startup, this cost will increase.

LEGAL $6,000 to $10,000 The legal cost really depends on how much work the client is willing to do (the DIY Model) vs. how much work is delegated to the attorney.

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The typical equity crowdfunding legal services include (a) preparation of Form C offering Statement, (b) assistance with the preparation of advertising and marketing materials for the offering and legal compliance review of the same, (c) review of materials posted on the funding portal, (d) quarterback the offering – coordinate with auditors, portal, marketing agency and other service providers, (e) prepare subscription documents for the offering, (f) draft any necessary ancillary agreements and documents, including board and shareholder consents, and (g) post-closing assistance and assistance with certificate delivery and record retention. The Form C offering Statement, which is very similar in size to a standard private placement memorandum, is responsible for most of the legal costs. In many instances, Bevilacqua PLLC is willing to defer a large portion of the fee until the closing of the offering in exchange for a small equity award from the company.

COMMISSION TO PORTAL

3% to 7% of amount raised plus equity portion

Good news is that this is paid at the closing of the offering. There typically are no significant upfront fees or retainers. This commission is the cost of using the portal to create a landing page for your offering and use of the portal’s technology to facilitate sending funds into escrow and signing documents. All offerings must take place through a FINRA member broker-dealer with a funding portal or a funding portal member of FINRA.

MARKETING $15,000 to $20,000 Marketing is critical to the success of the offering. Again, in some cases, the marketing firms will work with you and let you defer a portion of the fee until the closing. This is not the place to skimp. This cost covers things like (a) social media campaign (AdWords, Facebook, Linked In, Twitter and other advertisements), (b) email marketing campaigns, (c) digital media, (d) influencer outreach including coverage by editors and bloggers, (e) press releases, (f) public relations (local, national trade and consumer and investor), and (g) potentially, if the budget is large enough, television and radio placement.

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BLUE SKY FILINGS FEES AND RELATED LEGAL COSTS

Max. $1,000 plus any state filing fees.

Title III of the JOBS ACT (Section 305) amended Securities Act Section 18(b)(4) to preempt the ability of the states to regulate certain aspects of equity crowdfunding. What this means is that there is no State review or registration requirement. However, the States can (and some do) require notice filings. At most, you could be required to file in two states: (1) the state where your principal office is based, and (2) the state where the majority of the funds came from.

SHAREHOLDER SERVICES

$500 to $1,000 per year

If you successfully complete an equity crowdfunding offering, you may end up with hundreds of shareholders. You will either need to engage a transfer agent or obtain cap table management services. Many portals offer cap table management for a flat annual fee.

ONGOING REPORTING REQUIREMENTS

$2,500 to $5,000 per year

A company that sells securities in an equity crowdfunding offering is required to provide an annual report on Form C-AR no later than 120 days after the end of its fiscal year. The report must be filed through EDGAR and posted on the company’s website. The annual report requires similar information to what is required in the Form C Offering Statement although usually neither an audit nor a review of the financial statements is required.

MISCELLANEOUS COSTS

1% to 2% of Offering Amount

To be safe, I recommend that you budget for miscellaneous costs that might arise. A good budget would be one to two percent of the offering amount.

If you are interested in learning more about equity crowdfunding or need help deciding whether it is appropriate for your company, please contact me. I would be happy to discuss this with you. I can be reached at [email protected] or by phone at (202) 869-0888 (ext. 100).