Regulation Crowdfunding (Reg CF) Financing
The keyword is access. Crowdfunding is a revolutionary way for a company to raise capital with debt, equity, convertibles, revenue sharing, or other offerings. It gives access to investors that don’t necessarily have enough money to deploy and make a difference on their own. Smaller individual investors can contribute to combine forces with companies they already support by using their products or services, or connecting with the mission and vision on any level. Crowdfunding presents a unique opportunity to grow with a business that might not have a way to get bank loans or traditional funding.
It all started with the JOBS Act in 2012. Reg CF (Title III of the JOBS Act), Rule 506(c) (Title II of the JOBS Act), and Reg A (Title IV of the JOBS Act) are different paths to crowdfunding. This article will focus on Reg CF, but discusses some of the interplay and overlap with the others. There have been many developments and updates over the past decade, and no doubt those will continue to roll out as we learn more about the successes and failures of these offerings in due time. The authorities that govern these investments are the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA), as well as state agencies.
Any time you (a founder of the issuer) are taking money from an investor, you should be careful to fully understand what is required from a regulatory standpoint, and practically. These people will want to know what you’re up to with their money, and there are a few ways to let them know upfront and as you go with disclosures and updates. Compliance with securities regulations can seem complex, but it really boils down to being honest, forthcoming, and real about the deal.
Structuring
Since being amended in March 2021, an issuer can raise as much as $5 million within 12 months, increased from the prior/lower limit of $1,070,000. Since the SEC published new, inflation-adjusted limits and thresholds for Reg CF effective September 20, 2022, first-time issuers are required to provide audited financial statements if they plan to raise at least $1,235,000. Simultaneous/sidecar financings with Reg D are a way to take bigger investments from accredited investors with a 506(c) offering that permits general solicitation, while having smaller investments funneled through the crowd and a special purpose vehicle (SPV).In the early days, one complication and deterrent to crowdfunded equity raises was adding hundreds of investors to the mix. With an SPV, though, only one entity will be listed on the capitalization table as an investor. When determining how to structure your offering consider whether you have had (or plan to have) any other offerings, since multiple offerings may be integrated, and what kind of security you are selling, be it a loan you have to pay back over time with interest (note), a convertible security, a portion of your earnings into the future (rev share), or an immediate ownership stake in your company (stock/shares/units/interest/equity).
Filing
The Form C asks for basic information but also digs pretty deep so an investor can gauge whether the deal makes sense for them. You have to describe the securities offered and pricing, list the directors, officers, and owners, capital structure, dilution, debt, related-party transactions, your financial condition, financial statements, bad actor disclosures, provide your business plan with risk factors and a legend/warning, and include any other information that might be material/important for an investor to understand and make an informed decision about what they’re getting into.There are also ongoing reporting requirements to consider. After filing the first Form C/AR under Rule 202, which is the annual report required after the offering is completed, you may be able to stop filing those with a Form C/TR if you have less than 300 shareholders and $10,000,000 in assets.
Advertising
Reg CF has limits on advertising. Until you file the Form C and the offering is live, you should not mention the financing unless you have a “testing the waters” disclaimer. That disclaimer allows you to gauge interest and get traction without officially making the offering available. When the offering does go live, try not to mention (1) how much money the company is trying to raise, (2) what kind of securities the company is offering, (3) the price of the securities, or (4) the closing date of this offering. If you say any of these four things, the communication is subject to the “tombstone” limits of Rule 204 of Reg CF. These are strict limits.With any marketing effort, an issuer can run “tombstone” ads directing potential investors to the funding portal and giving the basic terms of the offering like the amount being raised and price per share, but that’s it – if you say one of those four things, you can only say those things, and flatly, to direct attention to the funding platform/portal where they can learn more. An issuer can't advertise the details of the offering using the Internet, print ads, airplane banners, or otherwise (except through the funding portal).It is best practice not to include information about the offering on the company's website, or else the entire website is subject to Rule 204 scrutiny. Instead, have a separate landing page with a link to the funding portal. The spirit of the rules is that each potential investor should have access to the same information, and all of the information that’d be required to make an informed investment decision. No pressure, just presentation of the opportunity.
Closing, Funding, and Aftermath
After you’ve raised at least the minimum amount, you may access the funds and take them out of an escrow account set up by the portal. Most intermediaries keep track of who has invested and how much, and provide resources to help you reach them and pay them back if the deal terms call for that. It is very important to consider the investors to be part of your company and community, as they have aligned interest in seeing you succeed. Consider ways to engage and activate this base of supporters.With SPVs and the help of the portal, it’s relatively easy to send streamlined updates to the lead investor or representative for the crowd, and to honor whatever deal you struck with them. Whether that’s providing ongoing access to financial statements and a percentage of revenue, or a convertible instrument that gives investors equity when a triggering event happens, remember that these investors will eventually want to see a return or at least an update.If you’re considering crowdfunding, we’re here to help.Picture on the top is by Pixabay and is in the public domain.Headquartered in the Research Triangle region of North Carolina, Fourscore Business Law serves entrepreneurs and businesses in the Triangle, throughout the Southeast and in Silicon Valley / San Francisco. We also represent venture capital funds and other investors who invest in companies throughout the U.S. The idea of delivering maximum impact in a simple and succinct manner is what we’re calling the Fourscore Principle. And that is what Fourscore Business Law is based on. Our clients operate in a broad range of industries including tech, IoT, consumer products, B2B services and more. Questions? Shoot us an email or give us a call at (919) 307-5356. Your first call is on us.