This blog provides information and updates on the North Carolina Providing Access to Capital for Entrepreneurs and Small business Act (NC PACES Act) which enables a new way to finance small business in North Carolina using investment crowdfunding. The NC PACES Act was passed unanimously in the North Carolina General Assembly and signed into law by the Governor in July 2016. The rules are in place and the law is now in effect as of April 1st, 2017.
Benji's Blog - By Benji T. Jones This is part 2 of a 2 part post on the five myths of investment crowdfunding. Part 1 is here.
Myth #3: Will Regulation
Crowdfunding make all other paths redundant?
No. There is no one-size-fits-all
exemption. Issuers may have many
different objectives that impact which path is best. Just look at the offering caps – companies
can only raise $1 million per year under Regulation Crowdfunding. That might be too low. So companies may need to consider alternate
paths to raise a larger amount of capital.
Local crowdfunding exemptions may provide access to a larger
amount. Currently, SB481 (NC PACES)
would permit companies with reviewed or audited financials to raise up to $2
million in a 12-month period. Regulation
A increases those caps to as much as $50 million in a 12-month period; Rule 506
has no cap. Despite the lower offering
thresholds, some issuers may be drawn to the Regulation Crowdfunding or local
crowdfunding statutes for the marketing bonus – harnessing the “crowd” to
promote an enterprise can be an extremely powerful tool and added bonus for
some issuers. Alternatively, other
companies will require more sophisticated investors, preferring to target only
accredited investors through Rule 506 or structure a hybrid offering under
Regulation A. Regulation Crowdfunding
simply opened up another avenue for companies to pursue capital, but it is
unlikely to become a roadblock for pursuing other options.
Myth #4: Are all investors created equal?
Know your audience.
Understand the costs and
benefits associated with accepting money from investors who may lack experience
in making investments in private companies (where securities have to be held
for an indefinite period of time and there is no public market for secondary
sales). Their tolerance for risk or
their expectation of how long they should have to wait before they are able to
get a return on their investment may be different. The value they may add to a business
enterprise may not be the same as the “super wealthy” experienced investor. Will your investors be easy to manage and
communicate with or will they require extensive hand-holding? It’s important to understand the pros and
cons of taking an investment from anyone – before making the offer.
Note also --- you may
need to verify who is an Accredited Investor.
Rule 501 of Regulation D
currently defines “accredited investor” to generally include: (1) banks and
other large entities; (2) executive officers and directors of the issuer; and
(3) high net worth individuals who have earned income that exceeded $200,000
(or $300,000 together with a spouse) in each of the prior two years, and
reasonably expects the same for the current year, or who have a net worth over
$1 million, either alone or together with a spouse (excluding the value of the
person’s primary residence and any loans secured by the residence (up to the
value of the residence)).
You cannot always check the box to confirm this
status. This is of particular importance
in Rule 506(c) offerings (which involve general solicitation), when an issuer
needs to “verify” that each purchaser is accredited. There are services issuers can hire to do
this, and there are principled approaches to undertaking the verification independently,
but the SEC has indicated that just getting an investor to “check the box”
isn’t one of them.
You will also need to stay abreast of changes in
the accredited investor definition. The
SEC has been actively examining this definition (as required every four years
pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection
Act). In December 2015, the Staff
released a detailed report analyzing the current
definition and making certain recommendations for modifying it. The Staff’s recommendations touched on ways
to adjust the financial threshold requirements (such as keeping the current
thresholds but applying investment limits or creating new inflation-adjusted
thresholds) and adding categories of accredited investors based on measures of
sophistication not currently contemplated (such as a minimum investment
threshold, professional credentials, etc.).
It will be important to monitor these changes and to be prepared to
explain to clients how these changes might impact their choices.
#5: Can companies “go it alone”?
many instances an issuer is not allowed to conduct an offering without the use
of a portal or intermediary. Practically
speaking, it also might not be prudent to try to conduct the offering without
using one. It just depends on what path
or exemption will be used. In a
nutshell: an issuer must use a crowdfunding intermediary (either a
registered funding portal or a registered broker-dealer) under Regulation
Crowdfunding. The same may be the case
for local crowdfunding exemptions, but it will depend on the rules that apply
to a particular jurisdiction. Although
companies are not required to use an intermediary for Regulation A offerings,
they may want to engage some kind of listing platform or broker-dealer
to help market the deal if they want to raise a significant amount of money
(say over $10 million). Accredited
Investor offerings are kind of a hybrid.
Theoretically, companies could advertise their offerings independently
under Rule 506(c), but many larger deals are conducted through platforms
(AngelList, Equity Shares, Funders Club, CircleUp, etc.) that structure direct
investments and syndicated investments in companies and facilitate verification
when general solicitation is involved.
But remember . . . not all portals are
Companies (and their advisors) need to carefully
diligence who to use to help with the offering.
Offering portals are potentially regulated as investment advisors and as
broker-dealers. They may also be
structuring transactions in a way that implicates the Investment Company Act of
1940. Portals will need to comply with
specific regulations imposed upon their activities (like under Regulation
Crowdfunding). The overlapping nature of
these regulations is complex, and it is important to find an operator that
understands how these regulations impact what it can and cannot do as well as
what it must do. We are just now
finding out who is registered as a funding portal – take a hard look at
them. Understand how platforms charge
fees, whether they conduct diligence on offerings, whether they structure
transactions or provide form documents.
Do they have experience in other forms of online offerings? What is their track record? Can they provide verification of accredited
investors or are they simply a bulletin board service? Are they a registered broker-dealer or
working with one? Read the fine print and
the FAQs on the portal’s website. Look for the regulatory disclosures to assess
how they operate (or if they even know that there are compliance issues to
address). Use the Internet to assess the
reputation and success of different portals.
See what bloggers are saying about the landscape.
diligence before engaging a partner or commencing an offering and then work
with your client to determine what best serves its needs.
* * * *
Benji Jones is a partner at the
Smith Anderson law firm with extensive experience in representing companies in
exempt and non-exempt securities offerings.
Feel free to reach out directly to the author with questions or