Welcome to the world of crowdfunding. For those of you that have just heard the term, the crowdfund exemption was signed into law by the President April 5th. It is part of the Jumpstart Our Business Startups (JOBS) Act. It will take 270 additional days for the SEC to provide final regulatory guidance.
Scenario
Fast forward a year. The SEC has promulgated rules affecting Title III – Crowdfunding. Crowdfund Investing Portals (CIP’s), investors and issuers have had time to digest the SEC’s rubric.
Many CIPS do not qualify for registration. They fail to provide adequate measures to protect, educate and inform investors; or they fail to demonstrate the means to properly qualify issuers or report to the Commission.
Investors flock to the remaining registered CIP’s (if they have not done so already); fill out an application and answers questions to determine suitability, comprehension of risk and liquidity. Since the Act limits the amount of capital they can commit, investors speculate wisely (see footnote 1).
Issuers must comply with the transparency, due diligence and reporting requirements imposed. They quickly realize the costs associated with compliance may be more than the amount of capital needed.
Planning
For investors to win, they obviously need to pick investments with the best upside. Aggregate investment limits set by the Act reduce downside risk, but limit upside if they happen to pick the next Google (see footnote 2). They should choose issuers and CIP’s that offer resources beyond what is required by law.
Issuers need a well thought out plan for success. There will be a rude awakening for entrepreneurs who think they will be able to fund an “idea” without embracing transparency issues. They should prepare for full disclosure requirements by setting up cloud-based access to their business plan, financial summaries and other due diligence documentation. Assembling a board of advisors to help run the business and act as a sounding board for legal and accounting issues is a must.
Successful CIP’s will attract and keep investors by profiling issuer companies which produce results. One way to accomplish this is to specialize in vetting a particular market segment or segments such as “green”, energy, technology or socially responsible companies, for example. Another way for CIP’s to increase the odds for a healthy Return on Investment (ROI) is to provide issuers with access to advisory services to help grow their companies and/or M&A services when it is time to exit.
The goal of the Act is to create jobs. The goal for the SEC is to protect the investor. The SEC has plenty of latitude to augment the rules beyond the minimum requirements currently in the Act (my previous blog explores this topic). CIP’s need to plan now by implementing policies and procedures which will position themselves to qualify for registration. Investors should choose issuer companies with a well-defined game plan to produce jobs. This strategy should produce the highest ROI. Issuers should choose to register on CIP’s that either specialize in vetting companies in their particular industry and/or provide access to M&A and advisory services.
I am willing to host a webcast to answer questions concerning crowdfunding…particularly questions as it pertains to M&A strategies for issuers. Please let me know if you would be interested. If I get enough inquiries, I will schedule one.
One last item – a precursor
The SEC has 90 days (from April 5th) to revise its rules issued in the Code of Federal Regulations, section 230.506 of Title 17. This will allow for general solicitation or general advertising of securities to accredited investors. Dodd-Frank changed the accredited investor definition to exclude the value of the investor’s principal residence and any debt secured by the principal residence (not exceeding the value of the residence). The issuer is responsible for verifying an investor is accredited. It will be interesting to see if the SEC changes the current method of verification which is a self-authenticating questionnaire sent to the investor by the issuer or broker/dealer. It will also be interesting to gauge the latitude used by the SEC during the 506 determination. This will be a good indicator of what lies ahead for the crowdfund exemption.
Footnotes
(1) the greater of $2,000 or 5 percent of the annual income or net worth of such investor, as applicable, if either the annual income or the net worth of the investor is less than $100,000; and
(2) 10 percent of the annual income or net worth of such investor, as applicable, not to exceed a maximum aggregate amount sold of $100,000, if either the annual income or net worth of the investor is equal to or more than $100,000.
Navocate provides Business Sales and Acquisitions services for Emerging Companies with revenues from $3M - $30M. Specifically, Navocate focuses on the market segment above business brokers, and below investment banks. For more information please visit www.navocate.com.
The team that wrote this legislation came out of Silicon Valley which is mostly IT dominated. A $1M to develop an app or a program is reasonable. But in the Mid-west where manufacturing start-ups are trying to get funding, $1M does not do much. This is disappointing.
ReplyDeleteThe other issue is why are so many investors always interested in finding the next Google. They would be better off going to Las Vegas. Also in manufacturing, we focus on long term sustainable businesses not flash in the pan companies that look for a quick exit. Why is the investor market not interested in long term sustainable companies?
Posted @ Tuesday, April 24, 2012 11:40 AM by Richard Marks
Point well taken, Richard.
ReplyDeleteI agree some manufacturing start-ups need be capitalized better.
Check this out. Sec. 4A of the Crowdfunding Exemption (requirements with respect to certain small transactions) part (g) Rule of Construction states that “nothing in this section or section 4(6) shall be construed as preventing an issuer from raising capital through methods not described under section 4(6).”
This means any company (including manufacturers) are not prevented from raising additional capital by other methods, as long as they are not relying on the exemption. The $1M could certainly position the company for a larger raise.
I think the key, if you are an issuer, is to choose a Crowdfund Investing Portal (CIP) that vets their companies beyond what regulations require, provide access to advisory services to help them grow and have strategies in place when the companies need access to larger capital, whether they are a technology or manufacturing company.
The Google example is just that, an example. Although investors do diversify across different industries sectors, they would rather choose an investment which produced the five year ROI of a company like Google, or Home Depot, or McDonald’s, etc. (with the benefit of hindsight). CIP’s can help achieve this goal.