Sunday, April 29, 2012

Dissecting Crowdfunding

Reprinted from Capitalist Exploits

by MARK WALLACE on APRIL 24, 2012




I wrote a piece on crowdfunding back in November, right after congress overwhelmingly passed The Entrepreneur Access to Capital Act.


Well, on April 5th President Obama signed into law the Jumpstart Our Business Startups Act (aka the JOBS Act). This pretty much cements crowdfunding as an alternative to traditional capital raising channels.

That being said, the SEC will have 270 days to review the ACT and set its own rules for investors and issuers looking to become involved in this new area of capital raising. Let’s see how badly they mess up a good thing.

Although we’ve talked about it before, let’s dive a bit deeper and tear the Act apart.

First, let’s define crowdfunding. According to Oxford Dictionaries it is:

“The practice of funding a project or venture by raising many small amounts of money from a large number of people, typically via the Internet.”

I like this definition from USLegal.com better:

“Crowd funding refers to the collective cooperation, attention and trust by people who network and pool their money and other resources together, to support efforts initiated by other people or organizations. The purpose of crowd funding varies, from disaster relief to citizen journalism to artists seeking support from fans, to political campaigns. Crowd funding is also used for startup companies.”

That last part is what we are interested in – startup companies. Title III of the Act covers crowdfunding of securities… like those a startup would issue to seed or fund its growth.

The Act creates a new exemption under Section 4 of the Securities Act of 1933 that permits the sale of securities (stock) through crowdfunding. Issuers (private companies) can now publicly sell up to $1 million of securities per year (every 12-months).

Despite some in the media’s immediate negative reaction and assumption that crowdfunding will lead to widespread fraud, it’s not a free-for-all, in fact, far from it.

First of all, if you are already public, a foreign issuer, or a company considered an investment company under Section 3 of the Investment Company Act of 1940, sorry but you will not be able to utilize crowdfunding.

As you’ll see, the disclosure and registration requirements that intermediaries (brokers, or websites) and issuers have to adhere to are adequate enough to protect investors.

Issuers still need to file with the SEC and provide information to the agency and investors. This information includes the issuer’s business description and business plan; annual operational and financial reports; ownership and capital structure; and, a description of the intended use of the financing proceeds.

Issuers are not allowed to advertise (outside of the web-based portal or through a broker), and they cannot hire promoters, lead generators or finders. They must also provide the following financial information:

  • For offerings that have target amounts under $100,000, the issuer’s most recent tax return and financial statements certified by its principal executive officers;
  • For offerings with target amounts between $100,000 and $500,000, the issuer’s financial statements reviewed by an independent public accountant;
  • For offerings with target amounts of over $500,000, the issuer’s audited financial statements;
Issuers need to set a target amount for the fund raising and a deadline to reach the target amount. The price of the offering, and how it was arrived at needs to be disclosed, as does the ownership and capital structure of the issuer, including, among other things, a description of how the exercise of other shareholders’ rights could negatively affect investors.

The intermediary broker or funding website also has to register with the SEC, and the funding transaction has to be conducted through one of those two channels. The broker or funding website also have to ensure that investors understand the risks of the investment and meet certain requirements, including:

  • If the investor’s annual income or net worth is less than $100,000, the greater of $2,000 or 5% of the investor’s annual income or net worth, or;
  • If the investor’s annual income or net worth is $100,000 or more, 10% of the investor’s annual income or net worth, but not more than $100,000.
The intermediary must also conduct background checks for each officer, director, and holder of more than 20% of the issuer’s shares; disseminate the offering proceeds to the issuer only when the target offering amount is reached or exceeded; and ensure that no investor has exceeded the individual investment limit.

In most cases the securities will also need to be held for 12 months before they can be sold.

Phew, it’s not as simple as some would have us believe is it?

Once investors purchase a security via a crowdfunding financing, the purchased securities will be “Covered Securities.” This pre-empts the application of state blue sky laws. States can still require a filing or payment of a fee with respect to securities issued under the crowdfunding exemption, but only if the issuer’s principal place of business is in the state, or the purchasers of fifty percent or more of the aggregate amount of the securities sold are residents of the state.

States can also chase fraudsters and take enforcement actions if they feel something shady has occurred or an issuer has misrepresented the offering.

How do intermediary sites make money?

Good question. Given the clear restrictions in the Act regarding issuers’ and intermediaries’ ability to pay for promotion, or otherwise exchange fee for services, it will be interesting to see how the sites that evolve to fill this niche actually monetize their services!

Sites like IndieGoGo charge issuers a fee of between 4%-9%. Kickstarter charges 5% only if the funding is successful. However, the important difference is that these sites are not really funding companies, they are funding projects, and the people doing the funding are pledging very small amounts, and receiving something other than securities in exchange.

For instance… If I fund my buddies rock band to go on tour in New York, I may receive tickets to their next local show, a t-shirt, or a copy of their latest CD single. Since these sites are not selling a “security” the same rules don’t apply.

Under the Act, a crowdfunding website acts as an intermediary in a funding transaction, but does not offer investment advice or recommendations; solicit purchases, sales, or offers for the securities featured on the website; compensate its employees, agents or others for such solicitation or for the sale of securities featured on its website; or hold, manage or otherwise handle investor funds or securities.

So I’ll ask it again, and if anyone out there knows the answer please do tell… How will sites functioning as the middle men in crowdfunded securities transactions make money? And, why would a traditional broker bother with any of this?

What about liability?

Issuers still have liability to investors under the Act. If they make an untrue statement of material fact, or fail to state a material fact in a transaction, an investor who purchases their security can bring an action against them.

Another thing worth mentioning is that since the Act’s definition of “issuer” includes any person who offers or sells a security in a crowdfunding transaction and, to the extent that they offer or sell a security in such a transaction, also includes the issuing company’s directors, partners, and principal executive, financial and accounting officers, there exists a great deal of personal liability for officers and directors.

One of the most interesting sections of the Act regards “aggregate capital raised,” and the all-or-none nature of crowdfunding transactions. An intermediary may provide offering proceeds to the issuer only when the aggregate capital raised is equal to or greater than the target offering amount, and the issuer must allow all investors to cancel their commitments to invest. This implicates Rule 10b-9 of the Securities Exchange Act, which requires that, in an all-or-none offering, any money paid for the securities be “promptly refunded” to investors if all of the securities are not sold.

So after all that, come up $1000 short and forget it..?

What do we make of all this?

We were chatting with our friend Dan Faiman, who is working on a platform in this space as well. That platform will be part of the incubator Chris and I have talked about herein on several occasions.

Dan feels that we’ll see hundreds of sites pop up to try and take advantage of the perceived opportunity in this space. He has a few ideas of his own about how to monetize a site like this without running afoul of the Act or its likely interpretations.

As mentioned earlier, the SEC has yet to formulate any rules on crowdfunding, but you can be sure that they will have quite a lot to say. What this whole thing looks like once they get through with it is anyone’s guess. Those that are rushing headlong into the space willy-nilly are likely to find themselves paddling upstream, sans paddles.

It seems that a prudent approach would be to sit back and wait until we get a bit more clarity. Meanwhile working to create something where you’re not just providing a match-making service between investor and project, but actually adding a bit of value in between, may just be the way to go.

Tomorrow we’ll hear from our friend Jeff Bone again. Jeff has some interesting things to share with us on this topic, and more.

Mark

Friday, April 27, 2012

U.S. House Passes Controversial CISPA Cybersecurity Bill 248 To 168

Reprinted from: The Best iPad (Frederic Lardinois) - 4/26/12 7:33 PM

The United States House of Representatives · House.gov

This afternoon, the U.S. House of Representatives passed the controversial Cyber Intelligence Sharing and Protection Act (CISPA) by a vote of 248 to 168. UnlikeSOPA, which focused on copyright violations, CISPA wants to give Internet companies and the U.S. government the tools to protect and defend themselves against cyber attacks by sharing information with each other. Critics, however, argued that this information sharing would be happening with very little oversight and would put Americans’ privacy rights at risk.

Rep. Jared Polis (D-Colo.), an outspoken critic of the bill, argued that the bill would “waive every single privacy law ever enacted in the name of cybersecurity. Allowing the military and NSA to spy on Americans on American soil goes against every principle this country was founded on.”

Even though this bill has now passed the House, chances are that it will not get through the Senate. On Tuesday, the White House issued a statement condemning the bill and on Wednesday, President Obama threatened to veto the legislation because it “fails to provide authorities to ensure that the nation’s core critical infrastructure is protected while repealing important provisions” of long-established privacy law.

Critics, including the Electronic Frontier Foundation, argue that the current version of this bill is basically a major violation of established privacy rights and would allow companies to hand anything and everything you do and say online over to the government in the name of “cybersecurity.”

Proponents of the bill, including House Intelligence Committee Chairman Mike Rogers (R-Mich.),argue that the bill is “needed to prepare for countries like Iran and North Korea so that they don’t do something catastrophic to our networks here in America.”

An earlier provision in the bill that would have given Homeland Security more authority to monitor the Internet was dropped before the bill (PDF) passed. In return, though, a number of last-minute amendments, including one that expands the list of reasons for which shared information can be used. While the bill still allows for Internet companies to hand over confidential customer information to U.S. security and intelligence agencies, as well as local low enforcement services, it is worth noting that it does not require them to do so.

You can read a full version of the bill here (PDF).





Thursday, April 26, 2012

Crowdfunding and M&A - How to Yield Returns

Posted by Paul Winkle on Tue, Apr 24, 2012 @ 08:06 AM



Paul Winkle - crowdfundingWelcome 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.
crowdfung planning

Conclusion
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.

Tuesday, April 3, 2012

Should you use crowdfunding to buy or sell a business?

This article was written by Paul Winkle and published from  www.navocate.com



If you haven’t heard of the Crowdfund or JOBS Act of 2012…you soon will. The Bill, approved by the House of Representatives last November got a thumbs up from the Senate last week. The amended version was sent to the President Tuesday for his signature and is expected to be signed by the end of the week.

The idea behind the crowdfunding exemption is to allow individuals to collectively pool monies to invest in U.S. businesses via approved and registered crowdfund investing portals. Previously, this type of investment was only available to accredited investors. Business owners trying to raise funds will now be allowed to use advertisements to attract investors under the new crowdfunding guidelines.

Things to know if you are an investor:

  • There are restrictions on the amount of money you can invest and on the aggregate amount invested. 
  • You will not be able to readily sell your shares for a period of one year unless they are bought by an accredited investor or the issuer. 
  • There is not an established trading market and therefore limited liquidity. 

You should choose a registered crowdfund portal (any person engaged in the business of effecting transactions in securities for the account of others) that provides investor disclosures and education as required by the act. Crowdfund investing portals are required to screen candidate companies by performing extensive background checks. 

The hope, of course, is that you get lucky and invest in the next Facebook or Apple. To increase your odds of finding the next Google, look for registered sites that go beyond the required rules. These sites perform more intense screening techniques and take steps to create liquidity for the investors who register on their portal. 

A good example is www.earlyshares.com. EarlyShares profiles companies with the goal of providing their crowdfunding investors with those companies that will offer a good return on investment within three years of the funding date, preferably by means of acquisition (m & a). They don’t fund medical device companies, biotechnology companies, restaurants, consultancies, or real estate related projects and companies.

Things to know if you are a business owner:

The purpose for the Crowdfund Act is to create jobs in America. Every rule and regulation is there to assure that goal is accomplished. Click HERE To read the s. 2190 version of the Bill.

If you are a business owner or entrepreneur in search of funding for your company several factors need consideration, including those listed below:

  • File the proper forms with the SEC and provide investors and the relevant broker or funding portal pertinent information about your company and its owners.
  • Describe the financial condition of your business, the amount you want to raise, the deadline for raising the funds and the price and terms of the securities being offered.
  • Explain how the securities being offered are being valued.
  • Define the risks to purchasers of the securities.
  • Only provide notices which direct investors to the funding portal or broker (e.g., you may not advertise the terms of the offering.)

The rules can be onerous for the unfamiliar. That’s why it’s important to choose a crowdfund investing portal with the proper procedures already in place to manage the reporting requirements of the Act. 

An example of a company which provides compliant back office solutions for crowdfund investing portals is Funding Roadmap. They provide cloud-based business plan access, due diligence and GAAP compliant financial statements to meet the transparency requirements of the Act. Visit Crowdfundingroadmap for more information. 

Make sure that you also consider the long-term picture. Crowdfund Investing portals that have thoughtfully considered how to educate and align you, the owner, with capable experts will pay off. Pay particular attention to the ones that can introduce you to Merger and Acquisition (m & a) firms that specialize in helping Emerging Companies. You will need their help securing future financing or negotiating and executing the sale of your company. This will help keep your new shareholders satisfied. 

A great website to learn more about crowdfunding and the exemption framework is startupexemption.com.

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.

Crowdfunding Sites Are Springing Up Like Dandelions

The following is a repost of an article that appeared on the San Francisco Chronicle, as provided by Julie Bort

On Thursday, President Obama is scheduled to sign the JOBS Act which makes it easier to raise funds online. (Although not as easy as the original bill would've made it.)

Every day we hear from yet another crowdfunding site crowing about the situation.

Most of them were alive and well before the JOBS Act and they built their sites with the previous legal restrictions in mind. Project owners couldn't sell pieces of their company or pay back the money.  Instead they gave away rewards for different levels of investing like copies of the product, limited editions or weird things, like dinner with the inventors.

But a few new sites are in the works that will let investors get a financial return for their money.

All told, we know of seven sites to help you raise seed money online:
  • Crowdfunder: A new site in beta that will take advantage of the new law. Although it's not open for business yet, its founders claim it has 1,121 investors ready to spend $15.44 million on projects. It says 1,055 companies already lined up to grab those funds.
  • Wefunder -- Another new crowdfunding site in beta. It claims the site already has 3,649 funders who will invest $8,972,400 in startups.
  • Indiegogo: This site specializes in creative ventures, like movies, music, theater, fashion, even sports. But its got its share of products and tech, too.
  • AngelList: This site doesn't do the actual crowdfunding, but it helps a startup get discovered by angel investors.  Hopefuls post info about their company and the angels call them.
  • Kickstarter: The granddaddy of crowdfunding sites. So far in 2012, two projects have raised over $1 million on Kickstarter. Several others have surpassed $250,000. (Here's a list).


Click to read the article from it's original source