Monday, April 9, 2012

National Crowdfunding Association Begins Work with SEC on Crowdfunding Regulations

April 9, 2012
Washington, D.C.

Today the National Crowdfunding Association (NLCFA took the first steps in its mission to work closely with the SEC as the SEC begins drafting crowdfunding regulations under the recently signed JOBS Act.  DavidMarlett, the association’s Executive Director, said, “One of the key objectives of the association is to represent the industry to the SEC and to the crowdfunding self-regulatory organization which will arise in the coming months.”  Marlett is the CEO of the crowdfunding consulting firm, CrowdFund Advisors.

The NLCFA, which launched two weeks before the President signed the JOBS Act on April 5th, has grown exponentially ever since.  The association’s members include all industries and professions affected by the crowdfunding provisions of the Act, including crowdfunding portals, issuers (entrepreneurs seeking financing), consultants, attorneys, accountants, venture capital firms and investment banks, and software vendors to the industry.

Fellow NLCFA board member, Sara Hanks added, “The SEC regulations will have to address the need for simplicity in these small transactions, while also being effective tools for protecting investors.”  Ms. Hanks is a longtime Washington D.C. securities attorney who served as general counsel for the TARP Congressional Oversight Panel under Harvard professor and current Senate candidate in Massachusetts, Elizabeth Warren.   In addition, Ms. Hanks is CEO of CrowdCheck which provides due diligence services for crowdfund investors, venture capital firms, and portals.

In an effort to better represent the varied interests of its members, the NLCFA asked them the following:

  1. What are your top three concerns regarding the SEC’scrowdfunding regulations?
  1. Will you be looking for authorization of “sidecar” preferred (Reg D) offerings to your crowdfunding offerings?  If so, how are you hoping such sidecars will be allowable?
  1. Are you planning to begin general solicitations for Reg D offerings after the 90-day period ends?
  1. If you’re a portal, what do you want to be able to show on your site during the regulation-drafting period?
  1. How should the SEC monitor the total CF investments an investor makes in a 12-month period?
  1. Is there a need for new SEC regulations to cover any secondary market that arises for crowdshares?
  1. Would you prefer (and why) the crowdfunding industry develop its own stand-alone self-regulatory organization (SRO), or should theCrowdfunding SRO be stood up as a new department of FINRA?
With this information, the NLCFA will be better informed as to the pressing concerns of its members regarding the SEC’s regulations.  “This is just the start of months of heavy dialog,” said Marlett.  “And we want input from all sectors:VCs, portals, private investors, institutional brokerages, and certainly the hundreds of thousands of entrepreneurs who are chomping at the bit to get funding through crowdfunding.”   In addition, the NLCFA is asking for m\embers’ opinions regarding this year’s first annual National Crowdfunding Conference.  

For more information:
David Marlett, JD CPA 
Executive Director, NLCFA  214-208-2148

Tuesday, April 3, 2012

Numerous Crowdfund Shareholders are Not a Problem

Recently there have been a lot of concerned comments coming from the venture capital and investment banking segments regarding the following:  Will a crowdfunded company be too shareholder-heavy to be a viable second-round, VC funding candidate?   Frankly, my response is, "Whatchutalkinbout?"  

A little perspective.   Venture capital (VC) firms (and here I am including investment banking firms and angel investors and their ilk) invest in start-up or first stage companies upon two usual parameters:  the company must look to have a very large upside potential, and the VC firm must be able to have some level of control until that break-out.  Thus, when the company has raised its initial funding from numerous friends and family members, and given them common stock for those funds, that can be cumbersome for the VC who later must deal with those shareholders.  Sometimes those shareholder-heavy start-ups are simply too cumbersome and the VC passes.

Thus, with the onset of legalized investment crowdfunding, and the new limits of shareholders for a non-public company boosted to 2,000, the VC marketplace is abuzz with concerns.

But this is quite easily resolved through planning by the company at the outset of their crowdfunding offering.  Most notably, the VC concerns can be allayed through the company's use of one or all of crowd-prenups, crowd-shares, and/or crowd-convertibles.

These are the terms, set out clearly, in the crowdfunding offering, and to be agreed to in writing by any crowd-investor, establishing how the crowd for that offering must operate in the future, including but not limited to acting with one voice (cumulative voting), management of joint claims, and rights regarding later rounds of financing.  This is very important, not only for the protection of the company, the crowd-investor, but also for easing the concerns of VCs and others who may wish to offer larger financing down the road.  These crowd-prenups should be part of every deal, whether or not they use other strategies like crowd-shares or crowd-convertibles.

Simply put, the company can authorize and issue a preferred class of stock for the crowd-investors, which I propose should be called crowdshares.  Though the crowdshare class of stock may be counted in the SEC's 2,000 limit headcount (yet to be decided by SEC), the VC concerns would be significantly mitigated.  Through the limitations placed on the crowdshares, and clearly explained in the company's crowdfunding offering documents, the crowd-shareholders can will be limited in their voting, proxy, dividend, buy-back and equity allocations.  Thus, when the time came for a VC to come aboard, the VC will have full flexibility in voting, common share equity allocation, etc.

Convertible debentures, a common form of security for start-ups and first stage companies, would work well in crowdfunding.  Here the crowd-investors would receive crowd-convertibles (debentures convertible to common stock, preferred and or crowdshare stock on some pre-determined (and fully disclosed) basis.  The triggers and options for conversion would be designed such as that even upon full conversion, future second round financiers (VCs) will still have the flexibility they need.  I have found that convertible debentures are also very psychologically pleasing to first round investors, as they give a time certain at which the company must return to them to either convert or pay out on those debentures.  That soft future line has a comfort value over a raw equity investment with an open-ended future.

There are other options as well, such as traditional preferred shares, other debt vehicles, a Class B common stock tied to crowd-warrants or crowd-options, etc.

I hope this helps alleviate some of the unwarranted VC concerns currently floating around regarding crowdfunding.  I invite comments.


Monday, April 2, 2012

Crowdfunding Industry Launches National Association

Crowdfunding Industry Launches National Association

The portals, consultants and other service providers of the nascent crowdfunding industry came together to form the National Crowdfunding Association

Online PR News – 02-April-2012 –There is a new excitement on Main Street, USA, as hundreds of thousands of entrepreneurs may now, through crowdfunding, find the financial resources they need to succeed. That means millions of new American jobs, a surge in innovation, and increased financial security for families coast to coast. In addition, CrowdFunding gives rise to new hope in our individual and collective pursuit of happiness and the fulfillment of realizing entrepreneurial dreams.
Today a collection of over fifty companies and individuals dedicated to the nascent crowdfunding industry announced that they have come together and established their professional organization: the National Crowdfunding Association (NCFA). These companies and individuals, including funding portals through which crowdfunding is offered, consultants and vendors to the industry, are united in the common purposes of promoting crowdfunding in America, educating the public and their members about crowdfunding, establishing best practices for the industry, and providing the many networking opportunities availed by such an association.
In addition to its formation, the group chose David Marlett JD, CPA and filmmaker, as its first Executive Director, as well as filling other initial officer/director positions. The group also decided to host the first annual National Crowdfunding Conference in July of this year, and to launch the association’s to-be-robust (temp page presently).
The White House has announced that President Obama will sign the JOBS Act, which includes provisions authorizing investment crowdfunding, on Thursday of this week. Marlett said, “It is fitting that our members come together to officially launch the professional association, binding ourselves to the common cause of the success of crowdfunding, simultaneous with the President signing the very law that allows for us to exist.” Marlett added that he is hoping the NCFA will be present at that signing as it is the organization most benefited by the legislation.
“Crowdfunding is hope. It represents the hope of entrepreneurs that they now have an opportunity to prove to the world what they can accomplish. That is powerful stuff.”
“We are grateful to the various individuals who fought to keep crowdfunding on the legislative agenda,” said Marlett, “and to those visionary, bipartisan political leaders who brought investment crowdfunding into existence.”
Asked to define crowdfunding, Marlett responded, “Overall, crowdfunding is hope. It represents the hope of entrepreneurs that they now have an opportunity to prove to the world what they can accomplish. That is powerful stuff.” He went on to explain that crowdfunding is the method through which a company can acquire the capital it needs through offering interests in the company to hundreds or thousands of small online investors. "We have put a more full definition of the term on our site...ready for Websters will use it," added Marlett.
Prior to the JOBS Act, raising funding for small entities was tricky water -- full of sink holes. Generally speaking, only wealthy investors and companies seeking millions of dollars were able to undertake investment activities. Small businesses and start-ups were practically precluded from entering the system. “It was inherently unfair,” said Marlett. “That changes now as legalized investment crowdfunding removes those barriers.”
The gist of the crowdfunding provisions of the JOBS Act is that now companies (called ‘issuers’ under the new law) can raise up to $1 million per year through issuing securities in exchange for small online investments from anyone (including non-accredited investors). To do so, investments must be made through an SEC registered 'funding portal' or website. Investors are limited in their total crowdfunding investments in all issuers, through all portals, in any single year based on their income or net worth.
The crowdfunding bill has been somewhat opposed (though it was overwhelmingly approved by Congress) due to concerns for the protection of investors. To that end, provisions were added by the Senate, placing significant disclosure and reporting requirements on the issuer and the portal, and allowing for liability to reach deep into the issuer’s company, all the way to the senior accountant. “That will sure put a chill in the coffee of hucksters,” Marlett added. “The NCFA applauds these restrictions, and we look forward to working with the SEC in their promulgation of regulations in furtherance of this law.”
Under the JOBS Act, the SEC has up to 270 days to implement regulations for the crowdfunding industry and provide protections for non-accredited investors. “This is a great opportunity for the NCFA and its members to get geared up for full operations," Marlett said, "and to assist the SEC in creating deliberate, vetted regulations that reflect the spirit of entrepreneurial freedom found in the JOBS Act.”
Some of the key mandates for the National Crowdfunding Association include:
1. Educating the public, media and regulatory bodies regarding crowdfunding;
2. Guiding issuers and investors into crowdfunding and on to success;
3. Educating its members as to best practices in compliance with applicable federal and state laws and regulations;
4. Educating its members and the public in identifying and reporting fraud in the crowdfunding industry;
5. Representing the crowdfunding industry to federal and state regulatory authorities;
6. Representing the crowdfunding industry to the media and the public;
7. Providing networking opportunities throughout the industry;
8. Building mutually beneficial relationships with the venture capital and investment banking industries; and
9. Developing and encouraging fund-seeding with leading companies in the entertainment, software, health, energy, manufacturing and finance industries.
“This is a great moment. Our members are undertaking the birth of a new industry, a tremendous boost for the American entrepreneur,” said Marlett. “We welcome investors, portals, entrepreneurs, venture capital firms, law firms, investment banks, academic faculty and students, and of course companies and individuals who may wish to use crowdfunding, to join the National Crowdfunding Association at We will get you plugged in.”

The National Crowdfunding Association is the professional organization of all companies and individuals with an interest in crowdfunding. The NCFA is charged with "supporting, educating and protecting the American crowdfunding industry".

David Marlett
Executive Director
National Crowdfunding Association

David Marlett Appointed Executive Director of NCFA

The various portals and vendors in the crowdfunding industry gathered together for a large, industry-wide conference call, last Friday, and formed the National Crowdfunding Association.  

I was appointed the new Executive Director, and several others (to be listed in another blog entry once we all agree on positions) were appointed to also serve the NCFL.

More information forthcoming, but I wanted to let you know.  Exciting stuff!

Fund on.

Sunday, April 1, 2012

What Does the New Crowdfunding Law Say?

President Obama will be signing the legislation on Thursday!
The name of the law is “Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure Act of 2012″ or the CROWDFUND Act.
Here are the basic provisions:
Maximum aggregate amount that can be raised under the exemption: $1 million
Maximum amount per investor:
  • For investors with less than $100,000 in annual income or net worth: the greater of $2,000 or 5 percent of the annual income or net worth of such investor
  • For investors with $100,000 or more in annual income or net worth: 10 percent of the annual income or net worth of such investor
Intermediary required: The transaction must be conducted through a broker or funding portal (aka intermediary) that complies with the requirements of the Act
Requirements for intermediaries:
  • register with the SEC
  • register with any applicable self-regulatory organization (as defined in section 3(a)(26) of the Securities Exchange Act of 1934)
  • provide such disclosures, including disclosures related to risks and other investor education materials, as the SEC shall, by rule, determine appropriate
  • ensure that each investor—
    • reviews investor-education information, in accordance with standards established by the SEC, by rule;
    • positively affirms that the investor understands that the investor is risking the loss of the entire investment, and that the investor could bear such a loss; and
    • answers questions demonstrating an understanding of the level of risk generally applicable to investments in startups, emerging businesses, and small issuers; an understanding of the risk of illiquidity; and an understanding of such other matters as the SEC determines appropriate, by rule
  • take such measures to reduce the risk of fraud with respect to such transactions, as established by the SEC, by rule, including obtaining a background and securities enforcement regulatory history check on each officer, director, and person holding more than 20 percent of the outstanding equity of every issuer whose securities are offered by such person
  • not later than 21 days prior to the first day on which securities are sold to any investor (or such other period as the SEC may establish), make available to the SEC and to potential investors any information provided by the issuer
  • ensure that all offering proceeds are only provided to the issuer when the aggregate capital raised from all investors is equal to or greater than a target offering amount, and allow all investors to cancel their commitments to invest, as the SEC shall, by rule, determine appropriate
  • make such efforts as the SEC determines appropriate, by rule, to ensure that no investor in a 12-month period has purchased securities offered pursuant to the crowdfunding exemption that, in the aggregate, from all issuers, exceed the investment limits of the exemption
  • take such steps to protect the privacy of information collected from investors as the SEC shall, by rule, determine appropriate
  • not compensate promoters, finders, or lead generators for providing the broker or funding portal with the personal identifying information of any potential investor
  • prohibit its directors, officers, or partners (or any person occupying a similar status or performing a similar function) from having any financial interest in an issuer using its services
  • meet such other requirements as the SEC may, by rule, prescribe, for the protection of investors and in the public interest.
The SEC will exempt funding portals, conditionally or unconditionally, from the requirement to be licensed brokers, as long as they become members of a national securities association and do not
  • offer investment advice or recommendations;
  • solicit purchases, sales, or offers to buy the securities offered or displayed on its website or portal;
  • compensate employees, agents, or other persons for such solicitation or based on the sale of securities displayed or referenced on its website or portal;
  • hold, manage, possess, or otherwise handle investor funds or securities; or
  • engage in such other activities as the SEC, by rule, determines appropriate
Requirements for issuers:
  • file with the SEC and provide to potential and existing investors and the intermediary—
    • the name, legal status, physical address, and website address of the issuer;
    • the names of the directors and officers (and any persons occupying a similar status or performing a similar function), and each person holding more than 20 percent of the shares of the issuer;
    • a description of the business of the issuer and the anticipated business plan of the issuer;
    • a description of the financial condition of the issuer, including, for offerings that, together with all other offerings of the issuer under the crowdfunding exemption within the preceding 12-month period, have, in the aggregate, target offering amounts of—
      • $100,000 or less—(I) the income tax returns filed by the issuer for the most recently completed year (if any); and (II) financial statements of the issuer, which shall be certified by the principal executive officer of the issuer to be true and complete in all material respects;
      • more than $100,000, but not more than $500,000, financial statements reviewed by a public accountant who is independent of the issuer, using professional standards and procedures for such review or standards and procedures established by the SEC, by rule, for such purpose; and
      • more than $500,000 (or such other amount as the SEC may establish, by rule), audited financial statements;
    • a description of the stated purpose and intended use of the proceeds;
    • the target offering amount, the deadline to reach the target offering amount, and regular updates regarding the progress of the issuer in meeting the target offering amount;
    • the price to the public of the securities or the method for determining the price, provided that, prior to sale, each investor shall be provided in writing the final price and all required disclosures, with a reasonable opportunity to rescind the commitment to purchase the securities;
    • a description of the ownership and capital structure of the issuer, including—
      • terms of the securities of the issuer being offered and each other class of security of the issuer, including how such terms may be modified, and a summary of the differences between such securities, including how the rights of the securities being offered may be materially limited, diluted, or qualified by the rights of any other class of security of the issuer;
      • a description of how the exercise of the rights held by the principal shareholders of the issuer could negatively impact the purchasers of the securities being offered;
      • the name and ownership level of each existing shareholder who owns more than 20 percent of any class of the securities of the issuer;
      • how the securities being offered are being valued, and examples of methods for how such securities may be valued by the issuer in the future, including during subsequent corporate actions; and
      • the risks to purchasers of the securities relating to minority ownership in the issuer, the risks associated with corporate actions, including additional issuances of shares, a sale of the issuer or of assets of the issuer, or transactions with related parties; and
    • such other information as the SEC may, by rule, prescribe, for the protection of investors and in the public interest;
  • not advertise the terms of the offering, except for notices which direct investors to the intermediary’s web site
  • not compensate or commit to compensate, directly or indirectly, any person to promote the offerings without taking such steps as the SEC shall, by rule, require to ensure that such person clearly discloses the receipt, past or prospective, of such compensation, upon each instance of such promotional communication
  • not less than annually, file with the SEC and provide to investors reports of the results of operations and financial statements of the issuer, as the SEC shall, by rule, determine appropriate, subject to such exceptions and termination dates as the SEC may establish, by rule
  • comply with such other requirements as the SEC may, by rule, prescribe, for the protection of investors and in the public interest.
Transferability: Securities issued pursuant to the crowdfunding exemption may not be transferred for one year after purchase except back to the issuer, to an accredited investor; as part of a registered offering; or to a family member
Automatically becoming a public reporting company when a certain number of shareholders and asset amount is reached: securities acquired under the crowdfunding exemption will be exempted, conditionally or unconditionally depending on what the SEC does in its rulemaking, from this cap (which was increased from 500 investors to 2,000 by the JOBS Act – see future blog post on this subject!)
State preemption: the states are not allowed to require registration of offerings that are exempt under the crowdfunding exemption; however the can require notice filings and fees in the state that is the issuer’s principal place of business and in any state in which purchasers of 50 percent or greater of the aggregate amount of the issue are residents
Adjustment for inflation: Dollar amounts under the exemption will be adjusted not less frequently than once every 5 years to reflect any change in the Consumer Price Index
How long until the SEC finishes its rulemaking?  You’ll notice numerous places in the law that mention rulemaking by the SEC; until the SEC completes the rulemaking process, the law cannot go into effect; the statute gives the SEC nine months to complete the rulemaking process but there are no penalties if they do not complete the rulemaking within this time, so it is difficult to say how long it will take.