Thanks to SEC regulations passed last year under the federal JOBS Act,
it is now possible for small businesses, startup companies and other
privately-owned enterprises to raise capital and sell securities via
crowdfunding websites such as Kickstarter and IndieGoGo. A number of
specialized crowdfunding websites, known as “funding portals,” have been
set up to handle what is expected to be a “gold rush” of crowdfunded
offerings now that the regulations have become effective in May of this
year. But this so-called “equity crowdfunding” won’t be available to
every entrepreneur who wants to raise money, or every investor who wants
a piece of the next hot startup. Even if your crowdfunded offering is
successful, there are significant risks in opening your company’s doors
to hundreds or perhaps even thousands of individual investors before you
are ready to handle them.
1. Crowdfunding, Coin Offerings
and Other Cutting-Edge
Financing Techniques for Startup
Ventures
Cliff Ennico
Law Offices of Clifford R. Ennico
2490 Black Rock Turnpike # 354
Fairfield, Connecticut 06825-2400
Tel.: (203) 254 1727
Fax: (203) 254 8195
E-Mail: crennico@gmail.com
2. Disclaimers
• Views expressed in this program are Cliff’s own, and do not reflect
the views of NYSBA, or indeed anyone else.
• Legal and tax information presented in this program SHOULD NOT
be relied upon as legal or tax advice, which can only be given by a
lawyer, accountant or other professional licensed to practice in your
state.
• Tax-Related Disclaimer: To comply with the requirements of
Treasury Department Circular 230, which provides regulations
governing certain conduct of U.S. tax professionals giving written
advice with respect to U.S. tax matters, please be aware that any
U.S. federal tax advice contained in this communication (including
any attachments) is not intended to be used and cannot be used, by
you or any other person for the purpose of (i) avoiding penalties that
may be imposed under the Internal Revenue Code or (ii) promoting,
marketing or recommending to another party any tax-related matter
addressed herein.
3. What is Crowdfunding?
• Raising money from “the masses”
• Base of the Statue of Liberty (1885)
• For a “project” of some type, such as:
– An invention;
– A book or other creative project;
– A surgical procedure not covered by insurance
• Launch a “campaign” on a crowdfunding portal such
as kickstarter.com, Indiegogo.com
• Then promote it aggressively on social media
4. Types of Crowdfunding
• In “project crowdfunding,” investor gets
something in return (eventually)
• In “gift crowdfunding,” investor gets a
warm, fuzzy feeling (and maybe a tax
deduction)
• Beginning May 16, 2016, there is “equity
crowdfunding” – raising money for your
business, and offering stock or debt in
return!
5. The JOBS Act of 2012
• In April 2012, President Obama signed the “Jumpstart Our Business
Startups” Act [Pub.L. 112-106, codified in scattered sections of 17
U.S.C.]
• Note the acronym . . .
• Several major changes:
– Allowed offerings to “accredited investors only” using “general
solicitation/advertising” (Title II)
– Allowed offerings to the masses via crowdfunding portals (Title
III)
– Expanded Regulation A (Title IV)
– Pre-empted regulation at the state level (in most cases)
6. The SEC Weighs In
• August 29, 2012 – proposes regulations implementing Title II of JOBS Act [SEC
Release No. 33-9354];
• July 10, 2013 – approves regulations implementing Title II of JOBS Act [SEC Release
No. 33-9415];
• October 13, 2013 – proposes regulations implementing Title III of JOBS Act [SEC
Release No. 33-9470];
• December 18, 2013 – proposes regulations implementing Title IV of JOBS Act [SEC
Release No. 33-9497];
• March 25, 2015 – approves regulations implementing Title IV of JOBS Act [SEC
Release No. 33-9471];
• October 30, 2015 – approves Regulation Crowdfunding implementing Title III of
JOBS Act [SEC Release No. 33-9974];
• May 16, 2016 – Regulation Crowdfunding goes into effect;
• December 9, 2016 – SEC publishes “roadmap” to crowdfunded offerings
[www.sec.gov/spotlight/jobs-act.shtml].
7. “Title II” Crowdfunding
• Can offer securities to an unlimited
number of accredited investors, in an
unlimited amount, AND use “general
solicitation/advertising” methods to reach
them!
• The catch: every single investor must be
“accredited”: make one mistake and
you’re toast (SEC Rule 506(c))
8. “Title III” Crowdfunding
• Taking the “friends and family” offering to a new level
– ideal for B2C companies with compelling products/services/stories
• Issuers can raise up to $1 million over a rolling 12-month period via specialized
gatekeepers called “crowdfunding portals”
– All communications with advertisers, and all advertising, must be conducted
through the portal
• Little or no regulation at the state level
• People other than “accredited investors” can participate, as long as they don’t
invest more than:
– $2,000 or 5% of their net worth or annual income (whichever is greater) in
crowdfunded offerings each year if their net worth and annual income are
both less than $100,000;
– 10% of their net worth or annual income (whichever is less) in crowdfunded
offerings if either their net worth and annual income is $100,000 or more;
– $100,000 total in crowdfunded offerings.
9. “Title III” Crowdfunding
• Who is crowdfunding?
– Leading the pack: beer and liquor!
– Next: entertainment, games, medi
– Next: small real estate development
– Next: inventors with tangible products
• Who is best suited for Title III crowdfunding?
• Probably not tech startups!
• Probably:
– “concept companies” at very early stage of development looking to
validate market and technology
– “small businesses” in retail/service sector with large followings on social
media
– “wowie/zowie companies” with marketing allure, sex appeal and pizzazz
10. “Title III” Crowdfunding
• The six steps in a Title III crowdfunding:
– Setting up the company and selecting the type of security to be offered, the
“min/max” offering amounts and funding timetable
• Securities should be “redeemable” and “nonvoting”
– Selecting and negotiating with a crowdfunding “portal” registered with the SEC
and FINRA
• Over 40 approved as of March 30, 2018 – see
https://www.crowdfundinsider.com/2018/03/131246-finra-approved-reg-cf-
crowdfunding-portals-38-and-counting/
• StartEngine.com and WeFunder.com lead the pack
– Preparing the required disclosure documents and posting them on the portal
• SEC Form C: must use XML-based fillable form to input on EDGAR
• Required disclosures described on pp 61-65 of The Crowdfunding Handbook
• Supplemental materials and financial statements (must be reviewed for
offerings over $100K, audited for offerings over $500K except first offering)
11. “Title III” Crowdfunding
• The six steps in a Title III crowdfunding:
– Marketing the offering
• Can occur ONLY on the funding portal, but can send “offering
announcement” (similar to a Rule 134 tombstone ad) directing people to the
portal
– Managing the “crowd” (if the offering is successful)
• Add “investor relations” to your resume
• Develop a shareholder communication program
• Watch out for Time Vampires, Mata Haris, Know-it-Alls, and Che Guevaras
– Following up on a successful offering
• Must file annual reports with the SEC and post them on the portal and
company website
• Can launch a subsequent or followup offering but must provide updated
disclosures, with a detailed explanation of why additional funding is
necessary
12. “Title IV” Crowdfunding
• SEC Regulation A-Plus
• Very popular for large-scale real estate offerings
• Creates two tiers of offerings:
– Tier 1, consisting of securities offerings of up to $20
million in a 12-month period; and
– Tier 2, consisting of securities offerings of up to $50
million in a 12-month period.
• For offerings of up to $20 million, a company can elect
whether to proceed under Tier 1 or Tier 2.
• Tier 2 offerings are exempt from state “blue sky”
regulation, but Tier 1 offerings are not
13. Coin Offerings (ICOs)
• Similar to project crowdfunding except involves
cryptocurrencies (Bitcoin, Ethereum)
• Investors pay in Bitcoin and receive cryptocoins called
“tokens”
– May represent a share in a firm, a prepayment
voucher for future services or in some cases no
discernible value at all
– Investor hopes for increase in value of tokens, not
necessarily an increase in value of the startup
• Transactions are reported on distributed ledger or
“blockchain” and may be freely tradeable
14. Coin Offerings (ICOs)
• Most issuers are extremely early stage or “concept”
companies.
• Startup creates a plan or whitepaper which states what
the project is about, what need(s) the project will fulfill
upon completion, how much money is needed to
undertake the venture, how much of the virtual tokens
the pioneers of the project will keep for themselves, what
type of money is accepted, and how long the ICO
campaign will run for.
15. Coin Offerings (ICOs)
• Three types of tokens*
– Payment tokens are synonymous with cryptocurrencies and have no
further functions or lines to other development projects. Tokens may in
some cases only develop the necessary functionality and become
accepted as a means of payment over a period of time.
– Utility tokens are intended to provide digital access to an application or
service.
– Asset tokens represent assets such as participations in real physical
companies or earnings streams, or an entitlement to dividends or
interest payment. As such, they are analogous to equities, bonds or
derivatives.
• Can be “hybrid” tokens, and any token can be considered a “security” if it
meets that country’s definition of a “security”
• Issuer needs to be “crystal clear” as to what the token represents and what
rights holders of tokens have.
16. Coin Offerings (ICOs)
• The four steps in an ICO:
– Preparation of the White Paper
• Essentially a business plan with a technical description of the underlying technology for
which funding is sought, the potential use and benefits of the technology, and how
proceeds of the token offering are to be used.
• The structure and content of a white paper are not regulated, but many issuers follow
the required disclosures for a Title III crowdfunded offering of securities
– Pre-Sale of Tokens
• Essentially a “private offering” to a select investor group at a significant discount from
the proposed ICO price, with (sometimes) additional bonuses such as free access or a
bonus card
• Consider limiting these to “accredited investors,” such as hedge funds
• Consider a Simple Agreement for Future Tokens (SAFT) giving investors the right to
participate in the public ICO sale
– Use of Proceeds and Execution of the Project
• Hopefully can accomplish this with just proceeds from the pre-sale of tokens
– Crowdfunded Sale of Tokens to the Public
• Payment made in cryptocurrencies, usually Bitcoin or Ether
• Most ICOs have a minimum threshold for funding – if the threshold is not met within a
specified time period, funds are returned to investors automatically.
17. Regulation of ICOs
• People’s Bank of China banned ICOs in
September 2017
• US and UK regulators say the tokens may
be “securities”*
• In the US, will apply the Howey test**
• If a security, ICO offerings must be
registered with SEC or qualify for one of
the Regulation D exemptions
18. Some Points to Ponder
• Can an ICO offering be effected as a
private placement to accredited investors
only with “general solicitation and
advertising” under SEC Rule 506(c)?
• Can larger ICO offerings be made under
Regulation A-Plus?
19. Some Other “Cutting Edge” Tools for
Startups
• Royalty Financing (see materials)
• Simple Agreement for Future Equity (SAFE)*
– Issuer agrees to give investor a future equity stake if certain
triggering events occur
• The “equity linked note”**
– No interest, holder gets % of increase in underlying
equity x “participation rate”
• The Rollover as Business Startup (ROBS)***
– Form a C corporation, then roll over 401(k) into
corporation’s profit sharing plan
* See generally Financial Markets Supervisory Authority of Switzerland, ICO Guidance 04/2018, published at https://www.finma.ch/en/news/2018/02/20180216-mm-ico-wegleitung.
* See generally Financial Markets Supervisory Authority of Switzerland, ICO Guidance 04/2018, published at https://www.finma.ch/en/news/2018/02/20180216-mm-ico-wegleitung.
-- www.sec.gov/news/press-release/2017-131; www.fca.org.uk/news/statements/initial-coin-offerings. For a summary of SEC enforcement actions to date, see SEC Public Statement, “Statement on Digital Asset Securities Issuance and Trading,” November 16, 2018, available online at https://www.sec.gov/news/public-statement/digital-asset-securites-issuuance-and-trading.
** -- Securities and Exchange Comm’n v. W.J. Howey & Co., 328 U.S. 293 (1946).
*--https://en.wikipedia.org/wiki/Simple_agreement_for_future_equity_(SAFE); but see SEC Investor Bulletin, “Be Cautious of SAFEs in Crowdfunding,” May 9, 2017, available online at https://www.sec.gov/oiea/investor-alerts-and-bulletins/ib_safes.
**--http://en.wikipedia.org/wiki/Equity-linked_note
***--http://en.wikipedia.org/wiki/Rollovers_as_Business_Start-Ups