Financing a company through Crowdfunding campaigns, and alternative funding for startups. (6/16)

1. Roger Royse
Royse Law Firm, PC
Silicon Valley , San Francisco, Los Angeles
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www.rroyselaw.com
Skype: roger.royse
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Crowdfinancing:
Moving Beyond Kickstarter

2. JOBS Act Overview
• Improves access to capital markets for emerging growth companies
o Relaxes reporting and disclosure requirements for public companies
with less than $1 billion in gross revenues
• Crowdfunding/Crowdfinancing
o Exemption from registration for issuance of securities
o Securities issued through crowdfunding do not count towards
registration threshold
o Possible Problems
 Fraud
 Costs
 Unsophisticated nature of investors
• Increases 500 shareholder registration threshold
• General solicitation in Rule 506 offerings, provided that all investors
are accredited

3. JOBS Act – Key Provisions
• Crowdfunding (Title III of the JOBS Act)
o Allows companies to raise a limited amount of funds from the
general public (Effective as of May 16, 2016)
o Investment must be through an intermediary broker or funding
portal
• General Solicitation (Title II of the JOBS Act)
o The SEC has extended the exemption for private offerings under
Rule 506 to allow for general solicitation providing certain
requirements are satisfied
o Can only issue securities to accredited investors and there are
additional filing requirements
• New Regulation A, nicknamed “Regulation A+” (Title IV of the JOBS Act)
o Preempts state registration, allow for what some call a “mini-IPO”

4. Crowdfunding
Exemption from Registration
• The private company issuer (aggregated with predecessors and companies
under common control) may sell up to $1 million of securities in a 12-month
period
• Individual investments in all crowdfunding issuers in a 12-month period are
limited to:
o If either their annual income or net worth is less than $100,000, then the
greater of:
 $2,000 or
 5 percent of the lesser of their annual income or net worth
o If both their annual income and net worth are equal to or more than
$100,000, then
10 percent of the lesser of their annual income or net worth (up to a
maximum of $100,000)
o Issuer may rely on intermediary’s calculation of investor limits, unless issuer
knew it was or would be wrong
• Process is likely to prove expensive and overly burdensome
• Effective as of May 16th, 2016

5. Crowdfunding
• Investment must be through the online platform of an “intermediary” broker
or funding portal
o Intermediary must register with the SEC and any applicable self-
regulatory organization and national securities association (e.g., FINRA);
o Issuer can only use one intermediary in any concurrent offerings based
off of crowdfunding exemption
o Many limitations on what entities ca be intermediaries (e.g., must be
good actor)
o Stringent limitations on having financial interests in issuers using platform
o Only allow issuers if reasonable to believe they are compliant, and there
is no reasonable basis to think there is a potential for fraud
o Cannot accept commitment from investor until investor has account with
platform, and platform provides needed information
o Must make sure investors aren’t exceeding their caps, and that they
acknowledge and understand the risks
o Must provide communication services between investors and issuer
o Many other requirements and filings

6. Crowdfunding
• No integration with non-crowdfunding offers
o Be careful to ensure crowdfunding communications do not go
to wrong offerees who are not supposed to receive them
(e.g., Rule 506(c) offerees)
• Limits on advertising and compensation for promoters
• Post fundraising
o Securities cannot be resold within 12 months (unless to an
accredited investor)
o Private right of action for material misstatements/personal
liability

7. Crowdfunding
• Issuer disclosure requirements
o File basic business, offering details in Form C with SEC; then display publicly
o Amend Form C if any material changes occur via Form C/A
o File updates with SEC within five days of certain milestones (such as enough
commitments, offers, or closing of issuance)
o File financial statements meeting GAAP, and GAAS or PCAOB if applicable
 Audited if offering exceeds $500,000, except first time issuers need
only have independent CPA review
 Reviewed by an independent CPA if offering is between $100,000 and
$500,000
 If $100,000 or less, certain information from tax forms and CEO-
certified financials
 In any event, if more trustworthy financials available than are required
(i.e., if audited or CPA-reviewed are available), use those instead
o File annual SEC reports via Form C-AR
o File Form C-TR to terminate reporting obligations in five days of eligibility
(e.g., became Exchange Act issuer, has too few assets or shareholders)

8. Crowdfunding
Points for Consideration
• Crowdsourcing through donations (e.g., IndieGoGo and Kickstarter) may
be cheaper and easier, and does not require the company to issue
equity
• Advertising terms of offer is restricted
o Issuer can only direct investors to broker/funding portal
• Costs of disclosure and reporting (15%)
• Use of intermediary
• Risk of fraud
• High number of unsophisticated investors
o Fiduciary duties to all investors
o Could be a concern for VCs in future fundraisings

9. General Solicitation
• Rule 506 now provides for two different types of private offering:
o Rule 506(b) is essentially the same as the old Rule 506, providing an
exemption for non-public offerings but prohibiting general
solicitation
o Rule 506(c) is a new exemption that allows general solicitation, but
with certain restrictions and filing requirements
• Rule 506(c): issuers can offer securities through means of general
solicitation as long as:
o All purchasers are accredited investors; and
o The issuer takes “reasonable steps” to verify the purchasers’
accredited investor status

10. General Solicitation
• A determination of “reasonable steps” requires consideration of:
o Nature of the purchaser;
o Amount of information the issuer has about the purchaser; and
o Nature of the offering, terms, amount, and method of solicitation
• The SEC has provided a non-exhaustive list of methods to verify status:
o Review IRS forms that report income e.g. Form W-2 or K-1;
o Review documents for asset details e.g. bank or brokerage
statements; or
o Obtain confirmation from CPA, lawyer, SEC-registered investment
advisor, or broker-dealer that reasonable steps were taken to verify
accredited investor status

11. General Solicitation – Proposed Rules
• Form D Filing
o Under the current rules only one Form D filing is required (within 15
days of the first sale of securities)
o Under the Proposed Rules a Rule 506(c) issuer must file:
Advance Form D at least 15 days prior to the first use of general
solicitation materials in an offering;
Full Form D within 15 days of the first sale of securities; and
Form D Closing Amendment within 30 days of the termination of
the offering
o Rule 506(b) issuers must file the Full Form D and Closing
Amendment

12. General Solicitation – Proposed Rules
• Filing of General Solicitation Materials
o Proposed Rule 510T requires 506(c) issuers to electronically submit
general solicitation materials to the SEC
o Current intention is for this requirement to expire within 2 years
o Submissions would not be made publically available
• Legends – all general solicitation materials will need a legend that states
the following:
o The securities may only be sold to accredited investors;
o The securities are offered under an exemption to the Securities Act
and therefore certain disclosure requirements do not apply;
o The SEC has not given approval to the securities, terms of the
offering, or the accuracy of the offering materials;
o The securities are subject to legal restrictions on resale; and
o Investing in securities involves risk and investors should be able to
bear a loss

13. Private Offerings Under Rule 506(b)
• Under what is now Rule 506(b), issuers are prohibited from making
general solicitations
o The emergence of internet funding websites creates some potential
problems for issuers relying on Rule 506(b)
• A communication that is publically available (e.g. on a website that is
not password protected) is a general solicitation
o This can be avoided by only providing access to accredited investors
• Direct communications to persons with whom the issuer or its broker
has a “pre-existing, substantive relationship” are not considered general
solicitations
o However, the SEC believes that such a pre-existing relationship
usually only exists where the communication is from a registered
broker-dealer

14. SEC No Action Letters
• In 2013, the SEC released two no-action letters confirming that certain
fund-raising websites did not need to register as broker-dealers:
o AngelList LLC
Matches investors with companies
Exclusively available to accredited investors
No transaction-based compensation
o FundersClub Inc
Posts details of companies to its website after they pass initial due
diligence
Exclusively available to accredited investors
No transaction-based compensation
• In 2012, the SEC charged some companies operating secondary markets for
private stock
o SecondMarket escaped unscathed which it puts down to its
transparency, rigid accreditation process, and strict adherence to rules
on general solicitation

15. Pitch Competitions
• The proposed regulations pose a number of potential problems to pitch
competitions, for example:
o The pitch could be considered a general solicitation and therefore
any presentation materials would need to be filed with the SEC
o If the pitch is amended after feedback from judges then the new
presentation would need to be filed with the SEC before the next
pitch
• Issuers that break the rules are subject to a one year penalty
o Very onerous and essentially a death penalty for early stage
companies

16. Intrastate Crowdfunding
• SEC has proposed updates to Rule 147 with new exemption, and to expand
Rule 504 of Regulation D to have higher limits (up to $5M from $1M), to
facilitate the use of these new state laws
• The North American Security Administrator Association (NASAA) has
recently released a model rule for states to use in implementing
crowdfunding
• As of late 2015, 22 states have finalized legislation granting crowdfunding
exemptions
o Others are in the final leg of passing the legislation
o Others yet in the early stages of considering legislation
o A few have rejected crowdfunding legislation

17. Intrastate Crowdfunding
• Per NASAA, these exemptions from state securities rules tend to involve:
o Qualifying for the federal intrastate offering exemption from Federal
registration (if intrastate offer to intrastate buyers, Federal securities
rules do not apply)
o Wide ranging offering caps ($100k-$5M over 12 months)
o Wide-ranging investment limits ($100-$100k, with increase for
accredited investors)
o Internet-based offerings and platforms are increasingly important to new
exemptions, as are broker-dealers
o Registration-lite and periodic reporting-lite

18. Reg. A – History
• The oldest exemption issued by the SEC
• Although it allowed non-accredited investors to invest, was rarely used,
because of high compliance costs relative to the maximum funds raised
o $5 million maximum offering
o Did not preempt state law registration, requiring registrations in many states
• The JOBS Act included legislation to create what is nicknamed
“Regulation A+”, an upgrade to Regulation A
• The new Regulation A keeps the allowance of non-accredited investors,
and features two kinds of Regulation A offerings, called “Tiers”:
o Tier 1, with a $20 M maximum, does not preempt state law registration, but has low
federal compliance burdens
o Tier 2, with a $50 M maximum, preempts state law registration, but has high federal
compliance burdens including ongoing semi-annual, annual, and current disclosures

19. • Went into effect June 19th
• States do not like Tier 2
o Tier 2, per the JOBS Act, only preempts state registration for
“qualified purchasers” with the seeming intent to not totally
preempt the states
o However, the SEC defined “qualified purchasers” to mean all Tier 2
purchasers
o State securities regulators resent this loss of power
• States have been creating a multistate single-registration process to
make Tier 1 more palatable, and to show they deserve to not be
preempted
• The “mini-IPO” of the new Regulation A has excited investors, and for
many companies may be better than relying on the crowdfunding
exemption
o Including for offerings done via Internet portals
Reg. A – History Continued

20. • Two kinds of Reg. A offerings, called “tiers”, with different qualities:
Issue Tier 1 Tier 2
State law regulations? Not preempted;
multistate
coordinated review
program to help
Preempted
Maximum amount raised? $20 M in 12 months,
up to $6M of which
from current holders
$50 M in 12 months, up to $15M
of which from current holders
Per investor maximums? None Up to 10% of greater of non-
accredited investor’s net worth or
net income; unlimited for
accredited
Investor limitations Accredited and non-accredited okay
Issuer limitations Cannot be public, shell company, bad actor, those failing
certain SEC compliance rules
Reg. A – Two Options (“Tiers”)

21. • Two kinds of Reg. A offerings, called “tiers”, with different qualities:Issue Tier 1 Tier 2
Solicitation, advertising Testing for interest, soliciting OK, though notices needed
and materials may be exhibits on SEC filing; potential to
keep confidential SEC filings during this time
Initial disclosures Financial statements
for past two years,
plus offering circular
Same as tier 1, plus audited
financials
Disclosure to buyers? Circular or most recent Tier 2 report due to buyers by
specific time before sale
Ongoing disclosures File exit report at
end of offering
Yes, if 300+ holders; annual,
semiannual, and current events.
Limitation on need for full
Exchange Act registration
Securities restriction Unrestricted; affiliates have some limitations
Allowed securities? Asset backed-securities banned
Integration safe harbor Exists; allows non-US and crowd-funding to be separate
Reg. A – Continued

22. Issue 506(b) 506(c) Reg. A Tier 2
State law
regulations?
Preempted Preempted Preempted
Maximum amount
raised?
Unlimited Unlimited $50 M in 12 months, up to
$15M of which from
current holders
Per investor
maximums?
Unlimited Unlimited Up to 10% of greater of
unaccredited investor’s
net worth or net income;
unlimited for accredited
Investor limitations Unlimited
accredited, and
35 sophisticated
non-accredited;
self-certification
standard
Accredited
only, and issuer
must take
steps to certify
they are
accredited
Unlimited accredited (self-
certified), unlimited non-
accredited
506(b), 506(c), and Reg. A Tier 2

23. • Two kinds of Reg. A offerings, called “tiers”, with different qualities:Issue 506(b) 506(c) Reg. A Tier 2
Issuer limitations No bad actors No bad
actors
Cannot be public,
shell company, bad
actor, those failing
certain SEC
compliance rules
Solicitation,
advertising
Banned Soliciting of
anyone is
allowed
Testing for interest,
soliciting OK
Initial disclosures Non-accredited:
Equivalents of what they
get in registered offering,
plus anything accredited
investor can get
For accredited, see 506(c)
Optional;
must be
available to
answer
questions
Financial statements
for past two years
disclosed, plus
offering circular
with audited
financials
506(b), 506(c), and Tier 2 (Continued)

24. Issue 506(b) 506(c) Tier 2
Ongoing disclosures Form Ds Form Ds Yes, if 300+ holders;
annual, semiannual, and
current events. But special
exemption from Exchange
Act registration until over
$75M float.
Share restriction Restricted for a
year
Restricted for a
year
Unrestricted; affiliates still
have some limits
Allowed securities? ABS not
specifically
banned
ABS not
specifically
banned
Asset backed-securities
banned
506(b), 506(c), and Tier 2 (Continued)

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