A PROFESSIONAL DEVELOPMENT JOURNAL for the CONSULTING DISCIPLINES VALUATION • The Growth of Equity Crowdfunding CROWDFINANCE OPTIONS FOR PRIVATE COMPANIES —AND SECONDARY MARKETS FOR INVESTORS—WILL KEEP EXPANDING By David M. Freedman, Editorial Adviser to The Value Examiner and Matthew R. Nutting, Esq. • ost Americans either the New York Stock Exchange and THE “NEW” don’t know what crowd- Euronext NV). Niederauer predicted NEW INTERMEDIARY funding is or still think that equity crowdfunding, if properly Crowdfunding is a method of crowdfunding is nar- done, “will become the future of how collecting many small contributions, by rowly confined to Kickstarter and other most small businesses are going to means of an online funding platform, 3 Mrewards-based fundraising websites. In be financed. ” Mary Jo White, the to finance or capitalize a popular polite company, the terms “securities SEC chair since April 2013, said that enterprise. Thanks to the phenomenal crowdfunding” or “equity crowdfund- crowdfunding is “the start of what success of rewards-based crowdfunding ing” typically evoke bewilderment, promises to be a period of transformative platforms like Kickstarter and Indiegogo 4 derision, or fear of fraud, oh my. change in capital formation. " since 2008, and donation-based sites Meanwhile, start-ups and growing If equity crowdfunding goes well for like GoFundMe since 2010, it was companies have raised billions of dollars issuers and investors, a surging supply only natural that intermediaries in through equity-based offering platforms (of early-stage equity offerings) and the angel capital world would exploit 1 on the Internet. Some exuberant demand (for investment opportunities and adapt the crowdfunding platform pioneers in this new investment class have in those offerings by investors who want infrastructure, harnessing the power of predicted that crowdfunding will spark to diversify into alternative asset classes) social networking and e-commerce to a revolution in private capital markets, could result in not only phenomenal accomplish the following objectives: if not the redefinition of Wall Street.2 growth of private capital markets but A moderate optimist, and one with also “transformative” innovations. • Unite start-ups and growing whom we agree, is Duncan Niederauer, Innovation might include not only Web companies with angel investors CEO of NYSE Euronext (a merger of technology that better connects issuers • Announce equity offerings, and to investors and facilitates disclosures disclose risks and deal terms and transactions, but also simplified deal • Enable potential investors to 1 Equity-based offering platforms, featuring terms, automated valuation “calculators” Regulation D offerings, were at first reluctant to call collaborate with one another on deal their operations “crowdfunding” because (before (see sidebar on page 10), and new selection and due diligence June 2015) they were not open to the “crowd” of business entities (like a Subchapter CF • Facilitate investment transactions. nonaccredited investors. The SEC generally uses corporation) structured specifically for • the term equity crowdfunding portals in reference Accomplish all of that in a matter to Title III of the JOBS Act of 2012, which allows equity crowdfunding transactions. of weeks or days, sometimes nonaccredited investors to participate, but which even hours, at little cost has not yet been implemented. Gradually, however, Reg. D platforms have come to be referred to in the media, and in the crowdfunding industry as well, as 3 “The New Thundering Herd,” The Economist, The Jumpstart Our Business Startups equity crowdfunding platforms. June 16, 2012, p. 71 2 A December 17, 2013, conference in New York 4 Mary Jo White, SEC chairwoman, speech to Act of 2012 accelerated the growth of City, cosponsored by Thomson Reuters, was called the 41st Annual Securities Regulation Institute, equity crowdfunding. Title II of the JOBS “Crowdfinance 2013: Redefining Wall Street.” Coronado, California, January 27, 2014 6 July/August 2015 the value examiner A PROFESSIONAL DEVELOPMENT JOURNAL for the CONSULTING DISCIPLINES Act lifted the ban on general solicitation where issuers with headquarters in a it lifts the ban on general solicitation. for securities offerings under Regulation particular state may sell securities to But only accredited investors may D, Rule 506(c), which allows equity all investors (nonaccredited as well as participate, on- or off-platform. This crowdfunding platforms to advertise accredited) who live in that state. At this is where consumer product and retail those offerings, and thereby publicize moment, at least seventeen states have companies tend to congregate. equity crowdfunding itself, much such exemptions in place, and at least one more widely than before. On-platform more is awaiting the governor’s signature. Title II went into effect in 2013 with the Reg. D offerings are still open only to Some of these exemptions are variations full implementation of SEC regulations. accredited investors, about seven percent of Title III of the JOBS Act, in terms of Now you might see 506(b) offerings, of the population. the dollar limits on raises and investment 506(c) offerings, and Reg. A+ offerings all Title III of the JOBS Act will someday limits for nonaccredited investors. listed on the same equity crowdfunding let nonaccredited investors, the other Securities crowdfunding also includes platforms. But the tendency among ninety-three percent, participate in peer-to-peer lending (P2P), more successful platforms these days is to private securities offerings, but this recently known as marketplace lending specialize in one kind of exemption exemption (also called Regulation CF) because true peers (individuals) are or another. So, for example, you will has not yet become effective. The SEC being overwhelmed by institutional see some tech-oriented crowdfunding may issue final rules under Title III this lenders. Debt-based crowdfunding is a platforms with predominantly 506(b) year, although it is possible that Congress hot sector of the securities markets in the “quiet deals.” Consumer product will revise Title III before the SEC blesses United States and some other countries, companies naturally tend to gravitate it. The U.K. and Australia are way ahead including China. to platforms that focus on 506(c) deals. of the United States in letting average or You will also find platforms that focus on “unsophisticated” investors participate REGULATION D PLATFORMS particular industries, such as real estate— in equity crowdfunding, but investor Issuers have raised tens of billions of which is the hottest sector of securities demand for crowdfunded securities is dollars through Reg. D offering platforms crowdfunding after P2P. still fairly weak in those countries.5 since they launched in 2011 in the United According to Crowdnetic’s Q1 2015 Title IV of the JOBS Act, which States. These early-equity offerings used Report,7 in the first quarter of 2015 alone, became effective in June 2015, does the Rule 506 exemption under Reg. D. the seventeen most prominent securities allow nonaccredited investors to invest That was before the JOBS Act, which offering platforms (not including P2P) in “Regulation A+ offerings,” some of most argue will boost overall volume in the United States recorded capital which will be made via crowdfunding of capital formation, now that the non- commitments totaling about $650 platforms. The Title IV exemption is solicitation rules have been relaxed. million—a thirty-five percent increase structured primarily for growth- and What Title II of the JOBS Act did from the previous quarter. These figures later-stage companies that want to file was prompt the SEC to split Rule 506 represent the performance of offerings “mini-IPOs,” not ideal for seed-stage into parts: under Rule 506(c); they do not include start-ups since compliance costs alone Rule 506(b) offerings, some of which may overwhelm the amount of capital • Rule 506(b) is the “traditional” are listed on crowdfunding platforms being sought. part, also known as the “quiet deal,” as well. It is likely that the numbers of Another form of equity crowdfunding because it retains the ban on general 506(b) offerings, and the amount of is the intrastate securities exemption,6 solicitation. For off-platform offerings capital raised thereby, are higher than it permits up to thirty-five non- that of 506(c) offerings. Rule 506(c) allows 5 Richard Swart, “Challenges in SME Access to accredited investors to participate general solicitation, while Rule 506(b) Capital,” Roosevelt Institute, July 6, 2015 (https:// in each deal. This is where many does not. nextamericaneconomy.squarespace.com/thought- high-tech start-ups have tended briefs/2015/7/7/challenges-to-sme-access-to- capital) to congregate. 6 Under Section 3(a)(11) of the Securities Act of • Rule 506(c) is the “new” part, because 7 http://www.crowdnetic.com/reports/apr-2015- 1933 report (accessed July 8, 2015) the value examiner July/August 2015 7 A PROFESSIONAL DEVELOPMENT JOURNAL for the CONSULTING DISCIPLINES Significantly for the valuation Regulation A+” at http://www.sec.gov/ Professionals in the securities industry profession, the types of securities offerings news/pressrelease/2015-49.html. are calling Reg. A+ offerings “mini-IPOs,” that received capital commitments were: Some Regulation A+ offerings will be as issuers are required to go through a equity (sixty-two percent), convertible listed through online offering platforms.