Everyone knows the “100 investor rule” is a thorn in the side of Crowdfunding portals. The good news is you can still use subsidiaries to protect yourself from liability.
The basics of the 100 investor rule:
- A company engaged in the business of investing in securities is an “investment company” and subject to burdensome regulation under the Investment Act of 1940.
- A “special purpose vehicle” formed by a portal to invest in a portfolio company is engaged in the business of investing in securities.
- There’s an exception: if the SPV has no more than 100 investors, it’s not an investment company.
Today, most deals on Crowdfunding portals are funded with fewer than 100 investors and qualify for the exception. But that’s because most Crowdfunding deals are still small, i.e., less than $2 million. As the deals get bigger and, most important, as we start to see pools of assets rather than individual assets, SPVs will no longer be available. Already, they’re not available for Regulation A+ deals.
In the absence of an SPV, investors will be admitted directly to the issuer’s cap table. But what if the issuer owns one or more subsidiaries? Will the issuer itself be disqualified as an investment company?
Here’s an example. Suppose NewCo is raising $25 million to acquire 10 properties, and we expect 1,000 investors. We’d like to put each property in a separate subsidiary because (1) we might want to finance them separately, and (2) we don’t want the liabilities arising from one property to leak into another property. But would that make NewCo an investment company, holding the stock (securities) of 10 subsidiaries?
Fortunately, the answer is No.
For purposes of deciding whether NewCo is an investment company, the rule is that you ignore securities issued by any company that NewCo controls, as long as the company itself is not an investment company.
That means NewCo can put Business #1 in Subsidiary #1, Business #2 in Subsidiary #2, and so on and so forth, without becoming an investment company. Most likely, NewCo will hold each property in a separate limited liability company, serving as the manager of each.
Don’t fool around with investment company issues. A company that becomes an investment company without knowing it can face a world of trouble, including having all its contracts invalidated.
Questions? Let me know.
Mark Roderick is spearheading Flaster/ Greenberg’s Crowdfunding Practice. He speaks and writes regularly on Crowdfunding. Expanding on his in-depth knowledge of capital-raising and securities law, Mark represents many portals and other players in the Crowdfunding field, spending much of his day helping entrepreneurs build an entirely new industry from the ground up.
Mark also maintains a widely-read Crowdfunding blog at crowdfundattny.com. In addition to Flaster/ Greenberg’s Crowdfunding Practice, Mark is also a member of the firm’s Mergers and Acquisitions, Business and Corporate, and Taxation Practice Groups. He represents entrepreneurs and their businesses across a wide range of industries, including technology, real estate and healthcare. Mark holds a Master’s degree in mathematics as well as a J.D. from the University of Virginia. You can reach Mark at 856.661.2265 or mark.roderick@ flastergreenberg.com.
For more information on Crowdfunding, including news, updates and links to important information pertaining to the JOBS Act and how Crowdfunding may affect your business, follow my blog, or twitter handle: @CrowdfundAttny.