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2017 Real Estate Crowdfunding: Surveying the Landscape

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“Copyright” By Jonathan B. Wilson CrowdFund Beat Sr. Guest Editor, Partner, Taylor English Duma LLP

The impact of crowdfunding on real estate finance and deal-making has been one of the hottest topics of the past year.[1]  With the advent of crowdfunding, real estate developers and investors have multiple pathways to finance their projects and even to plot their exits.  But in many ways the impact of crowdfunding has not yet arrived.  Crowdfunding for real estate is still in the early stages and may take several detours along the way to its final destination.

What is Crowdfunding?

The idea of “crowdfunding” has been in the news a great deal but investors have only just begun to realize its potential for the industry.  Crowdfunding is the idea that a large number of people, with no particular expertise, can accurately predict the likely success or failure of a venture by combining their own observations and communicating with each other.  James Surowiecki‎, in his book, The Wisdom of Crowds[2], recounts dozens of examples where a large group of people who were able to collect and share information were able to make more accurate guesses about the success of a project than the best guess of any individual expert in the topic.  The Internet, with its ability to collect a large number of people quickly and easily, makes it possible to collect a “crowd” to evaluate an idea better than was ever possible before.

Crowdfunding applies this idea to the process of evaluating investment opportunities, allowing members of the crowd to put money behind their predictions and preferences.  Proponents believe that by allowing a crowd of potential investors to share their opinions about the investment and the information they collect that crowd will be better able to predict the success of the investment than individual investment experts.  Sydney Armani, the publisher of CrowdFundBeat, says, “People get excited when they engage with a new product that arouses their passions.  Those passions take on even greater intensity when they can invest in that new product.” [3]

Crowdfunding can take several forms.  Popular crowdfunding sites like Kickstarter and Indiegogo let project sponsors describe their projects to the public and ask for donations.  In an “affinity” campaign, supports of a project pledge funds for a project because they like it and support it.  Their affinity for the project is their only reward.  In a “rewards-based” campaign, project sponsors offer rewards for cash contributions.  Rewards may range from recognition on a website or on a wall, to t-shirts, products samples and more.

Securities-Based Crowdfunding

Securities-based crowdfunding is possible through several recent changes in U.S. securities laws, most of which are derived from the 2012 Jumpstart Our Business Startups Act (or “JOBS Act”).  In particular, the JOBS Act created three types of crowdfunding: (a) crowdfunding to “accredited investors” under Rule 506(c), (b) crowdfunding for up to $50 million each year under new Regulation A+ and (c) crowdfunding to both accredited and non-accredited investors in small offerings under Title III.

Investing Under Rule 506(c)

First, a sponsor could offer debt or equity securities to “accredited investors” under Rule 506(c).  The JOBS Act changed some of the rules affecting private offerings under Rule 506 so that sponsors could publicly-advertise their offerings.  Before this change in the law, public solicitations of private offerings were strictly prohibited.  Under new Rule 506(c) however a promoter that wants to advertise publicly must take various steps to ensure that every investor who participates in the offering is “accredited”, which is defined as having a net worth of over $1 million (excluding the investor’s principal residence) or having an income of more than $200,000 for two consecutive years ($300,000 is the investor is married and files tax returns jointly with a spouse).

Crowdfunding under Rule 506(c) has been feasible for more than a year and several websites, have had some success hosting real estate crowdfunding campaigns that have included securities under Rule 506(c).  Most of the popular real estate crowdfunding sites included in our survey, however, require accredited investors to create a membership on the site before they can view any live offerings.  As a result, the offerings made available to members are intended as a private offering, and not a general solicitation.  Because there is no general solicitation, those websites take the position that their offerings are private offerings under Rule 506(b) rather than publicized general solicitations under Rule 506(c).

Investing Under Regulation A

Another legal change that came from the JOBS Act was a change to Regulation A, an SEC rule that allows a private company to qualify its securities (which may be equity or debt) through filing a formal prospectus with the SEC.  The SEC reviews the prospectus to ensure that it adequately describes all of the risks of the business and the risks to investors.  Once the issuer’s prospectus is approved by the SEC (at which point it is said to be “effective”) the sponsor may sell the securities to both accredited and non-accredited investors.

Before the JOBS Act, offerings under Regulation A were limited to not more than $5 million.  Under the new provisions of Regulation A (sometimes called “Regulation A+”) an issuer of securities may raise up to $50 million in any 12-month period.

One of the advantages of a Regulation A offering is that the company will be able to solicit investments from both accredited and non-accredited investors, thereby widening the scope of interest in the project.  The SEC’s rules, implementing these changes to Regulation A, however, have only been effective since October 2015.  As a result, there have been relatively few offerings that have completed the new process and it is harder to tell how these new offerings will be accepted by investors.

Regulation CF

The third possible route for crowdfunding is often called “Title III” because it arises under Title III of the JOBS Act.  Although the JOBS Act became law in 2012, the SEC only released its rules implementing this new law in October 2015 and those rules didn’t take effect until May 2016.  Under those roles, a promoter may issue securities, in an amount up to $1 million in any 12-month period, to both accredited and non-accredited investors.  But, soliciting for investors may only take place through licensed crowdfunding portals that have received a license from the Financial Institutions Regulation Authority (“FINRA”).

Under Regulation CF (the name used for the SEC’s Title III regulations), issuers do not file a prospectus with the SEC but do need to include certain disclosures about the company in their offering memorandum.  The funding portal will also be liable for making sure that all of the prospective investors receive certain notices about the process and for ensuring that each investor does not invest more than a certain maximum that is derived from the investor’s taxable income.  While a Regulation CF offering can “go national” by accepting investments from people across the country (whether they are accredited or not) the $1 million limit and the requirement that all solicitations take place online through the licensed portal make this approach a challenge for many new ventures.

Because of the $1 million annual cap on fundraising under Regulation CF, however, this approach is usually not a good fit for real estate projects that often require more than this maximum amount.

Surveying the Landscape

The following websites have used one or more of these regulatory pathways to create a marketplace for crowdfunding real estate projects.  By surveying some of the more popular websites I have tried to provide an overview for how industry players are using these now crowdfunding regulations to make deal flow and investment opportunities possible.  This list is not an endorsement of any of these sites and a site’s omission from this list is not intended as a criticism or a suggestion that the site is not worthwhile or valuable.

Peer Street

PeerStreet specializes mostly in residential debt investments (with a smattering of multifamily and commercial). PeerStreet utilizes Rule 506(b) to solicit accredited investors to participate in loans that are secured by real estate.[4]  They have one of the lowest minimums in the top 10 ($1K versus $10K average), and a healthy volume of new transactions.

Virtually every site in the industry claims that they have superior due diligence. PeerStreet, however, supports its claim with concrete proof.  PeerStreet allows investors to review the performance of every past investment. PeerStreet’s site claims that, since 2014, the site has offered more than 200  notes but without any foreclosures or unremedied defaults.

Unlike many other real estate crowdfunding sites, however, PeerStreet does not originate its loans.  Rather, project sponsors introduce opportunities to the site and then earn a fee based on successfully closing the investments.  As a consequence, investors that participate in deals on PeerStreet pay slightly higher total fees than some other sites.  Because of the relatively high performance that PeerStreet’s deals have produced,[5] however, these fees so far have not kept investors away.

Real Crowd

Real Crowd acts as a syndication platform for real estate development companies and real estate funds.  The development companies and funds pay a fee to Real Crowd to have their offerings listed on the site.  Viewing the offerings is possible only for accredited investors who have created a free membership account on the site.  Most of the opportunities on Real Crowd involve commercial real properties or multi-family properties.  Some of the investments are funds in which the fund manager will be investing in the proceeds in a targeted type of property while others are syndicating take-out financing for existing properties.

From the investor’s point of view, Real Crowd has successfully recruited a large number of property developers and fund managers, so there are many investment opportunities to consider.  Most investments, however, require a minimum investment of at least $25 to $50,000, so the platform is not friendly to small retail investors who want to dip their toes in the water.   In addition, most of the investment opportunities are equity securities, so there is a higher risk of principal loss than is generally the case with debt-oriented platforms.

Realty Mogul

Realty Mogul is one of the largest real estate crowdfunding sites and it uses several different approaches based upon the needs of the project sponsor and the class of investor involved.  Accredited investors may invest in either debt or equity securities.  Accredited equity investors invest in syndicated private placements of special purpose limited liability companies that exist to finance equity investments in particular properties.  The equity investment has the higher potential return associated with equity as well as the potential downside risk of loss.

Accredited investors may also invest in debt securities called “Platform Notes”.  Each Platform Note is a debt security issued by a Realty Mogul special purpose vehicle which uses the proceeds of the Platform Notes to make a loan to particular sponsored investment.  By issuing the note from its special purpose vehicle, Realty Mogul is able to take on the management function of managing the underlying loan (reviewing financials, monitoring loan covenants, working out any defaults, and so on) without involving the passive investors who have purchased the Platform Notes.

For non-accredited investors, Realty Mogul has sponsored its own non-traded real estate investment trust.  Although the REIT (called Mogul REIT I) is not traded on any stock exchanges, its shares were qualified with the SEC through a Regulation A prospectus.[6]  According to the prospectus (which went effective in August, 2016) the REIT plans to hold:

“(1) at least 55% of the total value of our assets in commercial mortgage-related instruments that are closely tied to one or more underlying commercial real estate projects, such as mortgage loans, subordinated mortgage loans, mezzanine debt and participations (also referred to as B-Notes) that meet certain criteria set by the staff of the SEC; and (2) at least 80% of the total value of our assets in the types of assets described above plus in “real estate-related assets” that are related to one or more underlying commercial real estate projects, these “real estate-related assets” may include assets such as equity or preferred equity interests in companies whose primary business is to own and operate one or more specified commercial real estate projects, debt securities whose payments are tied to a pool of commercial real estate projects (such as commercial mortgage-backed securities, or CMBS, and collateralized debt obligations, or CDOs), or interests in publicly traded REITs.  We intend to qualify as a real estate investment trust, or REIT, for U.S. federal income tax purposes beginning with our taxable year ending December 31, 2016.”

Because Realty Mogul facilitates both equity and debt investments for accredited investors as well as equity investments for non-accredited investors through MogulREIT I, Realty Mogul is ideally-situated to generate substantial deal flow and relatively rapid underwriting for projects that apply for funding.  As a platform for providing funding for sponsored-projects as well as a platform for creating investment opportunities, Realty Mogul has one of the best head starts of all the available real estate websites.

Those advantages, however, come at a cost.  Realty Mogul has a large staff operation (which is required for its extensive underwriting duties) and that cost is borne by investors through the 1-2% fees they pay to participate in investments on the site.  While the site has tremendous deal flow, however, a student of the industry might ask, “is this really crowdfunding?”  Because Realty Mogul takes such an active role in performing due diligence on its projects and in structuring the investment opportunities on its site, the overall experience is more structured than most crowdfunding sites and there is less opportunity for the collectively give-and-take than crowdfunding was originally thought to represent.

Realty Shares

Realty Shares facilitates both debt and equity investments into both commercial and residential real estate.  The site claims that it has funded over $300 million to 550 projects that have returned more than $59 million to the site’s more than 92,000 registered accredited investors.[7]   Project sponsors must submit to underwriting through Realty Shares and only projects that have exceeded the site’s standards can be offered to the site’s members.  Fees range from 1 to 2% of the investment amount, but investment minimums are as low as $5,000.

As with most of the other real estate crowdfunding sites, investments are made through private placements under rule 506(b).

Residential Real Property Sites

There are several websites that focus primarily on residential real estate.  Because of the similarity of their focus and approach, they can be surveyed as a group:

LendingHome

Lending Home describes itself as the “largest hard money lender” [providing] “fix and flip loans up to 90% LTC and 80% LTV.”[8]  Unlike many of the other sites that aim their value proposition at investors, Lending Home addresses itself primarily to homeowners how are looking for loans and are willing to pay “hard money” rates of interest to get cash.  Accredited investors can participate in Lending Home in increments as low as $5,000.[9]

Roofstock

Roofstock’s tagline is “Property Investing Like the Pros.”[10]  Like Lending Home, Roofstock focuses only on single family residential properties.  Differently, however, Roofstock allows accredited investors to invest directly through loan participations as well as through small funds that focus on particular regions or particular rates of return.  Roofstock also emphasizes, through its underwriting and its messaging, the underlying quality of the properties and their surrounding communities, school systems and the like.  Browsing through loan opportunities on Roofstock feels more like browsing through listings on Zillow than looking for investments.

Patch of Land

Patch of Land is one of the largest and most heavily-trafficked real estate crowdfunding sites.  The site claims to have originated more than 400 loans for over $245 million in loans, returning over $61 million to investors.[11]  Although Patch of Land has made investments in multi-family and commercial real estate, more than 70% by value of its investments have been made in single family real estate.

Fund That Flip

Fund that Flip is a site that proudly advertises its role in financing single family residential rehab and resale projects.[12]  The site claims that the sponsors underwrite individual deals, requiring borrowers to put at least ten percent in the property’s value in equity.[13]  The site also tries to entice investors, claiming average returns between 10 and 14%.

The Future of Real Estate Crowdfunding

Real estate crowdfunding has definitely arrived.  Through the dozens of existing sites claiming to offer some kind of real estate crowdfunding, investors have invested more than a billion dollars through thousands of investments in just a few short years.  While this method of investing is still very small (in contrast to retail investments in mutual funds and the stock market) it fills a market need that shows no sign of disappearing.

For real estate crowdfunding to achieve a wider degree of acceptance, platform owners will need to continue to facilitate high quality investment opportunities while improving transparency.  Wider acceptance will require a level of information sharing that does not yet exist in the industry.  Even the most popular sites today have varying levels of information available to potential investors.  These inconsistent levels of disclosure can undermine the trust that is necessary to grow crowdfunding as a method of investing.  Real estate crowdfunding sites that facilitate exempt transactions under Rule 506(b) are not regulated, and that is probably a good thing.  But the lack of regulation also permits a wide diversity in style and approach that can make comparing the platforms difficult.

If the leading crowdfunding platforms could collaborate on a standardized “scorecard” that pulled together standard metrics on transactions, investment amounts and rates of return, the result would make it possible for both investors and project sponsors to compare platforms on a level playing field.  The investor confidence that might come from such a development would encourage new investors to come into the market.  Platforms that did not adopt the scorecard at first would experience market pressure to begin reporting results in the scorecard format.  Adopting a standardized scorecard for recording would, in a sense, demonstrate the power that crowdfunding was supposed to represent, by making it possible for the market to adjust itself to the information needs of the investing community.

[1]           http://www.jdsupra.com/legalnews/the-evolution-of-real-estate-15259/

 

[2]           Surowiecki, James, The Wisdom of Crowds, Anchor Books (2005).

 

[3]           Wilson, Jonathan B., Follow the Crowd: What the Future of Crowdfunding Holds for Startup Restaurant Owners, Restaurant Owner Startup & Growth Magazine, 18 (Feb. 2016).

 

[4]           www.peerstreet.com.

 

[5]           PeerStreet claims that its loans have generally yielded between 6 and 12%.  See PeerStreet FAQs, available at https://info.peerstreet.com/faqs/how-do-peerstreet-returns-compare-to-other-debt-investments/ (last visited January 29, 2017).

 

[6]           MogulREIT I, LLC SEC File, available at https://www.sec.gov/cgi-bin/browse-edgar?action=getcompany&CIK=0001669664&owner=exclude&count=40&hidefilings=0 (last visited January 29, 2017).

 

[7]           Realty Shares website available at https://www.realtyshares.com/  (last visited January 29, 2017)

 

[8]           Lending Home website available at www.lendinghome.com (last visited January 29, 2017).

 

[9]           https://www.lendinghome.com/how-it-works/#individual-investors.

 

[10]          Roofstock website available at www.roofstock.com (last visited January 29, 2017).

 

[11]          Path of Land website available at https://patchofland.com/statistics/ (last visited January 29, 2017).

 

[12]          Fund that Flip website available at www.fundthatflip.com (last visited January 29, 2017).

 

[13]          Fund that Flip website available at https://www.fundthatflip.com/lender (last visited January 29, 2017).

 

Setting Up an Efficient Crowdfunding Platform

BY Rachael Everly ,CrowdFund Beat Guest Post,

Crowdfunding platforms are a product of technological advancement. However at the end of the day they are a financial solution and their success is dependent on the economic situation at a given time. Many businesses prosper when the economy is booming and all is good. Crowdfunding on the other hand has always prospered when the economy is not doing well, and even during the worst recessions.

During the last recession of 2008, there was a great lack of confidence among banks. This led to a drying up of sources of finance for the small business owner and for individuals who were just starting out. Either their loan applications were outright rejected or they were given such high interest rate offers that they were forced to decline. But with the advent of digitalization came the much flexible option of crowdfunding that led smaller business achieving the necessary finances much cheaply and much easily.

crowdfunding concept. Chart with keywords and icons
crowdfunding concept. Chart with keywords and icons

 

Setting up a crowdfunding platform is an excellent business idea for it is something that the entrepreneurs need. However to be successful it has to meet the finance needs of people successfully.

 

 

  1. Initial set-up

Crowdfunding platforms are a place where investors and people looking for finance gather. So you need to be sure about how you are going to attract investors in your starting days. Your whole business is dependent on them.

You also have to ensure that you offer a “deal” that is both acceptable to investors and the people looking to borrow. The system has to be set up in a transparent way in order to induce trust from all the involved parties. In order to achieve this you will have to focus on a marketing strategy that delivers the maximum information. Information about how you operate, the charges for the borrowers and how are you going to handle the funds at your disposal. You will especially have to convince people that your platform is a secure place to invest. You will need to figure out your marketing channels. The most basic will be your own company blog and possibly even your own in-house developed app (which could be done via crowdfunding).

  1. Developing a brand

Once the crowdfunding concept was new and there were hardly any platforms on the scene. Now competition is arriving and the first mover advantage is long gone. You will have to differentiate yourself from your competition. In the simplest way, it could be by the way of focusing on the aesthetics on your website that is the logo and theme and the usability.

Secondly you should match the features being offered by the competition and where possible streamline your processes even more. You will have to communicate your “differences” via email marketing and company blog. The best way to do this is to provide content that is actually useful for the reader and yet brings your platform to attention.

  1. The technical expertise

At the end of the day customers prefer businesses that provide them with a superb quality service or product. Crowdfunding is essentially a fintech product and thus technology is its backbone. Your crowdfunding platform must not only be user friendly, but it also must be secure and have features that help you make better decisions. For example, Zopa has its own algorithm for deciding which borrowers are more likely to stick to repayment schedules.

In order to succeed it is very important that you analyze your existing competition and see what features you have to match in order to attract customers and what you can do better than them.

 

 

 

The Battle to Launch a Next-Generation Retirement Product & Control $14 Trillion in Investment Direction

By Dara Albright,CrowdFunding Beat Guest Editor, FinTechREVOLUTION.tv  , Dara Albright Media,

In the Fall of 2016, I penned an article entitled, “Modernizing the Self-direct IRA – The Trillion Dollar FinTech Opportunity” – the first in a new series of articles that focuses on next-generation retirement planning. The piece underscored how FinTech will mend America’s flawed retirement system and foster the growth of “digital” investing.

Retire1

This initial report drew attention to the growing necessity for a low-cost, high speed, autonomous retirement solution that would meet the demands of today’s alternative micro-investor. Most significantly, the piece summarized the two distinct individual retirement account prototypes – the Brokerage IRA and the Trust Company IRA – which are vying to become the self-directed IRA exemplar and dominate the $14 trillion retail retirement market.

Sometimes I feel like I am the only one sensing a war brewing in the retail retirement market. But then again, I am somewhat clairvoyant.

Perhaps the majority of America’s retail investors are too busy reluctantly allocating their retirement dollars to sanctioned bond funds – many of which yield more clout than performance – to even notice the race to create a next-generation retail retirement product that will economically custody coveted micro-sized alternative investment products and, in doing so, ensure that a greater number of Americans maintain more properly diversified retirement portfolios.

Maybe most old-school financial professionals are just too preoccupied chasing the “whale” to realize the imminent colossal impact of the rising micro-alternative investor.

No matter the rationale, the fact is that this battle to produce a next-generation retail retirement vehicle is likely to go down as the largest industry duel in the history of commerce – dwarfing the cola and software wars by trillions.

The victorious retirement product stands to inherit the power to redirect $14 trillion dollars of mutual fund assets and disrupt long-standing retirement asset monopolies – thus paving the way for a superior breed of investment products to emerge (download: http://www.slideshare.net/smox2011/the-trillion-dollar-fintech-opportunity).

Unlike previous corporate clashes, the winning IRA model is easy to predict. The frontrunner will be the one possessing the most optimum technological and regulatory framework to accommodate the needs of the modern retail investor. Today’s retail investor is not looking for another mutual fund. He is not begging for ETFs. Nor is he interested in day-trading stocks. Instead, he is craving yield, and he is demanding access to the same level of returns that institutions have been enjoying for years through alternative asset diversification. Simply put, modern investors are looking for a self-directed retirement vehicle that enables them to readily, easily and affordably spread tiny increments of retirement capital across a broad range of asset classes.

Except for the possibility of a sudden legislative change, hands down, the trust company based model will emerge as the clear victor. The Brokerage IRA is bound by too many compliance constraints to enable it to efficiently and cost-effectively facilitate micro investments into alternative asset classes such as P2P notes or crowdfinanced offerings.

The Trust Company IRA, by contrast, operates under a much more favorable regulatory scheme, and any technological shortcomings are presently being addressed and conquered (see: http://www.prnewswire.com/news-releases/ira-services-launches-p2p-lendings-first-cloud-based-api-driven-retirement-investment-solution-at-lendit-2016-300247413.html).

Because it is faster and easier to overcome a technological deficiency than it is to amend regulations, the Trust Company IRA will continue to amass a significant advantage. This is especially true as technology becomes less and less of a commodity and the political climate becomes more and more contentious

There are simply too many compliance-related obstacles that FINRA-regulated BDs would need to surmount in order to formidably compete with the trust company based model. Perhaps one of the most pressing is the Department of Labor’s fiduciary rule which is scheduled to take effect in April.

Under the new DOL rule – which expands the definition of a fiduciary to include commission-based brokers – brokerage firms that handle retail retirement accounts will find themselves facing additional and unwelcomed liability.

In the wake of the DOL rule, retail brokerages have already been seen scrambling to adjust their existing retail retirement product lines. Merrill Lynch has announced that it will be closing its commission-based retirement business altogether, and Edward Jones pronounced that it will simply stop offering mutual funds and ETFs as options in commission-based retirement accounts.

Yes, you read that correctly. Retail brokerages would prefer to limit access to investment products or exit the retail retirement business altogether than to deal with the regulatory headaches of helping small investors prepare for retirement.

Instead of being able to access “prepackaged” diversified investment products, Edward Jones’ retail clientele will either have to self-diversify across stocks, bonds, annuities and CDs, or move to a managed account that charges an asset-based management fee. Since the typical retail investor’s account is too small to properly self-diversify using individual investment products such as stocks and bonds, and since asset-based management fees tend to be much more expensive than one-time commissions, once again retail investors are getting the shaft.

According to CEI finance expert John Berlau, “The DOL fiduciary rule will restrict access to financial advice and reduce choices for lower and middle-income savers. The restrictions can deter companies from serving middle-class savers, creating a “guidance gap” that could cost an estimated $80 billion in lost savings.”

As the DOL Fiduciary Rule succeeds in eliminating both financial advisors and investment choices from the traditional retirement planning equation, smaller investors will be forced into taking a more autonomous stance to retirement prep – leading to a seismic shift in both retail assets and retirement vehicles.

This will have widespread implications on the financial services industry that will include a mass exodus from brokerage IRAs into Trust Company IRAs as well as a flock to robo-advisors, marketplace finance and well as P2P and digital investing – a trend in retail investing that is already well underway.

As the battle for the retail retirement account unfolds, I am going to be reveling in the irony of how once again needless regulatory oversight is helping fuel the FinTech revolution.

Originally published on Dara Albright Media.

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Dara Albright – President of Dara Albright Media, Co-founded the FinFair ConferenceFinTechREVOLUTION.tv

Recognized authority, thought provoker and frequent speaker on topics relating to market structure, private secondary transactions and crowdfinance. Welcome to my new personal blog where you can glean unique insight into the rapid transformation of global capital markets.

 

How 2016 Reshaped Financial Services for Generations to Come

By Dara Albright,CrowdFunding BeatGuest Editor, FinTechREVOLUTION.tv  , Dara Albright Media,
The year began with the renaissance of the retail investor and it ended with a massive crowdfinance conference which centered – for the first time – around the actual crowd (“retail”) investor.2016 will be etched in time as one of the most unpredictable and metamorphic years in our planet’s history. While every fragment of civilization will feel the effects of 2016, the year will leave an indelible imprint on financial services, global political landscapes and mass media for generations to come.

In between was the successful completion of the Elio Motors Reg A+ offering, the first phase of investment product ingenuity through JOBS Act exemptions, the launch of the first retail retirement technology, the “fix Crowdfunding bill”, the introduction of Congressman McHenry’s new FinTech legislation aimed at fostering financial innovation, the implementation of Reg CF, lots of industry turmoil, a surprising Brexit vote, and perhaps the most controversial and suspense-filled U.S. election in history.

2016 was also the year that the Cubs finally won another World Series and I discovered the video selfie.

Before I underscore how all of these events will have monumental economic implications on 2017 and beyond, let me just take a moment to boast about the accuracy of last year’s predictions.

istock_fourgenerations

 Last December I forecasted that:

  1. Robo-advisors will find opportunities in crowdfinance – Just as I predicted, ETF-centric robo-advisors made an entrance into crowdfinance this year. In early 2016, robo adviser, Hedgeable, first entered the crowdfinance space by offering its retail clientele opportunities to venture invest through leading equity crowdfunding platforms such as AngelList and CircleUp. A few months later, Hedgeable announced that it will soon be rolling out a peer-to-peer lending product. Furthermore, based on conversations that I’ve had in recent months with robo-advisory firms as well as with companies that develop technology for robo-advisors, I anticipate many more robo-advisors will soon be joining the party.
  2. Retail Financial Product Ingenuity will Escalate – As discussed last year, GROUNDFLOOR made history in late 2015 with its Reg A+ qualification to offer micro-investors small pieces of real estate debt. In 2016, two more companies broke ground in the Reg A+ arena: StreetShares and American Homeowners Preservation – offering retail investors the ability to capture both monetary and social returns through micro-investments into private businesses as well as individual mortgages, respectively. Companies like these are helping to inspire a new generation of retail alternative products. This type of investment product ingenuity is about to spread well beyond online platforms and marketplaces. I predict that any financial services business involved in the production or sale of alternative securities will soon look to expand distribution by taking advantage of this modern regulatory framework.
  3. Straight Equity Title III Offerings will Fall Flat – Indeed they have. According to NextGen Crowdfunding, a leading provider of crowdfunding deal data, investors have committed to invest slightly more than $15 million into Title III equity crowdfunding campaigns during 2016. $15 million equates to approximately 60 Hillary Clinton speeches or the amount that the U.S. national debt grew since you started reading this article. $15 million won’t even begin to scratch the surface of fixing our economic woes. To put it bluntly, $15 million is not an industry – it’s barely even a house in the Hamptons! Unless and until more creative hybrid financing structures are employed for Reg CF offerings, the market for Title III Offerings will remain insignificant.
  4. Reg A+ “Testing The Waters” will Call Attention to Serious Title II Crowdfunding Flaws – While no one really cared much about this issue in 2016, I do believe that the considerable disparity between total “indications of interest” and the amount of funding actually raised will eventually lead to regulatory amendments. It is completely misleading for a company to “advertise” that it has garnered sizeable funding interest without ever having to notify the public that it failed to raise even a fraction of the amount.
  5. The Crowdfinance Playing Field will Undergo Leadership Change – Wow, was I right about this one! Industry leadership has begun to undergo significant change in 2016 – particularly in marketplace lending. I stand by my statement that, “New leaders will rise. Some unexpected frontrunners will fall. The businesses that will best be able to oblige the retail customer, adapt to regulatory changes, and penetrate retail’s $14+ trillion retirement capital will prevail.”
  6. Hoverboards will Disappear from Toy Store Shelves – Uh, I meant to say Galaxy Note 7’s will disappear from the shelves. Yeah, yeah, that’s the ticket. (In the era of “fake news” this totally passé catchphrase deserves to make a comeback).

While some of my last year’s prognostications have yet to fully reach fruition, I’m still standing by all of my 2016 predictions. I’ve come to realize that predictions, much like karma, operate on their own timetable. Even some of the prophecies of the great Nostradamus were a year or two off. And, let’s not forget that Robert Zemeckis was just one year too early in forecasting the Cubs World Series victory.

Speaking of which, you are probably wondering what the Cubbies winning the World Series and video-selfies have to do with the future of personal finance anyway.

A lot. Maybe even everything.

The Cubs World Series win and video selfies are empowering underdogs everywhere. If the most mocked team in the history of professional baseball can win a World Series and amateur videographers can become universally recognized broadcast journalists, then long shots everywhere can achieve astonishing victories. Non-politicians can win presidential elections. Non-lawyers can prevail in litigation. Small businesses can access capital as freely as large corporations. And primarily due to crucial advancements in micro-investing technology, even investing novices will be able to outperform financial experts. At long last, the little guy can have just as much of an opportunity to create wealth as the George Soros and Warren Buffet ilk.

This brings me to my bold 2017 predictions (or as Ron Suber would likely call them “Big Hairy Audacious” predictions).

  1. Underdogs across the land will triumph in 2017 – The Chinese predict that 2017 will be the year of the rooster. I disagree. I believe that 2017 will be the year of the Rudy.
  2. The broader markets will correct – I foresee the broader markets headed for a crash – triggered primarily by manipulators, speculators and years of unsustainable monetary policy. Our public equity markets have been artificially propped up by policy for far too long. America simply can’t keep lowering rates and printing its way to prosperity. Interest rates have nowhere left to go but up, particularly if Trump makes good on his economic plan and we see some real economic growth. I foresee rate hikes leading to a stock market correction. Although it may be a short-lived correction, those who are well-diversified and have allocated some capital to less volatile, less correlated asset classes, will be better able to weather the storm.
  3. The face of financial media will Become Unrecognizable – In 2016 the established media awoke to the revelation that it no longer holds the relevancy that it did in previous generations – something housewives on Facebook have known since about 2008. Although it tried hard not to accept it, traditional media has been hemorrhaging influence for quite some time now. Just like how the video killed the radio star, how Napster crushed the CD, how Netflix annihilated Blockbuster and how Amazon overtook Barnes & Noble, communications technology is on an unstoppable path to demolish mainstream media. While bloggers have been gaining prominence for years at the expense of print media, it will be the video-selfie that delivers mainstream media its final blow. Financial media is no exception. The 2016 U.S. presidential election established social media – not television – as the dominant medium. Clearly, more people tuned into Infowars than to Rachel Maddow. If the video selfie can help influence a U.S. election, its impact on financial services will be colossal. Expect financial content to become edgier as well as more engaging, encompassing and interactive. Expect new financial voices to emerge and gain prominence. Most significantly, expect these new financial media players to forever transform the way people invest, where people invest and how people invest.
  4. FinTech will Expand into Older Demographics – I see countless FinTech business plans. Most of them are loaded with statistics on millennials, ideas for targeting millennials and even pictures of millennials. Yes, many of us industry folks are well-aware that millennials prefer having a root-canal than going to a bank. However, FinTech is not a millennial-centric market. I predict that 2017 will be the year that FinTech crosses demographical thresholds. I expect that older demographics will start incorporating FinTech into their daily routines. As a result, I envision more FinTech innovation being directed towards developing products for other generations, particularly retirees.
  5. The U.S. retirement infrastructure will begin to undergo monumental transformation in 2017 – The $14 trillion retail retirement industry is on the cusp of great transformation. Thanks to the progression of FinTech, RegTech and AltTech, the retirement industry is about to become fairer, simpler and more inclusive. Expect regulatory and technological innovations to be introduced that will unwind a broken and unjust retirement system. Expect retirement plans to become more consumption driven than employment-based. You can also look forward to seeing the mass adoption of game-changing financial products that will give everyone – including present retirees – a fighting chance to prosper throughout their senior years.

The story of financial services is unfolding and it is growing more fascinating by the minute. And I am truly grateful to be alive at this particular moment in time to witness it firsthand.

Anyone who has read my previous year-end articles knows how reflective I tend to get as I approach my Christmas Eve birthday. And this year I am especially pensive given the fact that I am turning 29 (again) and that mercury is in retrograde and that Uranus (pronounced: “Your Ron Issss”) is, well it is somewhere in the universe doing something to affect my mood. Whenever that happens, I tend to seek inspiration in a poem, a lyric or even in just one simple word.

It is for this very reason that I subscribe to dictionary.com’s word of the day. On December 16th, dictionary.com’s word of the day was “hotsy-totsy” and it means, “about as right as can be”. Because I vowed to find a way to incorporate this quirky “makes-you-feel-like-skipping” word into an article, I would like to simply conclude by wishing everyone a joyous holiday season and a very hotsy-totsy 2017!

Originally published on Dara Albright Media.

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Dara Albright – President of Dara Albright Media, Co-founded the FinFair ConferenceFinTechREVOLUTION.tv

Recognized authority, thought provoker and frequent speaker on topics relating to market structure, private secondary transactions and crowdfinance. Welcome to my new personal blog where you can glean unique insight into the rapid transformation of global capital markets.

 

CONNECT ON SOCIAL MEDIA:

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Crowdfunding- The Good, The Bad & The (really) Ugly Part II –The Bad

By Shane Liddell is the CEO and chief Crowdfundologist at Smart Crowdfunding LLC,. Crowdfund Beat Guest post,

Introduction

In Part 1 I covered all of the good things that we have seen as crowdfunding continuously gathers momentum across the world. The future looks bright indeed!

However, as with any new industry forging ahead and desperate for acceptance, the surrounding hype that comes with it often blurs reality, with any form of negativity simply  ‘brushed under the carpet’ so to speak. Naturally, those fully vested in the industry (including yours truly) have a lot on the line, as everyone charges ahead in full promotion mode. The ‘painted picture’ is a rosy one and for a very good reason, but there is a dark and sometimes sinister side to the industry as well.

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Part 2-The Bad

 The Industry Evolves

 

 

Let’s rewind a little. In an interview with Film Threat back in October 2010, Indiegogo co-founder, Slava Rubin said “… what we are now and what we are for the future is we’re all about allowing anybody to raise money for any idea” Although this may have been true at the time, it’s certainly not applicable today. Reality is that not ‘anybody ’can raise money through crowdfunding unless they are a) extremely lucky, or b) have a substantial amount of money to begin with. Let me explain a little further.

My own entry into the crowdfunding space happened by default during June of 2012 when confronted with a desperate plea for funding from a lady by the name of Louise Joubert of the Sanwild Wildlife Sanctuary. Louise put out a post on the Sanwild Facebook page saying that sponsors had pulled up to 70% of the funding for Sanwild due to the recession, so she was unable to feed the 16 lions she rescued from the ‘canned hunting’ industry, and she was getting to the point of desperation and was seriously considering euthanizing them. Louise saw this as the kind way to put an end to any potential suffering. This sad story really pulled at my heartstrings and after a phone call or two to South Africa, I volunteered to see if I could help by using this new fundraising method called Crowdfunding. To cut a long story short, we did manage to raise over $20,000 through an Indiegogo campaign and in turn bring a happy ending to this story with the 16 lions being saved. It was an exhausting process, especially with little to no budget to market the campaign; but through teamwork, perseverance and leveraging off of our social contacts, we made it. The point here is that with almost no campaign budget (but instead 100’s of hours invested) we were able to do what we set out to achieve – Save Our Lions.

During 2012 we saw on average 30-50 campaigns launching on the Indiegogo platform each week and probably around 60-70 per week on Kickstarter. These low numbers made things much easier for anyone crowdfunding their ideas, as competition for ‘eyeballs’ was almost non-existent, the media was receptive to any crowdfunding news at all, and the public was in a state of confusion as to what they were really doing when contributing to these campaigns, with many thinking they were simply making an online purchase just as they would do on Amazon.

How things have changed.

Fast forward to 2016 and with approximately 300-400 campaigns launching per week on the Indiegogo platform and up to 600 per week launching on Kickstarter, the competition is fierce. Add to this that there are now well over 1000 (and counting) crowdfunding platforms globally and you’ll begin to see the real picture.

The corporate world is now waking up to this new, low cost way of validating and funding projects and products. Big names such as Sony and GE’s entry into crowdfunding gives the small guy very little chance of competing with them.

In a recent article published by The Verge earlier this year titled “Indiegogo wants huge companies to crowdfund their next big products” and a sub heading which reads “Indiegogo wants big brands to start crowdfunding” we see how they have changed for the worse. Their “Enterprise Crowdfunding” clearly showing that they are not in any way ‘democratizing access to funding’ but instead are an entity solely in the business of making a profit at all costs (more on this particular story in Part 3 –The Ugly).

I guess the most disturbing words I read in that article are these:

“Large companies can also pay for special placement on Indiegogo’s site, making them more discoverable than other campaigns.”

So, Indiegogo now earns revenue from advertising placements only available to corporates? Shocking to say the least!

This whole scenario stinks and reminds me of a certain politician, who now as president elect, has already made several ‘about turns’, continuously going against the words he used to gain popularity.

I hope you all now realize why the small guy has little to no chance of success, especially now that the heavyweights enter with the resources to squeeze them out. In fact, a well know marketing agency recommends a campaign budget today of a whopping $40,000. I don’t know too many ‘little guys’ with that kind of cash to spend on an upcoming crowdfunding attempt, do you? Wasn’t the whole point of crowdfunding to raise money and not spend it?

Although crowdfunding was originally pitched as democratizing access to funding for the small guys, this is no longer true. Without a good chunk of capital to start with, their campaigns are doomed before they begin.

 

Equity Crowdfunding – The SEC (Securities and Exchange Commission)

Background

On April 5th 2012 president Obama signed the Jump Start Our Business Act (commonly referred to as “The JOBS Act”) giving the SEC 274 days to write up the necessary rules and regulations. The main purpose in the implementation of the JOBS Act was to stimulate the creation of jobs through small business access to capital.

The JOBS Act substantially changed a number of laws and regulations making it easier for companies to both go public and to raise capital privately and stay private longer. Changes include exemptions for crowdfunding, a more useful version of Regulation A, generally solicited Regulation D Rule 506 offerings, and an easier path to registration of an initial public offering (IPO) for emerging growth companies.

The titles of the bill that make equity crowdfunding work are:

  • TITLE II – Access to capital for job creators (REG D)
  • TITLE III – Crowdfunding (REG CF)
  • TITLE IV – Small company capital formation (REG A+ or mini IPO)

What’s with all this jargon you may ask? Good question, and the answer is one which I hope many academics will learn to answer in their writings. Effective communication is always better crafted to suit a broader audience. Within crowdfunding, I feel it is important for all – lawyers, accountants, broker dealers etc. – to understand that in our attempt to educate the market, we need to simplify the language used so as to be better understood by the majority.

Back in the 70’s the KISS acronym and methodology – “Keep It Simple Stupid” was very popular for good reason. The simplicity of this methodology should be more applicable today than it ever has been.

For clarification:
REG D allows the issuer to raise funds from accredited investors only meaning in essence from a select few rich people.

REG CF allows issuers to raise funds from both accredited investors and non-accredited investors (the general public) but is subject to limitations.

REG A+ allows the raising of up to $20M through Tier 1 and up to $50M through Tier 2.

Titles I, V, and VI of the JOBS Act became effective immediately upon enactment. Understanding these within the context of this article is not really important so I won’t bother explaining.

The SEC approved the lifting of the general solicitation ban on July 10, 2013, paving the way for the adoption of REG D which went into effect in September 2013. Following this was REG A+ which went live during June 2014 – 2 years after the signing of the Jobs Act – and finally the long anticipated (and most beneficial to small business) REG CF on May 16th 2016 – more than 4 years since the signing of the Jobs Act!

Yes, you read that right – 4 years later. A whole 4 years of lost opportunity. Why 4 years you may ask? Well, through a series of meetings, mountains of paperwork, a change of chair, commenting periods, rewriting this and rewriting that and a whole heap of other hurdles to jump through in between, a whopping 685 pages of regulations was created. Certainly no KISS methodology involved there!

During this period, how many small businesses have folded because they had no access to much needed capital? How many could have been saved from collapse? How many precious jobs were lost during this lengthy and tedious process? The answers should be fairly obvious to fathom.

Based on current information from successfully funded campaigns, we see that so far around $175M has been raised under REG A+ crowdfunding and about $15M over the past 6 months through REG CF. Imagine what these numbers would look like had the SEC been more efficient in the role they played during the entire rulemaking process.

On the other hand, the United Kingdom took a fairly relaxed approach to rulemaking which has led to the creation of the most dynamic alternative finance market in the world. In real terms they are 5 years ahead in the game and are seen as the leaders in this space. The United States is seen as a failure.

Were the SEC attempting to break records as the slowest crowdfunding rulemakers in the world? Maybe not, but it appears they are well positioned to claim this shameful accolade!

 

The Pretenders – Self –Promoters and the Charlatans

Before I begin, let me just say that there are many among us who have ‘earned their stripes’ in this industry. I hold these people in the highest regard for their dedication and commitment to the cause. Far too many to mention of course, but you know who you are, so thank you for doing what you do! Through the many long days of hard work, dedication, countless hours of research, and in some cases, hands on experience with crowdfunding projects of all shapes and sizes, they stay true to their objectives of making the crowdfunding industry one to admire. These people gain respect naturally through their words and actions alone. They generally keep a fairly low profile too, with little need to go on the self-promotion bandwagon, as people naturally migrate to them anyway.

Let’s briefly return back to 2012, when crowdfunding was really still in its infancy and there were very few players involved. To put things into perspective, at the time of launching my own crowdfunding marketing agency Smart Crowdfunding under the crowdfunders.us domain, there were only four other active crowdfunding marketing agencies globally. The industry was tiny and it was very easy to know who was who.

This leads me to a telephone conversation I had one day during early 2013 with one of the other agency founders who had taken issue with the fact that I was now actively competing with him. After listening to his concerns, I politely brushed them aside and ended the call saying “If you are concerned about competition now, then wait to see what’s coming over the next few years”. He grumped and the call ended. Move on to 2016 and we see a whole load of entrants into this space.

Back to the point:
There are those who clearly try to take shortcuts in an attempt to get to the top, with integrity thrown right out the window in their pursuit of money and stardom. Many of these types have little care for the health of the industry as a whole, but instead their own greed drives them forward. They are quite easy to spot though. Lies are abundant and a little due diligence goes a long way in discovering the truth about them. The wonderful world of the Whois lookup is a great tool to confirm some claims of “we’ve been doing this for the past 5 years” as domain registration dates tell the truth. Some have woken up to hiding these details and hide behind a proxy registration service. In fact, a little while ago I had discovered exactly this with a crowdfunding marketing agency who made such claims (and still do) of having been around for the past 6 years. I did a Whois search many months ago to only find that their domain was registered in 2013 – and not 6 years ago as claimed. Further investigation confirmed this. Today their domain registration information is now hidden via a proxy.

One of the most common things I see today is those with very little industry experience becoming self-proclaimed “Experts”. Let’s elaborate on this for a moment.

During 2014 I attended a crowdfunding industry conference, and as I sat in the audience while the proceeding began, the moderator allowed the panel give a brief introduction of themselves. There were 4 on this particular panel, 3 of whom I knew of. To my amazement, one particular character was introduced as a crowdfunding marketing expert. I listened intently to this persons ‘pitch’ and also the advice they gave to the audience when confronted with questions such as “What’s the single most important tool to use when crowdfunding? Their answer? PPC (Pay per click). Wrong! In disbelief, there were a few shaking heads in the audience, mine included. Had this person’s earlier claim of “I’ve worked on 80 Kickstarter and Indiegogo campaigns” during their introductory pitch been true, they would clearly know this was incorrect information. Following up from this and after checking out the real facts it turns out that today, this person has run a single Indiegogo campaign of which struggled to get to $10,000 funded. I suspect a fair share of self-funding activity there too. This example is one of many we see as the industry powers forward. Being able to spot these “experts” is fairly easy when you know what to look for.

You see, I have followed Indiegogo campaigns in particular like a hawk. My early career in crowdfunding was built around this platform so it’s rare that even a single campaign that’s raised more than $5,000 gets by me without notice.

The biggest telltale sign of those who attempt to take shortcuts to stardom is the lack of consistency in their pitch. Many appear to have short memories! The character I reference above has since spoken at numerous industry events and their pitch varies from “I have 8 staff and have worked on over 100 Kickstarter and Indiegogo campaigns” to “I have 25 staff and have worked on 80 Kickstarter and Indiegogo campaigns” In reality, as of today they’ve worked on a handful at most and only 1 on the Indiegogo platform can be confirmed under deeper investigation.

I have major concerns! Besides ‘the blind leading the blind”, the entire industry is at stake here, and addressing the real issues now can only bode well for a healthy and prosperous industry for all.

As a colleague recently said “….the integrity of the entire industry is on the line, and if the charlatans are allowed to run roughshod it’ll soon turn into a house of cards.” No truer words have ever been spoken.

Scampaigns – Yes and No

Now this section will be fairly short.

Let me start by saying that intentional scams are really very rare. During my time in the industry I have seen no more than 3 or 4 which were clearly scams from the very beginning ( I’ll elaborate more on this in Part 3 – The Ugly).

What I have seen, however, even from some of my earlier clients may surprise you. They begin the crowdfunding process with good intentions but unrealistic expectations (a common trait among those crowdfunding today).This is their real downfall.

Many are young, inexperienced men and women whose entire focus is on how great their product is. They are emotionally invested and in some cases spend lengthy periods developing their concept or prototype. When the time comes to go crowdfunding, in many cases they lay everything on the line. Some win. Some lose.

Even after running a successful campaign, for many the process of handling large amounts of cash and developing their idea into a real manufactured product, leads to failure due to lack of experience. A weak team adds to their woes and they burn through cash at an alarming rate. In time, they sit in disbelief that they no longer have enough cash to actually finish the product. At other times their concept was flawed from the very beginning but they only discover this when attempting to go to the prototype stage. Facing the inevitable truth is hard for them, and with the angry abuse from their supporters awaiting, they are stuck between a rock and a hard place. Many come to the conclusion that their only route of escape is a disappearing act.

What do the backers, journalist and millions of other disgruntled people call these people? Scammers. Many of their backers didn’t know at the time they were backing a concept in the first place and shout to the high heavens in disgust when they don’t get what they thought they “ordered’ a year prior.

A very recent case of the scam label being attached to something that was not a crowdfunding scam from the very beginning is Healbe GoBe – “the first and only wearable device that automatically measures the calories you consume and burn, through your skin” which raised over $1M. Despite being slammed by all and sundry – including backers, engineers, scientists, and journalists – they eventually brought their product to market, albeit with many ‘teething problems’ still to be ironed out.

Conclusion

My biggest challenge when writing  part 2 of my article, was in trying to condense as much as possible, but to still get the message(s) across. I hope I have achieved this even though we still ended up with over 3,000 words.  I promise a much shorter part 3. Thank you for reading and I hope this has been helpful.

Look out for Part 3 – The (really) Ugly, where I delve deeper into the real scams of the crowdfunding world, as well as extortion and blackmail attempts and the platforms that seemingly turn a blind eye to it all.

About The Author

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Shane Liddell is the CEO and chief Crowdfundologist at Smart Crowdfunding LLC, the crowdfunding marketing agency. He became active within the crowdfunding industry early in 2012, seizing the opportunity to offer help to crowdfunders from all corners of the world. He has delivered successful campaigns for entrepreneurs, startups, corporations and filmmakers and has assisted over 500 crowdfunders with campaign development, consulting, marketing and promotion services, some of whom have raised millions of dollars in the process. He has attended numerous equity crowdfunding industry events, including the SEC Small Business Forum and the CfPA Summit in Washington DC. Shane holds the position of Executive Director of the Crowdfunding Professional Association (CfPA).

On the SEC’s New Intrastate Crowdfunding Rules and the Nanny State

By Samuel S. Guzik, CrowdFundBeat special guest editor,  Guzik & Associate

On October 26, 2016, the SEC’s three Commissioners convened at their headquarters to adopt new rules intended to modernize what had historically been a little used path of raising capital for startups, early stage businesses and community-based enterprises: the so called intrastate exemption. It had its origins in our federal securities regulation legislation adopted back in 1933, which required the federal registration of the sale of securities in the U.S.  absent an exemption from registration.

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In 1933 Congress, in its wisdom, carved out from the registration requirement those offerings that were purely local in character, where offers and sales were made by local businesses within their state borders.  This area it left to regulation by the states – on a state by state basis – with each state left to decide for itself how best to balance the need to protect its investing public with the ability of local businesses to access capital.

And to facilitate the utilization of this exemption from registration the Commission enacted Rule 147, intended to be a non-exclusive safe harbor to facilitate compliance with the federal exemption.

Over the years it became more and more apparent that both the exemption itself and the Rule were flawed – hence its use languished – in favor of other more manageable exemptions from federal registration.   Its use was generally shunned by securities lawyers, as it was too easy to fall out of compliance with its requirements.

And time was not kind to the intrastate exemption. If your business was a corporation, the statutory exemption was limited to corporations incorporated in the state where the offering occurred, thus excluding local businesses who might elect to incorporate in out of state jurisdictions.   And with the onset of the Internet in the 1990’s the Commission struggled with how to address offers by a local business on the internet which by their very nature would cross state borders.  This struggle came to a head in 2014, when the SEC Staff issued an informal interpretation, a “CDI” (compliance and disclosure interpretation), opining that unrestricted Internet solicitation and advertising of an offering was taboo for an offering relying on the intrastate exemption.  This effectively put a damper on local investment crowdfunded offerings in the dozens of states that had adopted, or were to adopt, intrastate crowdfunding statutes relying on the intrastate exemption.

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The 2014 CDI was greeted with a growing chorus of mystified securities lawyers, state securities regulators and small business advocates.  At a time when the SEC was dragging its feet to adopt regulations to implement interstate (nationwide) investment crowdfunding,  it had in effect shut off many states from enacting local crowdfunding statutes which would enable SME’s to leverage the Internet in local investment crowdfunding campaigns.

Invest Today Billboard AdvertisementIn 2015 the Staff at the SEC’s Division of Corporation Finance took the bull by the horns, recommending that the Commission adopt new rules to modernize and expand the federal intrastate crowdfunding exemption. On October 30, 2015, the same day that the Commission adopted the long-awaited final rules implementing JOBS Act Title III crowdfunding, it came with its own October surprise: proposed rules to update and expand the intrastate exemption – notably, allowing unrestricted Internet advertising of an offering.

One year later, on October 26, 2016, the Commission adopted final intrastate crowdfunding rules, much improved from the proposed rules. Gone in the final rules, among other things, was a provision which would have prohibited state legislatures and state securities regulators from authorizing local investment crowdfunded offerings in excess of $5 million per year.  Though no state has yet to authorize crowdfunded offerings above this amount, virtually all of those who commented on the propose rules were unanimous: this was a matter best left to the discretion of each state – not the federal government.  And in the UK, where investment crowdfunding has flourished, the $5 million dollar ceiling has been broken and is expected to go higher.

Though the vote by the Commissioners on the final rules was unanimous, not so with the sentiment of the Commissioners.  In Commissioner Kara M. Stein’s public remarks on the final rules, she was not shy about expressing reservations about the ability of the individual states to protect their local residents from questionable offerings and bad actors, cautioning of the need for continuing federal oversight:kara-stein-sec-intrastate

“Today’s rules amend Rule 147, and create a new federal offering exemption known as Rule 147A.  Hopefully, the updated safe harbor and new exemption before us today will foster opportunities and create new paths forward for such smaller firms, while still safeguarding investors.”

 

“At least, this is the theory.  Like other experimental capital-raising rules, such as Regulation A+ and Regulation Crowdfunding, only time will tell how well the theory works in practice. Only time will tell whether we can relax capital-raising regulations, while also maintaining appropriate investor protections.  So, while today’s rules may provide smaller companies with additional funding opportunities, today’s rules also raise some investor protection concerns.”

And in closing her remarks, Commissioner Stein  again emphasized what she viewed as the “experimental” nature of these new rules:

“Today’s amendments to Rules 147 and 504 and the new exemption under Rule 147A are part of a suite of rules focused on providing options for smaller businesses seeking to raise capital.  On balance, I think they are worth the experiment.  However, by collecting, sharing, and examining data on how these new options are working in practice, we should be able to recalibrate these rules if the experiment is not working out as planned.”

Most respectfully, I must take exception to Commissioner Stein’s characterization of these rules. It is not a question of whether the glass is half full, or half empty. In my opinion, the glass, from Commissioner Stein’s perspective, is simply upside down.

Science Chemistry TechnologyThe real “experiment,” historically, dates back not only to 1933, when Congress first carved out this statutory reservation of power to the states. The “experiment” also dates back to 1776, when our Founders adopted a Constitution which gave specified powers to the federal government, with all other powers being reserved to the states.  The “experiments” our Founders had in mind were those which would take place under laws enacted by each of the states – as they, and not the federal government, saw fit.  States were to set up their own laboratories of experiment for matters uniquely concerning their residents, and occurring within their borders – free from interference by a federal bureaucracy.

Seems that Commissioner Stein never got that memo. In her view, it would be up to the SEC to “recalibrate” the new rules if the states get it wrong – in the judgment of the Commission, of course.

So Why Does Any of This Matter?

It would be easy to be dismissive of the recently adopted intrastate rules.  After all, historically the intrastate exemption has not been in favor –there have been much better options – with far fewer pitfalls. Even more so now, with new pathways of capital formation opened up by the JOBS Act of 2012.  And with the advent of federal investment crowdfunding, most would yawn when examining the seemingly unimpressive statistics for the use of intrastate crowdfunding during brief period in which intrastate crowdfunding has been allowed.

I submit that current statistics are not very meaningful – as they do not tell the whole story. There is a lag between the time that new capital raising paths are created and when they become “mainstream.”  And let us not forget – until these new rules go into effect (April 2017), as a general matter broad internet solicitation is not permitted in intrastate crowdfunded offerings relying on the current Rule 147 – covering most of the 35 states which have adopted their own intrastate crowdfunding statutes.  And crowdfunding without the Internet is more akin to a day without sunshine. Not much can grow in that environment.

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Size Does Not Always Matter

Statistics, however, do not tell the whole story. Most businesses start out as local businesses.  But when it comes to allocating investor capital in SME’s, most of it winds up in California, New York, and Massachusetts, leaving the vast majority of this country as “capital deserts.”

Patrick McHenry 2Those are not my words. They are the words of US Congressman and Deputy Whip Patrick McHenry, who hails from the Great State of North Carolina – the same gentlemen who has been unrelenting in his efforts to implement smart federal legislation intended to remove unnecessary federal regulatory barriers to SME capital formation: starting with the JOBS Act of 2012, and continuing to this day with a host of bills to further improve the access of SME’s to much needed capital – especially in capital-starved “flyover” states.

Make no mistake about it.  This is not a political issue, notwithstanding the heated rhetoric in 2016 which has saturated our media.  To put a fine point on this, I offer the views of our Democratic Vice President, Joe Biden, spoken in 2014 at the U.S. sponsored Global Economic Summit, on the other side of the world in Morocco to an assembly of thousands of entrepreneurs and government officials, including the head of the U.S. Small Business Administration, Maria Contreras – Sweet.

“The single most valuable resource on this planet I think we could all agree on in this room is not what’s in the ground, but what’s in the mind.  It’s the single least explored part of the world, the mind.  The things that are going to happen in the next two, five, 10, 15 years are breathtaking.  Investors, they have to be willing to expand the horizon and invest in early stage entrepreneurs — not only in Silicon Valley — but . . . everywhere, everywhere where there’s talent.”

maria-contreras“Governments have to unlock the marketplace of ideas by allowing people to express their views openly about what they’re thinking and what they’re trying.”

“They must unlock the commercial marketplace by eliminating barriers to access to capital; ensuring that rules are fair and predictable, removing excessive cumbersome regulations.”

“The government can’t grow the economy by itself.  As a matter of fact, it’s not the major reason.  It’s a catalyst for growth — no matter how big the megaproject.  To prosper in the 21st century, you also need to grow from the bottom up, allowing your people to unlock their talents through private enterprise and political and economic freedom and action.”

And there was some irony – not apparent from the remarks themselves.  They were spoken at a U.S. sponsored world conference intended to promote entrepreneurial activity in Muslim-majority countries – one of former Secretary of State Clinton’s initiatives started by her back in 2009.

Washington Monument DCSo let’s not be too “provincial” when pronouncing judgment on who knows best, when it comes deciding how investors should best be protected – or what is needed to enhance capital formation for SME’s –  or where those funds are needed most – especially when the boundaries of that “province” are marked by the Washington Beltway – and the matters at hand reside within the borders of a single state.

So let’s wake up – and give some deference to our local communities, big and small, U.S. entrepreneurs everywhere, including in the flyover states, and the state legislatures which regulate them.  Sometimes big ideas start in small, seemingly unlikely places.

“Bite-size” businesses, in the aggregate, are important to our economy and job creation. And in Finfair Panel with Amy Cortesethis day and age of readily accessible technology “Uber” sized businesses often have their genesis with relatively modest amounts of capital.

After all, it’s why one notable leader championing the importance of local investing, and New York Times contributor,Amy Cortese, calls it “Locavesting,” – not “Loco” – vesting.

OTC Markets Group and CrowdFund Beat to Host Regulation A+ Bootcamp in New York City

facebook_regabootcamp-1 NEW YORK, Oct. 26, 2016 /PRNewswire/ — OTC Markets Group Inc. (OTCQX: OTCM), operator of financial markets for 10,000 U.S. and global securities, and CrowdFund Beat, a news and information source for the crowdfunding market, today announced they will co-host a Regulation A+ Bootcamp on November 10 at OTC Markets Group’s headquarters in New York City.

 

The one-day workshop will provide startup companies and entrepreneurs with expert guidance on how to raise capital under Title IV of the Jumpstart Our Business Startups (JOBS) Act, also known as “Regulation A+,” which allows small companies to raise up to $50 million annually in crowdfunded offerings from accredited and unaccredited investors.  Speakers will include legal, accounting and other crowdfunding industry experts, including:

  • Kim Wales, Founder and CEO of Wales Capital, who will provide an overview of the state of the Reg A+ market
  • Doug Ellenoff, Partner at Ellenoff Grossman & Schole LLP, who will discuss legal considerations involved in a Reg A+ offering
  • Ron Miller, CEO of StartEngine Crowdfunding, Inc., and Darren Marble, CEO of CrowdfundX, who will discuss equity crowdfunding portals and marketing an offering
  • Craig Denlinger, Managing Partner of Artesian CPA and CrowdfundCPA.com, and attorney Mark Roderick of Flaster Greenberg PC who will provide an overview of the numbers, valuation and legal structure to be considered in a Reg A+ filing
  • Scott Purcell, Founder and CEO of FundAmerica, LLC, who will talk about the escrow process
  • Crowdfunding industry expert Dr. Richard Swart, Chief Strategy Officer of NextGen Crowdfunding, who will address how Reg A+ has evolved
  • Attorneys Seth Farbman and Yoel Goldfeder of VStock Transfer, LLC who will discuss selecting a transfer agent and depositing shares into brokerage accounts
  • Jason Paltrowitz, Executive Vice President of OTC Markets Group, who will discuss investor considerations and how and where a company’s Reg A+ securities can become publicly traded.

The event will conclude with a group discussion and question-and-answer session with Jonathan Frutkin of The Frutkin Law Group, Sam Guzik of Guzik & Associates, Brian Korn of Manatt, Phelps & Phillips, LLP, Blaine McLaughlin of VIA Folio™, a division of FOLIOfn Investments, Inc., and Jonathan Wilson of Taylor English Duma LLP.

Attendees will be able to ask questions and schedule one-on-one meetings with the speakers.

“It has been over a year since Reg A+ became effective, yet still there are questions about how it works and what is needed to make a Reg A+ offering successful,” said Jason Paltrowitz, Executive Vice President of Corporate Services at OTC Markets Group.  “Our boot camp is designed to answer some of those questions and provide small businesses and entrepreneurs with step-by-step instructions on how to conduct a Reg A+ offering and take their company public.  We are thrilled to partner with CrowdFund Beat on this initiative and look forward to an exciting event.”

“What’s most important is we have data over the past year on Reg A+ that will be shared by the conference’s panel who are the who’s who of the crowdfunding industry.  This boot camp is really about trends and where things are going forward,” said Sydney Armani, Publisher of CrowdFundbeat.com.

To register for the event or for more information, visit http://www.regapluslist.com/.

About OTC Markets Group Inc.
OTC Markets Group Inc. (OTCQX: OTCM) operates the OTCQX® Best Market, the OTCQB® Venture Market, and the Pink® Open Market for 10,000 U.S. and global securities.  Through OTC Link® ATS, we connect a diverse network of broker-dealers that provide liquidity and execution services.  We enable investors to easily trade through the broker of their choice and empower companies to improve the quality of information available for investors.

To learn more about how we create better informed and more efficient markets, visit www.otcmarkets.com.

OTC Link ATS is operated by OTC Link LLC, member FINRA/SIPC and SEC regulated ATS.

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About CrowdFund Beat

CrowdFund Beat is the Crowdfunding Industry’s go-to source of Smart Content for all news and trends Crowdfunding related.  With an extensive online video library, CrowdFund Beat is the Worldwide source of information.  The company also produces two marquee Industry Conferences: The Silicon Valley Fintech Conference in Silicon Valley and The Fourth Annual Conference and Workshop, held at the National Press Club in Washington.  This year CrowdFund Beat is commissioning a robust written and Video Report of where the Industry is heading called 2020 Outlook Crowdfunding Industry Report, to be Published in January, 2017.

Media Contacts:
OTC Markets Group Inc., +1 (212) 896-4428, media@otcmarkets.com
CrowdFund Beat, LLC, +1 (888) 580-6610, news@crowdfundbeat.com

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SOURCE OTC Markets Group Inc.

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NASAA and Members of Congress Come Together on the Need for the SEC to Expand Intrastate Crowdfunding Rules

By Samuel S. Guzik, CrowdFundBeat special guest editor,  Guzik & Associate

It is rare that I am able to find agreement with the publicly stated positions of the North American Securities Administrators Association (NASAA). Equally rare – members of Congress who are traditionally strong advocates for “smart” regulatory reform of capital formation by SME’s to find themselves on the same page as NASAA.  However, there appears to be a growing, even overwhelming, consensus that the SEC’s proposed rules to modify current federal restrictions on the intrastate sale of securities – are on the one hand a step in the right direction.  But on the other hand, the SEC’s rule, as proposed, does not go far enough, and places unnecessary restrictions on the ability of states to decide what is in the best interests of their constituents – free of interference from the SEC.

By way of background, on October 30, 2015, the same day that the Commission announced final investment crowdfunding rules in furtherance of Title III of the JOBS Act of 2012 to implement investment crowdfunding on a national level – it also issued for comment a proposed rule, primarily intended to facilitate investment crowdfunding at the state level – Rule 147A. Significantly, the proposed rule would allow companies to advertise their offering on the Internet, something which the SEC Staff has stated is prohibited under current Rule 147 – and much to the consternation of state regulators and securities lawyers  alike.  In doing so, the SEC proposed to limit the amount that a state could authorize under its laws to $5 million. And it also proposed to eliminate the existing rule, Rule 147, in its entirety.

On October 7, 2016, a bi-partisan group of 15 members of Congress, many members of the House Financial Services Committee, signed a letter addressed to the SEC, encouraging the Commission to finalize its rulemaking, but with some important modifications. In particular, as proposed by the Commission, the existing “safe harbor” rule, Rule 147, which would allow states to regulate offerings occurring entirely within their state, would be scrapped in its entirety, and replaced by a new rule, Rule 147A, under the Commission’s general rulemaking powers.  This approach, if adopted in the final rules, has at least two untoward effects, as regards the ability of states to fashion their own rules for intrastate offering, including intrastate investment crowdfunding.

First, of the 35 or so states which have enacted their own investment crowdfunding statutes, adoption of the Rule, as proposed, would in effect, terminate these exemptions in many of the states which enacted their exemptions based entirely upon the current rule – proposed to be eliminated – bringing intrastate crowdfunding to a halt.  Comment letters to date have almost universally requested the SEC to clarify and expand the existing Rule 147, but to retain the existing rule.  Though a technicality of sorts, failure to fix this glitch would require the large majority of states authorizing intrastate investment crowdfunding to go back to their state legislatures to incorporate any new rule which replaces the current Rule 147. And until then, intrastate crowdfunding would be shut down.

Second, though the SEC’s proposed rule makes necessary improvements, it comes with some conditions which many find unpalatable – and unnecessary. In particular, the SEC rule, as proposed, would limit the ceiling under this proposed exemption to $5 million.  Opposition to this condition has been strong, simply because this is a matter which ought to be determined by each state – on a state by state basis.

The latest missive by 15 members of the House Financial Services Committee includes Congressman and Deputy Whip Patrick McHenry, a leading proponent of the JOBS Act of 2012 and subsequent legislation, and Congressman John Carney, the original sponsor of a Bill which passed the House this year which if enacted would create a new, independent office at the SEC – Office of Small Business Advocate – and would report to the full Commission and to Congress.  Undoubtedly, their letter will signal to the SEC the need to approval final rules as expeditiously as possible nearly a year after originally proposed. So look for good things to come from the Commission in this area in the coming months.

For those who want to dig a little deeper, I am providing links to my Comment Letter to the SEC as well as the Comment Letter submitted by NASAA, both back in January 2016.

Samuel S. Guzik has more than 35 years of experience as a corporate and securities attorney and business advisor in private practice in New York and Los Angeles, including as an associate at Willkie Farr and Gallagher, a major New York based international law firm, a partner at the law firm of Ervin, Cohen and Jessup, in Los Angeles, and in the firm he founded in 1993, Guzik & Associates.

 

samuel guzik

Samuel S. Guzik has more than 35 years of experience as a corporate and securities attorney and business advisor in private practice in New York and Los Angeles, including as an associate at Willkie Farr and Gallagher, a major New York based international law firm, a partner at the law firm of Ervin, Cohen and Jessup, in Los Angeles, and in the firm he founded in 1993, Guzik & Associates.

Mr. Guzik has represented public and privately held companies and entrepreneurs on a broad range of business and financing transactions, both public and private. Mr. Guzik has also successfully represented clients in federal securities litigation and SEC enforcement proceedings. Guzik has represented businesses in a diverse range of industries, including digital media, apparel, health care and numerous high technology based businesses.
Guzik is a recognized authority and thought leader on matters relating to the JOBS Act of 2012 and the ongoing SEC rulemaking, including Regulation D Rule 506 private placements, Regulation A+, and investment crowdfunding. He has been consulted by Congressional members, state legislators and the U.S. Small Business Administration Office of Advocacy on matters relating to the JOBS Act and state securities matters.

Guzik & Associates

1875 Century Park East, Suite 700

Los Angeles, CA 90067

Telephone: 310-914-8600

www.guziklaw.com

www.corporatesecuritieslawyerblog.com

@SamuelGuzik1

Issuer-Dealer and Agent Registration Requirements for Issuers Not Utilizing a Registered Broker-Dealer for Offers and Sales of Securities under Tier 2 of Regulation A

By Sara Hanks , CrowdFundBeat  Sr.contributing Guest Editor  CEO/Founder, CrowdCheck, Inc.

The Securities and Exchange Commission’s (“SEC”) amendments to Regulation A went into effect on June 19, 2015. Those amendments provided companies not just with greater access to capital through the ability to raise up to $50 million, but also a greater ability to communicate with investors through novel communication rules previously unavailable to issuers in a public offering of securities. Whereas previously, communications for public offerings were limited to the information contained in an offering prospectus or offering circular, the amendments to Regulation A instead allow issuers to freely communicate before any filing or qualification with the SEC under the Testing the Waters provision (Rule 255), and after qualification (Rule 251(d)(iii)).

These communication rules can help companies go it alone, so to speak, without the assistance of a registered broker-dealer. In a traditional offering, a broker-dealer acts as an intermediary bringing investors to the issuer for a fee. For a company seeking investors among the general population, a broker-dealer may not be necessary to have a successful Regulation A offering. Issuers are able to publish their own marketing material about the offering, create their own online campaign pages, and generally solicit their targeted investor base. This may be especially relevant for consumer-facing companies interested in engaging customer-investors.

However, companies issuing securities in a public offering without the involvement of a registered broker-dealer should be aware that the company may be required to register in certain states as an issuer-dealer, or have members of its management team register as agents of the issuer. This memorandum provides an overview of the registration requirements for issuers and agents of the issuer when making offers and sales of securities in specific states that require such registration. This memorandum will focus on offerings under Tier 2 of Regulation A, as Tier 2 provides for preemption of state review of the offering and securities sold under a Tier 2 offering are considered “covered securities” under Section 18 of the Securities Act.

What does preemption get you?

As part of its rulemaking, the SEC defined securities offered and sold under Tier 2 of Regulation A as “covered securities”. Under Section 18 of the Securities Act, covered securities are exempted from state review of the offering through the exercise of federal preemption of state authority on matters of interstate commerce. Specifically, Section 18 provides that, for covered securities, any state is prohibited from “requiring … registration or qualification of securities, or registration or qualification of securities transactions…”. As a result, a state may not deny an issuer the ability to offer sell a security in the state that is seeking qualification, or has been qualified by the SEC under Tier 2 of Regulation A.

However, this exemption is limited to the registration requirements for the offering of the securities. It does not impact the registration requirements for intermediaries in an offering or whether issuers are required to register themselves as dealers, should they decide to not utilize a registered broker-dealer in the offering. As a result, companies may find it advantageous to work with a broker-dealer merely to avoid the issuer-dealer registration requirements of the states that have such requirements.

Nevertheless, many issuers still may decide that moving forward without a broker-dealer is in their best interest, even with the issuer-dealer registration requirements. As of July 2016, its appears that Arizona, Florida, New York, North Dakota, and Texas all require issuers to register as dealers in the state if they are not using a registered broker-dealer in an offering of securities under Tier 2 of Regulation A. Additionally, Alabama and Nevada each require an agent of the issuer to register with the state.

States that require issuer dealer registration

The first thing that may stand out to you is that there are not that many states that require issuer-dealer or agent registration. This is due to the fact that most state securities laws exclude issuers from the definition of brokers or dealers that need to be registered, as well as excluding officers and directors of the issuer as “agents” requiring registration.

Many states have adopted some form of the 2002 Uniform Securities Act (the “USA”). In section 102(4)(B) of the USA, issuers are exempted from the definition of a broker-dealer. Additionally, under Section 102(2), officer and directors of the issuer are deemed not to be agents unless they otherwise qualify for agent registration. The USA clarifies further, in Section 402(b)(3), that any individual who represents an issuer in the offer or sale of the issuer’s own securities is not an agent so long as the person is not compensated in connection with the sale of securities. A similar exemption exists under Section 402(b)(5) for sales of covered securities of the issuer so long as the person is not compensated in connection with the sale of securities. The uniform law drafting committee goes on in its official comments to states that “[u]nder Sections 402(b)(3) and (5) an agent may be exempt if acting for an issuer and receiving compensation, as long as the compensation is not a commission or other remuneration based on transactions in the issuer’s own securities.” As such, regular salary and benefits should not trigger agent registration requirements.

The following states have not adopted the USA in regards to registration of issuers as broker-dealers, or officers and directors as agents of the issuer. In each case, except for New York, issuers can estimate the registration process taking approximately 30 to 60 days to complete, not including the time it takes to pass any required examination. New York requires that any filed paperwork be complete, but it does not review the filings.

Arizona

Under Arizona law, issuers making offers and sales of their own securities in the state are required to register with the Arizona Securities Division as “Issuer-Dealers”. Under Section 44-1801(9)(b) of the Arizona Revised Statutes, issuers are defined as dealers of securities. All dealers are subject to the registration requirements of Section 44-1941.

In order to register as a dealer in the state, an issuer must submit a Form BD to the Division along with a $100 registration fee, audited financial statements, CPA consent, an affidavit that no sales have been made in the state, as well as evidence that the principals of the issuer have taken securities exams or have equivalent business experience.

In Arizona, any officer or director responsible for making offers and sales of securities must also register as an agent of the issuer. Agents are required to submit certain information in the Form U-4, along with a $45 filing fee, proof of passage of a written examination to determine the business experience of the applicant, fingerprints, and proof of lawful residence in the United States. In some cases, the executive officers and directors identified in the Form BD will be considered to have sufficient business experience by virtue of their positions with the issuer.

Florida

Under Florida law, issuers making offers and sales of their own securities in the state are required to register with the Florida Division of Securities. Under Section 517.021(6)(a)(2) of the Florida Statutes, issuers are defined as dealers of securities. Florida law then goes requires, under Section 512.12(1) that “no … issuer of securities shall sell or offer for sale any securities … unless the [issuer] has been registered” with the Division of Securities as a dealer. While the statute exempts issuers from the registration requirements for the sale of certain securities, the exemption does not extend to public offerings of securities under Regulation A.

To register as an issuer-dealer in Florida, issuer must submit a Form BD through its electronic filing system, as well as the Form OFR-DA-5-91: Issuer/Dealer Compliance Form, financial statements, corporate governance documents, and a $200 filing fee.

The issuer must also register at least one associated person who must file a Form U-4 along with a $50 registration fee per associated person. Issuers are allowed to register up to five associated persons who are then exempt from the examination process typically associated with registration of associated persons as associates of a dealer. Those persons must still submit fingerprints.

New York

New York has always been an outlier when it comes to regulation of securities. Rather than being based on any uniform standards, New York securities regulation is governed by its Martin Act, first adopted in 1921, and codified as Article 23-A of the New York General Business Law.

Under the Martin Act, issuers of securities are defined as dealers under Section 359-e(a). All issuers of securities are required to register as dealers in the state, unless the sale of securities is made through a registered broker on a firm commitment basis. Issuers making offers or sales of securities under Tier 2 of Regulation A are required to file the Form 99, the State Notice and Further State Notice, Form U-2, as well as the statutory filing fee of $1,200. The State of New York provides a helpful information sheet here.

New York does not require the separate registration of officers and directors of issuers as salespersons so long as those officers and directors are identified in the Form 99. However, if the issuer utilizes any salespersons that are not officers or directors, those salespersons are required to file the Form M-2, pay a fee of $150, and pass the FINRA Series 63 or Series 66 exam.

North Dakota

North Dakota utilizes a very broad definition of “broker-dealer” under Section 10-04-02 of the North Dakota Securities Act. As a result, any person that effects transactions of securities in the state for their own account meets the definition of broker-dealer. This includes issuers in offerings occurring under Regulation A.

Under North Dakota rules, issuers are required to submit North Dakota Form S-4, the constitutive documents of the issuer, Form U-2, Form U-2A, an Affidavit of Issuer/Dealer Activity, and a filing fee of $200.

Officers and directors of the issuer are required to register as agents of the issuer in the state. To register, agents of an issuer-dealer must file the North Dakota Form S-5, and pay a filing fee of $60. North Dakota allows for two officers or directors of the issuer to register as agents without being required to pass a written examination. Additional agents are required to pass the Series 63, or Series 66 and Series 7 exams.

Texas

Section 4(C) of the Texas Securities Act provides for the registration of issuers as dealers when offers and sales are not made through a registered dealer. The specific language of the Act states, “any issuer … who, directly or through any person or company, other than a registered dealer, offers for sale, sells or makes sales of its own security or securities shall be deemed a dealer and shall be required to comply with the [dealer registration provisions].”

The specific registration requirements are found in Rule §115.2 of the State Securities Board. Issuers are required to file the Form BD, Form U-4 for a designated officer and each agent to be registered, copies of the constitutive documents of the issuer, audited financial statements, and a $100 fee.

A designated officer is required to be registered. The issuer may be required to register agents as well if other officers and directors of the issuer are undertaking any selling activity. Rule §115.3 of the State Securities Board provides for the requirements for registration of such persons. In addition to the Form U-4 filed with the Form BD, each of these people are required to have passed a securities exam accepted by the State Securities Board. For officers and directors or issuers selling their own securities under Tier 2 of Regulation A, passage of the Series 63 or Series 66 exam, or passage of a state administered exam is required. The filing fee for each person is $100.

States that require agent registration but not issuer-dealer registration

The following states provide for exemptions from the registration of the issuer entity as a dealer of securities, but may still require the registration of any officers and directors of the issuer as an agent. As mentioned above, states that have adopted some form of the USA provide for an exemption from registration for the officers and directors of the issuer in the instances of the person selling the securities of the issuer, and selling securities defined as covered securities under the Section 18 of the Securities Act. In the following states, registration as an agent is required of any officer or director undertaking selling efforts in the state, even if the officer or director does not receive transaction based

compensation. There is no exemption for an officer or director of an issuer selling the securities of the issuer, or those securities being covered securities.

It should be noted again that should any officer or director receive transaction based compensation for the sales of securities of the issuer, no exemption from agent registration is available. That person will likely be required to register as an agent of the issuer in any state in which offers and sales of securities are made.

Alabama

Alabama does not provide for an exemption from registration as an agent for officers and directors of the issuer selling the securities of the issuer. As such, under Section 8-6-2(2) of the Alabama Securities Act, any officer or director representing an issuer in effecting sales of securities is defined as an agent of the issuer. An officer or director not undertaking any selling activities is not an agent of the issuer merely by being an officer or director. The officer or director must undertake selling efforts to require registration as an agent.

Section 830-X-3-.02 of the Alabama Administrative Code provides what information is required to register as an agent in the state. An agent of an issuer is required to register as a Restricted/Issuer Agent. The registration filing includes the Form U-4, and evidence of passage of the FINRA Series 63 or Series 66 exam, and a fee of $60.

Nevada

Similarly to Alabama, Nevada does not provide an exemption from registration as a sales representative for officers and directors of the issuer selling the securities of the issuer. Under Section 90.285 of the Nevada Revised Statutes, any officer or director representing an issuer in effecting sales of securities is defined as sales representative of the issuer. An officer or director not undertaking any selling activities is not a sales representative of the issuer merely by being an officer or director. The officer or director must undertake selling efforts to require registration as a sales representative.

The registration requirement for sales representative of an issuer includes the filing of the Form U-4, evidence of passage of the Series 63 or Series 66 exam, and a fee of $125. While Nevada has a provision to request a waiver from the exam requirements for officers and directors of the issuer under Section 90.372 of the Nevada Revised Statutes, that waiver is only available for registered offerings and offerings under Rule 506 of Regulation D.

Consequences of not registering

In general, there can be severe consequences for an issuer not registering as a dealer or agent where required. These consequences include liability to state regulators and investors in any offering.

Regulatory enforcement consequences

State regulators have the authority to issue cease and desist orders, civil penalties, and criminal penalties. Some of these penalties may trigger “Bad Actor” disqualification provisions, hindering the issuer’s future capital raising activities.

 

Alabama’s regulatory history also provides insight into enforcement against officers and directors of issuers that did not register as agents when required. In a 2010 enforcement action, Alabama issued a cease and desist order due to a director’s failure to register as an agent in the state. The cease and desist order notes that other potential administrative remedies could include monetary fines and a permanent bar from participating in any securities related activity in the state.

In Arizona, Section 44-1842 of the Arizona Revised Statutes makes the sale of securities by an issuer that did not register as a dealer in the state a class 4 felony. Class 4 felonies involve a minimum term of imprisonment of 1.5 years and a maximum of 3 years.

In applying the Martin Act, under Section 352-i, New York has determined that failure to register as a dealer of securities when making an offer or sale of securities in the state can be deemed a fraudulent practice. While considered a fraudulent practice, most orders involve a fine and instructions to register as a dealer in the state.1

Florida considers any act in violation of its Securities and Investor Protection Act to be a third degree felony under Section 517.302.2 The Florida Office of Financial Regulation has published a helpful overview of its disciplinary guidelines for non-compliance with statutes or rules governing the registration and operations of issuer-dealers. Based on the judgment of the severity of the violation, non-registration as an issuer-dealer may simply issuer a notice of non-compliance, or may include a fine of $2,000 to $10,000, suspension of the ability to register as an issuer-dealer in the state, or even a complete bar from registration as an issuer-dealer.3

Issuers should be aware that suspensions of the ability to register as an issuer-dealer or agent, or bans on registration are disqualifying events under the SEC’s Bad Actor Rule. This means that while the suspension or ban is in place, the issuer would be disqualified from the use of Rule 506 of Regulation D, Regulation A, or Regulation CF. Any selling activities continuing while the disqualification is in place would constitute a violation of Section 5 of the Securities Act, leading to additional liability and further disqualifications under the SEC’s Bad Actor Rule.

Further, a violations of New York’s issuer-dealer registration rules is defined as a fraudulent practice, which comes with a Bad Actor disqualification for 10 years.

Investor civil remedies

Additionally, issuers may be liable to investors for not registering as a dealer where required. Typically, an investor who purchases a security from an issuer that is required to register as a dealer or have an officer or director register as an agent, but did not so register, may sue for rescission or damages. A purchaser would seek rescission when that purchaser is still in possession of the security, and would seek damages if the purchaser had disposed of the security.

 

In the case of a Regulation A offering where there is limited liquidity, the liability is most likely to be rescission. Rescission requires that the issuer reset the entire transaction with the purchaser. Essentially, the investor has a two or three year put (depending on the statute of limitations) for receiving the return of their entire investment, plus interest. For a cash-strapped early stage company, retuning all of the invested funds could be a company terminating event.

Section 44-2001 of the Arizona Revised Statutes provides that transactions by unregistered issuer dealers and their agents are voidable at the election of the purchaser. Upon voiding the transaction, the purchaser is entitled to receive the return of all consideration paid to the issuer, plus interest, court costs, and attorney fees.

Similarly in Florida, Section 517.211 provides that any sale made when the issuer is in violation of its issuer-dealer registration requirements may be rescinded as the election of the purchaser, with interest and attorney fees.4 Florida goes further and provides that any control person of the issuer involved in making the sale is jointly and severally liable to the purchaser.

Section 33(a)(1) of the Texas Securities Act provides that any person who offers or sells securities in violation of Section 12, which requires issuer registration as a dealer for those offerings that are not exempted, is liable to the purchaser of the security.

Conclusion

The SEC’s recent amendments to Regulation A provide increased opportunities for companies to make offers and sales of their securities directly to investors without the utilization of a registered broker-dealer. This is primarily due to the Regulation A specific communication rules that allow for more open communication that can be accomplished in innovative ways.

Tier 2 of Regulation A also provides for preemption of state registration of the offer and sale of the security, but does not preempt state rules relating to the registration of the issuer as a dealer, or registration of officers or directors of the issuers as agents. While most states do not have such a registration requirement, the states of Arizona, Florida, New York, North Dakota, and Texas require registration of the issuer as a dealer of securities and corresponding agent registration. Additionally, the states of Alabama and Nevada require the registration of officers and directors undertaking selling activities as an agent of the issuer.

Failure to register where required comes with potentially severe consequences. States have the authority to make cease and desist demands, institute fines, or order suspensions or bars from participation from securities related activity in the state. Any suspension or bar qualifies as a Bad Act under the SEC’s Bad Actor Rule, thereby disqualifying the issuer from relying on Regulation D, Regulation A, or Regulation CF. Issuers also face liability to individual investors who would have the right to demand rescission of the investment.

 

1 See, e.g., People ex rel. Vacco v. World Interactive Gaming Corp., 185 Misc. 2d 852, 863-64, 714 N.Y.S.2d 844, 853 (Sup. Ct. 1999).

2 See, e.g., Robert Paul Murphy, Petitioner v. Board of Hearing Aid Specialists, Respondent, 2016 WL 349583, at *4.

3 See, e.g., Department of Banking and Finance, Division of Securities v. Boca Insurance Lenders, 1996 WL 636843, at *2.

4 See, e.g., Cifuentes v. Regions Bank, No. 11-23455-CIV, 2012 WL 2339317, at *1 (S.D. Fla. June 19, 2012).

sarahanks

Sara Hanks, co-founder and CEO of CrowdCheck, is an attorney with over 30 years of experience in the corporate and securities field. Crowd Check provides due diligence and compliance services for online alternative securities offerings. Its services help entrepreneurs and project sponsors through the disclosure and due diligence process, give investors the information they need to make an informed investment decision and avoid fraud and help intermediaries avoid liability. Sara’s prior position was General Counsel of the bipartisan Congressional Oversight Panel, the overseer of the Troubled Asset Relief Program (TARP). Prior to that, Sara spent many years as a partner of Clifford Chance, one of the world’s largest law firms. While at Clifford Chance, she advised on capital markets transactions and corporate matters for companies throughout the world.Sara began her career with the London law firm Norton Rose. She later joined the Securities and Exchange Commission and as Chief of the Office of International Corporate Finance led the team drafting regulations that put into place a new generation of rules governing the capital-raising process. Sara received her law degree from Oxford University and is a member of the New York and DC bars and a Solicitor of the Supreme Court of England and Wales. She serves on the SEC’s Advisory Council on Small and Emerging Companies. She holds a Series 65 securities license as a registered investment advisor. Sara is an aunt, Army wife, skier, cyclist, gardener and animal lover.images-10

 

For more information, contact:

Office: 703 548 7263

Sara Hanks

sara@crowdcheck.com

Andrew Stephenson

andrewstephenson@crowdcheck.com

CrowdCheck is not a law firm, the foregoing is not legal advice. The contents of this memo are subject to change as regulatory positions evolve and statutes are amended. Please contact your lawyer with respect to any of the matters discussed here.

©CrowdCheck, Inc., 2016

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The Tax Implications of Starting Your Own Business

Starting a small business is rife with regulations, tasks, and endless streams of expenses. One thing many entrepreneurs don’t consider at the onset of a new business is the major tax implications this venture can have. Check out what you can expect from the IRS after deciding to start your own business.

Consider Your Business Structure

As you begin your venture, consider how you’re going to structure your business. Will you classify your business as an LLC, partnership, S-corp, or C-corp? Many small business owners elect to declare their business as an LLC because this structure typically provides a larger amount of protection and a fair number of tax benefits. It’s always a good idea to consult with a business attorney before choosing a specific structure to ensure you have all the details you need to make an informed decision.

Applying for an EIN

As you get your business off the ground, you’ll need to apply for an Employer Identification Number (EIN) from the IRS. This number will be used anytime you interact with the government agency, and listed on your return and any other type of document that must be filed. If you are the sole proprietor of your business and you have no employees, you can use your social security number instead. You may also use your SSN if you have a government certified single-owner Limited Liability Company. Procuring an EIN is simple, as you can apply online or over the phone.

Prepare for Self-Employment Taxes

As you own your business, you will be subject to the self-employment tax. These taxes pay for contributions towards Medicare and social security options. In any other position of employment, your employer would withhold this money for you, so it will be up to you to keep track of and save the amount you’ll need to hand over to the IRS come tax season. You’ll pay 15.3 percent for the first $118,500 of your net earnings from self-employment income, and for anything over that amount you’ll owe Medicare taxes at a rate of 2.9 percent.

Employment Taxes

If you have employees, you’ll be required to pay the employer’s share of Medicare and Social Security taxes, and withhold their share of these costs from the paychecks. If your employees make less than $118,500, you and your employee will each be responsible for 7.65 percent on those wages. If your employees make upwards of this amount, you’ll only pay Medicare taxes, which is 1.45 percent for each party. You’ll need to have a clear understanding of the difference between employees and contracted individuals, as your tax liabilities can vary greatly depending on this distinction. If you employ independent contractors, you won’t be liable for employment taxes, and you’ll utilize different forms come the end of the year.

Prepare for Quarterly Estimated Payments

Small business owners and self-employed individuals are required to make estimated quarterly tax payments throughout the year to handle federal income tax liability. These payments generally fall in April, June, September, and January, and it’s important to remain on top of your finances year-round with the help of a financial advice service like that offered by Vanguard.

Accounting Methods

There are two general accounting methods for small businesses, known as Cash and Accrual. Using the Cash method means you’re counting income or expenses at the time you receive a payment or pay off a bill. These types of accounting repots only show the income you’ve received, and only the expenses you’ve paid off. In contrast, an Accrual method records income when it’s earned and expenses when you’re billed, not necessarily when you actually receive a check or make a payment.

Audits Become More Likely

It’s an unfortunate facet of being your own boss, but the IRS tends to audit self-employed individuals on a more regular basis. Being audited doesn’t necessarily mean you’re in trouble, but it’s safe to say that if you’ve done something illegal with your taxes, the IRS will figure it out. This is why it’s essential to remain organized and keep detailed records of all of your financial movements, income, and expenses. If you find yourself in debt with the government, your business could easily go under and you could face serious legal ramifications. If you currently owe money to the government, be sure to work out an IRS tax payment plan before beginning your business.

Starting your own business isn’t always a straightforward task, but remaining on the right side of the IRS regarding taxes is vital to success. Keep these tips in mind and work with professionals to ensure your business remains protected and you stay out of hot water.

A Reflection of Online Money Lending

By Steve Cinelli , CrowdFund Beat Sr. Editor, @stevecinelli

Some many months back, in fact prior to their listings, I wrote a piece questioning the lofty valuations of the marketplace lending platforms (LC and ONDK) as they entered the public markets.  The basic thesis was recognizing the fundamental business these platforms engaged, i.e., money lending, and how others in the same space, albeit not as “technology positioned”, delivered the same product and/or service, and I thus intimated that the newbies should be valued with similar metrics to the incumbent financial institutions.

In observing the platforms’ performances over the last year, as well as evolving market conditions, my thinking has changed.  In fact, I have furthered my assessment of relative values, and am concluding that there are actually distinct shortcomings in the current technology-enabled model vis-à-vis the conventional banking institutions.

The basic premise in the P2P space was that credit card rates were way too high, so why not provide an alternative to reduce the cost. Behold, lower rate amortizing term loans. Sounds fine, but essentially, such a model is based on price, i.e., something the big guys have an advantage.   True, a great technology interface, rapid underwriting and credit decision making were part of the thrill, but in the end, the “product” was better priced credit than other lenders provided.  Maybe 70% of P2P clients were “refinancing” high interest rate card debt, so bang…. the proposition seemed supportable.

Well consider any market that competes on price. All participants ride the price levels downward, so where’s the differentiation? There will always be someone that beats you, whether it’s sustainable or not.  This is where brand and a broader offering come in.  Consider all the major credit card providers, whether Capital One, Chase, BofA, Wells, and others.  They have the ability to adjust price for consumer credit as they monetize the broader banking relationship in many other ways.  Think about it.  I posed the question to a couple of the execs at a P2P platform, anxiously awaiting the response to what happens if Capital One or Chase come out with a permanent 3% card to their best consumer borrowers.  Recall that the P2P players target the top 10-15% of FICO scores, so price is the driver for the credit-worthy consumer.

But look at what’s happening now. Because the P2P platforms have just-in-time funding, i.e., they intermediate the transaction, using investor capital to fund loans, and rather than using core (and insured) deposits, they are beholden to their “cost of funds” to drive the price of credit to their borrowing customers.  In recent months, such investor capital has dried up, concerned with performance (risk-adjusted returns), as losses and delinquencies have been moving north.  So to attract such capital, higher returns are being sought by investors, read a higher cost of funds to the platforms.  This of course results in a higher price of credit to the consumer, which all the platforms have raised borrower loan rates.   So much for the market positioning of better borrowing costs.

We can further review the business model, and unlike banks that may be able to monetize their customer relationships over many products and services, and during an extended life cycle, these platforms live and die by their immediate transaction volume.  Turn on the spigot and they can grow as we have seen.  But without new deals, growth stagnates.  There is limited if any recurrent income, and the life time value of a customer is limited.  Are there recurrent borrowers?  Certainly.  But to that point, might those that refinance their credit card debt go back out and run up those credit limits once again, increasing their overall credit risk for the next time round?

There have been discussions about the technology enabled, algorithmic underwriting that the platforms utilize, which should be a value proposition.  Machine learning, AI, looking at credit factors beyond just FICO scores.  A bit of history here.  Consumer loans are relatively small, and with bank margins very slim, such credit historically was limitedly profitable. Enter Bank of America in 1958 with the introduction of BankAmericard, the first all-purpose credit card, in an attempt to do consumer lending quicker, faster, cheaper and more profitably. With direct marketing followed by a broad licensing program, the use of “plastic” became part of the banking and credit nomenclature in a huge way.  MasterCard, an association of other banks, was developed as a competitor, and BofA and its licensees, evolved into VISA International.     Such “plastic” became the protocol of consumer credit, and, while the interest rates were and still are lofty, this was to offset the expected portfolio losses, as underwriting mechanically had issues. The banks were still earning an ongoing net spread.  To be cost effective, the process of underwriting a new card applicant has been credit scored since the 1960’s, with possibly in retrospect antiquated algorithms, but still the process was streamlined with scoring methodologies to expedite decision making and deployment.   How much human underwriting time can actually be spent on granting a card with a $500 credit limit, given the amount of profits that can be had?   Don’t you think Capital One and Chase apply technology and algorithmic underwriting to their current card business as a matter of efficiency?  And lastly, have you actually looked at the unit economics of a P2P loan, particularly the marketing cost of origination.  Banks can cross-sell; the platforms have one product directly originated.  I do acknowledge that some platforms have different types of loans now, but the fundamental model characteristics remain.

So the query is posed.   Where lies the sustainable value in these platforms?  The product is not unique, i.e., consumer loans. They compete largely on price, which in any market is a concern.  The model requires new relationships to grow, rather than monetizing a relationship many times over.  The ability to grow is further challenged in a “just-in-time” funding model, with such cost of funding subject to more volatility than the banking industry. As few hold a recurrent revenue portfolio, there doesn’t seem a tangible asset to place value, nor is there the ongoing net interest spreads to capture.   There is now a move towards balance sheet lending.  Hmm.  Seems like the banks have something with being a depository with a stable and well price funding pool.  That said, how and with what do the platforms fund their balance sheets with?  More equity?  A bit dilutive, eh?

Finally, is there real intellectual property contained therein, such as risk assessment and underwriting methods, that the larger card issuers and consumer lenders do not enjoy?   This of course begs the questions, are these sustainable models, and do they have strategic and economic value for an acquirer, as it appears that many have “for sale” signs up?  Maybe for someone outside the space looking to enter gingerly, but for a big player, what would they be buying?  What is the value add?

While this assessment is not meant to be a complete disparagement of P2P or online finance.  In fact, I am one of the biggest bulls on online lending and capital formation.  Money lending is actually the “world’s oldest profession”, even longer recognized than the business of carnal frivolity according to the Code of Hammurabi in 1800 BC.   Modern banking developed during the Renaissance periods with the brilliant European merchant banks, such as the Rothschilds, Warburgs, Medicis, Fuggers, and Barings, that transitioned from “merchant” activities to extending credit to other merchants, as the depth of their knowledge was unparalleled and they found the returns from money lending were more attractive than trading goods.   The predicate of their activities was knowledge and information: about their clients, the markets, the external conditions, and how to price their risk.   Theirs was keenly an information business.  And now, we live in an information world, where data and facts are readily available, in all quantities and qualities, able to be assembled and analyzed for risk and return assessment. Information technology is meant to be applied to finance and money lending.  It is only natural and commonsensical.  But what will the sustainable models look like:  that’s for another chapter.