Tag Archives: equity crowdfunding

Parallels between ICO’s and the early days of Equity Crowdfunding

 Founder Raiseworth.

(Here is a post from 2015 when I started pushing for Crowdfunding to be moved to the Blockchain)

If I go back to 2008, in the very early days of Equity Crowdfunding, the ASSOB platform has already been operating for around four years. This meant there were plenty of learnings in place even before any other equity platforms had started.

There are parallels here with ICO’s as in the early days many people that approached us to raise capital on ASSOB had not much more than an idea or a sketch on paper. We learnt as the years went by that the existing regulatory structure was not detailed enough to protect investors so we put in place the ASSOB compliance framework. This stood the test of time as 300 odd raises later no evidence of fraud has emerged. This included an “offer document” not dissimilar to the “White Papers” that set out all aspects of the raise including:

  • OPPORTUNITY KEY DETAILS
  • KEY INVESTOR HIGHLIGHTS
  • EXECUTIVE SUMMARY
  • ABOUT THE COMPANY
  • CORPORATE OBJECTIVES
  • COMPETITION & RISK
  • ABOUT THIS OFFER
  • HOW TO APPLY FOR SHARES
  • OWNERSHIP STRUCTURE
  • STRATEGIC GROWTH PLAN
  • USE OF FUNDS
  • DIRECTORS DECLARATION
  • DISCLAIMER
  • GLOSSARY OF TERMS

This was not prescribed anywhere in regulations for documents that weren’t disclosure documents but over a period of time things like quarterly reporting, annual accounts and other things were added to the mix to strengthen the self-regulated compliance framework.

With ICO’s I see the same effort by early adopters in their documents. There is an eagerness to be transparent and provide valuable and essential information for prospective funding providers. However as these are early days there is a widely disparate level of transparency and disclosure by ICO promoters. This is to be expected but just as equity crowdfunding evolved around the world as players engaged with regulators, so will the ICO area.

The main difficulty at ASSOB from 2004 to 2010 was that entities often had no turnover, maybe not a product and no track record. The question was how do you assess these companies as potential investments. This same question is front and centre for ICO’s.

We solved this at ASSOB by using “Fundability Circles” to assess opportunities. Since 2015 a lot has changed, including the emergence of ICO’s so I thought it would be good to update this and do an ICO version.

Here it is!

Here is how you use it!

When you look at an ICO opportunity the three circles equal the main areas to assess a raise. I’ve listed some factors to assist you but basically each of the areas should have a total of 10 points with the total being 30. Obviously if you get 30 out of 30 for an ICO raise you are good to go. What happens though is usually one area is much lower than the other two. Often you can have a great idea with a very technical team but nobody in marketing or legitimisation. Or at other times the marketing team is great but the people are not around to build it.

Most ICO “White Papers” usually include Story, Team and Legitimisation but often they are weighted differently in each white paper. If you are involved in an ICO, or you are promoting one, you should yearn to get balance in the document so the three areas are equally reflected. (Note the intersecting areas between each circle)

  1. The Team must be capable of implementing the story
  2. The Team must appear credible to the potential partners and investors
  3. The Story must be relevant to potential partners and investors

Trust this assists you with your ICO. After seeing 300 odd raises go through this process it is indeed a great way to get an early grip on the possibility of success or as it says in the middle … the “Fundability Potential”.

REPORT: Crowdfunding meets Blockchain

 

 

 

 

By Navroop Sahdev

Centre for Blockchain Technologies, University College London, UK
Centre d’Économie de l’Université Paris-Nord, France
June 2017

Table of Contents
1. Introduction
2. The Advent of Crowdfunding
3. Market design and Liquidity Considerations for CFE Trading on the
Blockchain
3.1. Liquidity and Price Discovery
3.2. A game of Information
3.3. Asset Servicing and Voting
3.4. Market Making versus Tokenization
3.5. The impact of Transparent Holdings
4. Concluding remarks
5. Endnotes
6. References

CLICK HERE FOR FULL REPORT 

Abstract

Blockchain, the technology behind Bitcoin, promises to be nothing less than Internet 2.0. The
financial services industry, in particular, is preparing for the disruption blockchain/distributed
ledger technology promises to cause. In the current business environment, the majority of
startups and small businesses have to look for alternative sources of funding given that ‘going
public’ is increasingly expensive. The crowdfunding space has seen tremendous growth as an
alternative way to raise capital by businesses. However, these crowdfunded shares cannot be
traded for 7 – 10 years on average on any given platform in the U.S. currently.
To build a trading platform on the blockchain which is completely P2P, immutable, fully
transparent and low-cost presents some key design issues. In particular, the issue of liquidity – and
price discovery – on the blockchain continues to be a puzzle. At the same time, the proposition of
removing middlemen from equities trading is a very attractive one, streamlining the process of
capital formation with higher market efficiency.

The current paper addresses the following key questions: How can a DLT trading platform ensure
adequate liquidity? What would be the process of price discovery? While some recent studies hail
blockchain technology as a boom for market liquidity, it is not immediately clear what the impact
of P2P trading would be on the prices of various stocks. There are no ‘solutions’ just yet. At the
same time, the lack of regulation around trading on the blockchain creates an environment of
uncertainty for all players.
In particular, the implementation of such a platform can revolutionize capital formation and build
robust markets in both developing and developed countries where crowdfunding has proven to
be a successful model. While my research is targeted at solving a very specific pain point for both
researchers and companies working on distributed ledger technology, ultimately, it would be a
significant step forward towards onboarding underserved communities across the world who
don’t have access to financial services.

List of Abbreviations

1. DLT: Distributed Ledger Technology
2. CFE: Crowdfunded Equity
3. EC: Equity Crowdfunding
4. CFP: Crowdfunding Platform
5. ECP: Equity Crowdfunding Platform
6. CETP: Crowdfunded Equity Trading Platform
7. MVP: Minimum Viable Product
8. POC: Proof of Concept
9. P2P: Peer to Peer

Introduction

These days, ‘blockchain’ inspires a degree of reverence in the fintech industry. Set to become the
defining technology of the current day – Internet 2.0. – The industry is aggressively testing POCs
and figuring out which processes should be moved to a blockchain architecture in the short to the
medium term. Of course, revamping the monstrous infrastructure of the financial services industry
is no easy task and unlikely to be undertaken overnight. The way forward is to test specific use cases
and find ways to integrate these as well as integrate the new blockchain infrastructure with the
old centralized infrastructure. The shift is expected to be gradual, as is the regulatory catch-up.
And yet, the activity that blockchain – along with other vertical technologies – has inspired is
unprecedented along with the regulatory participation in co-creating this brave new world.
The story of the blockchain can have many starting points. It can be a technology-driven one,
where a foundational technology can potentially provide a more secure and robust digital
infrastructure and with the current days being the early days of the technology. Alternatively, it
can a story of demand-driven factors – where small businesses need to find ways of raising capital
along with new opportunities of financial intermediation. Or we can pick an even more interesting
story – that of a crisis-driven market – desperately in need of a breakthrough technology, that can
lower costs and provide a more robust digital infrastructure. Indeed, it’s probably no coincidence
that the Bitcoin blockchain came into existence right after the 2007-08 banking crisis. Or it can be
the familiar story, of an archaic regulatory regime, that piles up-regulation designed for securities
trading from a century ago; this is the story of fragmented markets which are an outcome of such
a regulatory structure. With the advent of any new financial activity – crowdfunding, for example
– new regulation is introduced, which only seems to add to the existing regulatory burden.
Whatever the chosen entry point, we are here now.

CLICK HERE FOR FULL REPORT 

The Best industries for Regulation Crowdfunding

 

 

 

By: Sherwood Neiss and Jason Best, Principals Crowdfund Capital Advisors, LLC

Into the second year of Regulation Crowdfunding there are now over 475 companies that have filed offering documents with the Securities and Exchange Commission (SEC) to raise up to $1,070,000 from their customers, communities, friends and family. But in which industries are these investors most interested in deploying their capital? The good news for companies considering using Regulation Crowdfunding, is that these online investors have a diverse appetite. While software/gaming application companies receive the most commitments, breweries, entertainment companies, personal transportation vehicles, restaurants and personal services (i.e. fitness training, veterinary, grooming, etc) aren’t far behind. They key data points for potential issuers to understand are: 1) How much money do you need to raise for your business in relation to the average amount raised for your industry? 2) Where is the crowd is engaged in deals and dollars? Meaning is there enough interest in your business (industry) to crowdfund. And 3) what is the crowd’s average check size – to determine how much you can realistically raise from your network compared with what you need?

At Crowdfund Capital Advisors, we track all Regulation Crowdfunding offerings across the entire industry. Our team of analysts maps each company to Morningstar’s Global Equity Classification Structure©. There are 148 industries in Morningstar’s classification. Once the data from each offering is on-boarded and cleansed, each offering is tagged with this Morningstar classification so we can track not only the progress the offering is making towards its funding target but which industries are receiving the most interest, and ultimately, which offerings close successfully.

Now that the market is over a year old, we can begin to see signs of where the crowd has an appetite and hence where prospective Regulation Crowdfunding companies should be considering this an attractive funding mechanism for at least a portion of your capital needs. The following Tree Map visually displays all the data to date. Each leaf measures an industry the number of commitments and the number of backers. The larger the leaf the greater the number of commitments the darker the leaf the greater the number of backers.

Source: Crowdfund Capital Advisors, LLC

By Number of Campaigns
Digging into the data, Application Software (i.e. Electronic Gaming and Software) had the most number of offerings (n=94). This was followed by Breweries, Wineries & Distilleries (n=29), Entertainment companies (i.e. movie studios, theatre, music, sports league, entertainment parks, n=29), Personal Service companies (i.e. spas, barber, kids activities, photographers, clubs, pet services, rideshare, wedding services, n=28), Restaurants (n=28), Consumer Electronics (n=25), Personal Transportation Vehicles (i.e. electric bicycles, cars, boating, etc., n=23), Apparel (n=21), Consumer Packaged Goods (n=19) and Retail (n=18).

However, when we filter for only those campaigns that hit their Minimum Funding Target and hence were successful, we see an interesting outcome. Electronic Gaming and Software drops to 40, a 43% success rate; Breweries, Wineries & Distilleries companies falls off but not as much to 23, a 79% success rate), Restaurants (n=18 or 64% success), Personal Service companies (n=17 or 61% success rate), Personal Transportation Vehicles (n=15 or 65% success rate), Entertainment companies (n=14 or 48% success rate), and Apparel (n=12 or 57% success rate). So, while the Gaming industry had the most offerings, the greatest success was with Brewers, Wineries & Distilleries who enjoyed 79% success followed by Personal Transportation Vehicles, 65%, Education 63%, Personal Services 61% and Restaurants with a 61% success.

By Dollars Committed

Table 1: Committed Dollars by Industry

Source: Crowdfund Capital Advisors, LLC

Where is investor money going? When we filter by total amount of capital committed (table to the right) we see that Software and Gaming companies received the most commitments. (Keep in mind, until a campaign closes and is funded those dollars are just pledges and not actual investments). This is followed by Breweries, Wineries & Distilleries and Personal Transportation Vehicles. These Top 10 industries received 71% of all the capital committed to Regulation Crowdfunding campaigns.
By Dollars Funded

Table 2: Funded Dollars by Industry

Source: Crowdfund Capital Advisors, LLC

However, Committed Dollars don’t mean much unless a campaign hits its Minimum Funding Target. So, we again filter for campaigns that did so and hence were “Funded.” The table at the right shows that nine of the Top 10 industries that received the most commitments also received the most Funded dollars – Computer Hardware fell off the list and Medical Devices was added. Pay close attention to the conversion rate of Committed dollars to Funded dollars. The higher the conversion means that if you are in any of these industries your chances of receiving the money that is pledged is greater than some of the other industries. It will be interesting to see if this trend holds over the next few months.

By Total Investors

Table 3: # of Investors per Industry

Source: Crowdfund Capital Advisors, LLC

Finally, we answer the question, what industries are driving the most investor interest? The table at the right answers this. Again, Software and Gaming had the most backers, followed by Entertainment, Breweries, Wineries & Distilleries and Personal Transportation. The Top 10 here represented 74% of all the individual backers. So if you aren’t in one of these industries it doesn’t mean you won’t attract the crowd, it just might be more challenging.
Source: Crowdfund Capital Advisors, LLC

But perhaps most important is what’s the average check size for industries where campaigns are funded? Here are the current results: Entertainment $2,448, Personal Transportation, $2,375, Personal Services, $1,292, Breweries, Wineries & Distilleries, $1,231, Software and Gaming: $1,196, Apparel $979, Computer Hardware $857, Restaurants $598. This seems to indicate that that so far, crowd investors are willing to more money individually into things that benefit them or they consume directly. Seems they are investing in brands, experiences, and people they trust.

Conclusion

While we talked extensively about the “Top 10’s” as we analyzed the data, it is very important to understand that there have now been successful campaigns in 56 of the 148 industries in the Morningstar classification system, and the geographic distribution of campaigns is also expanding (now at 44 states). Investors are deploying capital across a significant and growing number of industries across the country. They are especially investing in companies that deliver a direct benefit/relationship with the product, in addition to the desire for long term appreciation of their capital. We estimate that over $100M will be committed to Regulation Crowdfunding campaigns by the end of 2017. All from a standing start 18 months prior. This is a strong early signal of the long-term success of this funding channel.

Into the second year of Regulation Crowdfunding there are now over 475 companies that have filed offering documents with the Securities and Exchange Commission (SEC) to raise up to $1,070,000 from their customers, communities, friends, and family. But in which industries are these investors most interested in deploying their capital? The good news for companies considering using Regulation Crowdfunding, is that these online investors have a diverse appetite. While software/gaming application companies receive the most commitments, breweries, entertainment companies, personal transportation vehicles, restaurants and personal services (i.e. fitness training, veterinary, grooming, etc) aren’t far behind. The key data points for potential issues to understand are: 1) How much money do you need to raise for your business in relation to the average amount raised for your industry?  2) Where is the crowd is engaged in deals and dollars? Meaning is there enough interest in your business (industry) to crowdfund. And 3) what is the crowd’s average check size – to determine how much you can realistically raise from your network compared with what you need?

At Crowdfund Capital Advisors, we track all Regulation Crowdfunding offerings across the entire industry. Our team of analysts maps each company to Morningstar’s Global Equity Classification Structure©. There are 148 industries in Morningstar’s classification. Once the data from each offering is on-boarded and cleansed, each offering is tagged with this Morningstar classification so we can track not only the progress the offering is making towards its funding target but which industries are receiving the most interest, and ultimately, which offerings close successfully.

Now that the market is over a year old, we can begin to see signs of where the crowd has an appetite and hence where prospective Regulation Crowdfunding companies should be considering this an attractive funding mechanism for at least a portion of your capital needs. The following Tree Map visually displays all the data to date. Each leaf measures an industry the number of commitments and the number of backers. The larger the leaf the greater the number of commitments the darker the leaf the greater the number of backers.

Crowdfund Capital Advisors (CCA) delivers strategic insights to government agencies, financial institutions, regulators and multilateral organizations seeking to both create and implement innovative strategies to utilize crowdfund investing (CFI) technologies to drive innovation, job creation and entrepreneurship. We also study and invest in the emerging ecosystem of crowdfunding and the new solutions being created that will impact the broader private capital markets. We are passionate about creating innovation, entrepreneurship, and jobs through the use of crowdfunding.  CCA delivers strategic services and implementation programs that create, proprietary deal flow for professional investors, better access to capital for businesses and policy and regulatory innovation for governments.

 

 

 

Interact with FactRight’s Reg A+ Database

According to FactRight’s tracking, the SEC qualified 21 Reg A+ Tier 2 offerings in the second quarter of 2017, maintaining a brisk pace by the standards of Reg A+’s relatively short history. Approximately 45% of the 96 Tier 2 offerings qualified since late 2015 (not later withdrawn or used for merger purposes) have been qualified in just the first half of this year.

 

Three issuers made headlines in June 2017, when each listed common equity (that had been previously issued under Regulation A offerings) on a national securities exchange: Myomo, Inc. (NYSE: MYO), Adomani, Inc. (Nasdaq: ADOM), and ShiftPixy, Inc. (Nasdaq: PIXY). In the wake of successful public listings, it will be interesting to see whether a growing proportion of issuers will seek to use Regulation A as a stepping stone to becoming a fully public company.

Interact with FactRight’s database through the charts below to glean additional insights about the state of the Regulation A space through the second quarter of 2017. The charts below are dynamic; if you click on a single data point in any chart, it will filter the data displayed on the sidebar at left and in the remaining charts. (For instance, if you click on the bar for Tier 2 offerings qualified in the second quarter of 2017, all of the refreshed data in the sidebar and throughout the charts will only pertain to offerings qualified in the second quarter.) Hover your cursor over a chart for additional information.

 

Is the Party Over? SEC Concludes Cryptocurrency Offering Required Registration

By Trudy-Anne McLeary, Associate, Corporate and Finance | Benjamin T. Brickner, Associate, Corporate and Finance

In an investigative report and investor bulletin, the SEC concludes that offers and sales of cryptocurrency coins and tokens may be subject to federal securities laws.

On July 25, 2017, the Securities and Exchange Commission (the Commission) released an investigative report with important implications for issuers and sponsors of initial coin offerings (ICOs) that raise funds for cryptocurrency ventures. The report, prompted by the recent proliferation of such activity, concluded that coins offered to purchasers in ICOs constitute securities regulated by the Securities Act of 1933 (Securities Act) and the Securities Exchange Act of 1934 (Exchange Act). As a result, absent an exemption, such offerings must be registered with the Commission, similar to other public offerings.

The press release accompanying the report notably quotes the new Commission chairman and the new heads of the Corporation Finance and Enforcement divisions. This combined statement gives the report unusual weight and makes clear to Commission Staff that its contents describe senior officials’ current thinking on cryptocurrency regulation.

Background

In early 2015, The DAO, an unincorporated association, organized an IPO-style offering in which investors were offered DAO Tokens in exchange for Ether, a cryptocurrency similar to Bitcoin. The proceeds of the offering were intended to finance projects approved by a vote of DAO Token holders. Projects were to consist of investments in “smart contracts,” multiparty agreements encoded on a blockchain (a transaction ledger stored on a diffuse computing network). This arrangement enables transactions contemplated by such contracts to be self-executing by facilitating their verification and enforcement.

The offering presented investors with the opportunity to share in the earnings from these projects and, importantly, was marketed as such. In June 2016, however, hackers gained control over one-third of the Ether raised through the offering, then valued at about $50 million. Only by fundamentally altering the computing platform on which Ether is based was The DAO able to regain control of most of the stolen assets. Following this attack, the Commission launched an investigation into the applicability of the federal securities laws to DAO Tokens and similar offerings.

Securities Regulation of DAO Tokens and Implications for ICOs

In its investigation, the Commission sought to determine whether DAO Tokens and similar instruments constitute securities for purposes of the Securities Act and the Exchange Act. A security is broadly defined to include investment contracts.1 The Commission found that DAO Tokens met all three prongs of the 70-year-old Howey test for identifying investment contracts and, therefore, constituted a security. Specifically, the Commission’s analysis concluded that The DAO’s investors (1) invested money (2) with a reasonable expectation of gaining profits (3) that were derived from the efforts of The DAO.

The investment-of-money prong was met by investors’ exchange of the digital currency Ether. The expectation-of-profits prong was satisfied by how the offer was marketed. Statements made by promoters and on The DAO website marketed the offering as an investment. The Commission discussed at greater length whether the offering depended on the efforts of others. Here the Commission framed the “central issue” as whether the efforts made by those other than the investors were “undeniably significant” and “essential managerial efforts which affect the failure or success of the enterprise.” The Commission noted that the creators of The DAO “held themselves out to investors as experts in Ethereum,” the blockchain protocol on which The DAO operates. Moreover, they informed investors that they had selected key personnel to manage the enterprise “based on their expertise and credentials.”

The Commission provided extensive additional analysis of this prong of the Howey test, examining marketing factors specific to The DAO, suggesting that other platforms could be structured to avoid the inference that the profits were derived from the efforts of others, thereby avoiding the conclusion that securities were involved. For example, the Commission noted that DAO Token holders’ voting rights “did not provide them with meaningful control over the enterprise.” The Commission observed that the ability to vote for contracts was “largely perfunctory” and that token holders were “widely dispersed and limited in their ability to communicate with each other.”

The Commission proceeded to describe and examine these features at length. This emphasis is notable and suggests that technological innovation could provide token holders with voting rights and communication abilities sufficient to reach a different conclusion under the Howey test’s third prong. Implementing such a platform could be very difficult, especially where holders are numerous, because effective voting control may not be practical. However, the Commission’s detailed discussion on these points, and the issues it identified in The DAO’s offering, raise intriguing questions about how a different approach might ultimately be successful.

The report also noted that The DAO offering would not fall under the JOBS Act’s crowdfunding exemption because The DAO did not meet certain threshold criteria, such as being registered with the Commission and the Financial Industry Regulatory Authority as a broker-dealer or a funding portal. The DAO also raised more than the $1 million annual cap applicable to exempt issuers under Regulation CF.

The Commission’s report does not assert that all coins and tokens necessarily constitute securities, nor that all ICOs are “offerings,” but does emphasize the broad application of securities laws “regardless [of] whether the issuing entity is a traditional company or a decentralized autonomous organization” and “regardless [of] whether those securities are purchased using U.S. dollars or virtual currencies.” The Commission’s simultaneous issuance of an investor bulletin on ICOs explains that “depending on the facts and circumstances of each individual ICO, the virtual coins or tokens that are offered or sold may be securities,” such that their offer and sale would be subject to securities regulation.

Until now ICOs have been organized on the theory that the coins and tokens being issued are currency and therefore exempt from securities regulation. The Commission rejected this argument, likely because purchasers of coins and tokens do so with intent to invest and for value appreciation, not to hold legal tender currency. Likely due to the novelty of the transactions involved and apparent good faith intentions of the participants, the Commission decided not to pursue an enforcement action against The DAO. Future ICO sponsors are unlikely to receive a similar free pass.

Important Takeaways

  • Although the Commission’s report is directly applicable only to DAO Tokens, it effectively puts other ICO issuers on notice that all cryptocurrency coin and token offerings are potentially subject to securities regulation. In particular, coins or tokens that meet the Howey test as applied in the Commission’s analysis are particularly likely to be regulated, as the offering of such tokens likely constitutes an investment contract and therefore will be subject to securities regulation. In addition, ICO platforms should be aware of the circumstances under which they might constitute an exchange, requiring registration as a broker-dealer, national securities exchange or alternative trading system in the absence of an exemption.
  • The Commission’s report raises the question of whether alternative approaches, with robust managerial control in the hands of holders, could be developed to avoid the third prong of the Howey test. Although significant caution is in order, the Commission’s analysis may offer hope to market participants who innovate in ways that carefully address the concerns articulated in the report. As the Commission itself noted, “[w]hether or not a particular transaction involves the offer and sale of a security—regardless of the terminology used—will depend on the facts and circumstances, including the economic realities of the transaction.” Nonetheless, we believe the Commission and Staff will be highly skeptical of conclusions that the federal securities laws do not apply to coin and token offerings.
  • The Commission’s report does not consider whether The DAO’s activities render it an “investment company” for purposes of the Investment Company Act of 1940, which generally requires investment companies to register with the Commission. Given the broad definition of “securities” under this act, and the Commission’s conclusion that cryptocurrency coins and tokens may constitute securities, ICO issuers should carefully consider the applicability of this act to their offerings, and the obligations this would entail.
  • The Commission’s message is clear: ICO issuers and brokers must tread carefully and fully consider the regulatory implications of offerings prior to launch. If the coins or tokens being offered are securities, registration with the Commission will be required, unless an exemption is available, such as in private placements and foreign offerings to accredited and overseas investors, respectively.

Final Thoughts

The Commission’s detailed legal and factual analysis of the DAO Token offering suggests the Commission is closely monitoring cryptocurrency and ICO activities. The Commission observes that “virtual organizations and associated individuals and entities increasingly are using distributed ledger technology to offer and sell instruments such as DAO Tokens to raise capital.”

We expect the Commission will continue to examine the applicability of securities law to each iteration of ICO as this form of fund-raising evolves. Issuers considering an ICO should consult securities law and digital finance experts, including competent legal counsel, before undertaking such activities.

Related Links

Securities and Exchange Commission, “Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO” (July 25, 2017), available at https://www.sec.gov/litigation/investreport/34-81207.pdf

Securities and Exchange Commission, Press Release, SEC Issues Investigative Report Concluding DAO Tokens, a Digital Asset, Were Securities (July 25, 2017), available at https://www.sec.gov/news/press-release/2017-131

Securities and Exchange Commission, “Investor Bulletin: Initial Coin Offerings” (July 25, 2017), available athttps://www.investor.gov/additional-resources/news-alerts/alerts-bulletins/investor-bulletin-initial-coin-offerings

Delaware Blockchain Initiative?

Crowdfund Beat News Wire,

Delaware Blockchain Initiative: Transforming the Foundational Infrastructure of Corporate Finance

or much of American corporate finance is Delaware corporate law. Later this year, a small change to Delaware corporate law, if enacted, could facilitate a major simplification of the plumbing of the financial system built on top of that foundation. The change is part of the Delaware Blockchain Initiative (DBI), which then-Governor Jack Markell introduced in May 2016. The initiative will allow for the application of distributed ledger technology to many of the private sector’s most basic and critical legal documents, which companies currently file with the Delaware Division of Corporations.

What Is Blockchain Technology?

Blockchain technology, also known as distributed ledger technology, is a new type of information technology that combines two components: distributed ledgers and smart contracts.

Distributed ledgers are mutual, shared ledgers. They create a single record of transactions among multiple parties, providing one immutable, “golden copy” of data that all parties see at the same time and can trust as valid. Consequently, parties do not need to maintain their own copies and reconcile with each other. Distributed ledgers are append-only databases that maintain a perfect, immutable audit trail of who did what and when they did it.

Smart contracts are automated “if/then” software programs that self-execute when a specific trigger occurs. Online bill payment is a widely-used example of a smart contract. On the due date of your bill, the software springs into life and automatically pays your bill by executing the instructions you previously provided. Smart contracts automate workflow.

When smart contracts run on top of distributed ledgers, the combination is so powerful that it can automate wide swathes of financial services. Software can fulfill the functions of clearing and settlement intermediaries, thereby streamlining today’s labyrinthine workflows and eliminating today’s unnecessary counterparty risk and latency in transaction settlement. The transition may take 20 years to complete, but it has already begun.

The Delaware Blockchain Initiative

When then-Governor Markell launched the DBI, he committed State government to use the technology and asked the Delaware State Bar Association’s Corporation Law Council to consider clarifying Delaware corporate law to expressly authorize tracking of share issuances and transfers on a distributed ledger.

The first milestone on DBI’s roadmap has been reached. It is the rollout of distributed ledger technology at the Delaware Public Archives, which has been the “beta” test for the technology within State government. New “smart records” technology automates compliance with laws pertaining to retention and destruction of archival documents, among other features.

The second milestone will be “smart UCC” filings, which will be rolled out later this year. Many attorneys are familiar with the UCC filing process, which is still surprisingly paper-based, slow and error-prone. UCC filings on a distributed ledger will (1) automate the release or renewal of UCC filings and related collateral, (2) increase the speed of searching UCC records, (3) reduce mistakes and fraud and (4) cut cost. Banks have already told us they welcome this upgraded technology for UCCs, and we believe lawyers will as well. We anticipate banks will ultimately link their “smart UCCs” into software that values their collateral, so that the “smart UCC” can automatically call for additional collateral from a borrower when the value of collateral covered by a UCC financing statement drops below a threshold loan value. The new technology will permit UCC filings to become critical tools through which lenders actively manage credit risk, rather than mere “check the box” documents.

The third milestone—distributed ledger shares—will be next on the roadmap.

Why Distributed Ledger Shares Would Transform the Foundational Infrastructure

If shares are registered on a distributed ledger, investors and issuers would be able to interact directly. Property rights would be crystal clear. Capitalization table management would become easy. Proxy voting would be transparent and always accurate. Dividends and other corporate actions (such as stock splits) would be automated and always accurate. Certificates of good standing would never again require a prerequisite forensic audit. Securities lending records would always be accurate, so accidental over-issue of securities would never happen.

None of the above is necessarily true of the status quo.

Delaware’s move to authorize distributed ledger shares would be much more significant than simply an upgrade to shareholder recordkeeping tools. When a company chooses to incorporate in Delaware using distributed ledger shares, the Division of Corporations could validate and file the incorporation plus transfer the authorized shares to the new company. Only shares that are cryptographically “signed” and transferred by the Division of Corporations, in that genesis transaction for the new company, would be considered validly-authorized distributed ledger shares (and a similar procedure would apply to converted corporations). By doing this, the Division of Corporations establishes a perfect record of authorized shares, and the distributed ledger can then track shares that are issued and outstanding.

Gone would be the days of discovering that a company’s capitalization table is wrong before a material corporate transaction, which today requires a scramble to perfect the capitalization table through a Section 204 filing that, in turn, requires a forensic audit and payment of overdue franchise taxes. Furthermore, even after a capitalization table has been perfected, errors still occur today that would simply not be possible with distributed ledger shares. Examples include cases in which a company’s SEC filings report that more shares are issued and outstanding than were actually authorized in Delaware filings, or in which the securities industry counts more shares in omnibus accounts than are authorized in Delaware filings. Distributed ledger technology solves all of these problems, and more, automatically.

Importantly, distributed ledger shares would also solve an inconsistency between corporate and securities laws that has created real-world consequences. Delaware corporate law generally confers rights on the direct, record owners of shares. By contrast, certain federal securities laws pertaining to listed securities require that securities be “depository eligible,” which, in practice, means investors own them indirectly. When investors own securities indirectly, what they own is not legally a security but instead is a pro rata share of fungible “security entitlements” under UCC Article 8—which are IOUs issued by a broker/dealer (a “securities intermediary”), which in turn holds a pro rata share of security entitlements from other securities intermediaries, which in turn hold a pro rata share of the actual securities that are legally owned by a nominee called Cede & Co. (itself a nominee of The Depository Trust Company). At each of these layers above the broker/dealer, intermediaries account for security entitlements on an omnibus basis. This means they track owners only on an aggregate basis, not by tracking the true beneficial owner.

This ownership inconsistency between corporate and securities laws, direct vs. indirect, sometimes creates bizarre and unintended outcomes.

For example, the Bank Holding Company Act restricts a single shareholder’s ownership of a bank holding company to 24.99% of any voting class of shares. Consequently, is it consistent with the Bank Holding Company Act that the DTC’s Cede & Co. owns nearly 100% of the shares of every U.S. bank holding company whose shares are publicly-traded? Other ownership restriction laws, including those restricting foreign ownership of airlines, nuclear facilities, mining interests, communications companies and other critical infrastructure, similarly were drafted to restrict ownership without acknowledging that beneficial owners are frequently not the same as record owners. Another example is the SEC’s Regulation AB, which requires trustees of asset-backed securities to facilitate communications between investors. Yet, how can trustees comply when the simple fact is trustees have no right to access the list of beneficial owners and therefore cannot verify ownership?

The system is also a recipe for mistakes. While it works fairly well, mistakes happen surprisingly frequently. And they can be costly.

Delaware Chancery Court Vice Chancellor J. Travis Laster, in a speech to the Council of Institutional Investors in September 2016, provides several examples. He encouraged investors to adopt blockchain technology as the plunger that can unclog the plumbing of capital markets for the benefit of investors. Pointing to conflicts with federal securities law, he said: “Delaware corporate law is not built to accommodate the nominee system. It assumes that stockholders own shares directly…”

Prominent judges do not often call their own legal opinions “absurd,” but Vice Chancellor Laster did just that in a case involving T. Rowe Price (In re Appraisal of Dell Inc. (Dell Continuous Ownership), 2015 WL 4313206 (Del. Ch. July 30, 2015)). This is one of many examples he shared in which Delaware corporate law conflicts with federal securities law regarding direct vs. indirect ownership. T. Rowe Price paid $194 million to compensate its clients for actions for loss of appraisal rights and a proxy voting mistake that were, at root, caused by the indirect system of share ownership. Vice Chancellor Laster said, “Personally, I think that [decision] is absurd. This was an example of people doing what they should do and then getting caught up by the system…The upshot for present purposes is that the complexities of the nominee system harmed stockholders.”

Another recent example is the Dole Food Company class action litigation, in which Vice Chancellor Laster revealed a curious fact in his decision of February 15, 2017. Investors filed claims to 49.2 million Dole shares that were “facially eligible,” but only 36.8 million Dole shares were outstanding.

Most of the difference was caused by unsettled trades during the final three trading days (“T+3”) before Dole’s buyout closed, because “DTC’s centralized ledger did not reflect all of the trades in Dole common stock on the day of the merger or during the two days preceding it.” The rest of the difference resulted from uncovered short sales of Dole stock. As Vice Chancellor Laster wrote,

The shorting resulted in additional beneficial owners who received the merger consideration, who fell within the technical language of the class definition, and who could claim the settlement consideration. Meanwhile, the lenders of the shares, not knowing that the shares were lent, also could claim the settlement consideration. This is another means by which two different claimants could submit facially valid claims for the same underlying shares.

In a footnote to the opinion, Vice Chancellor Laster wrote,

…despite laudable and largely successful efforts by the incumbent intermediaries to keep the system working, the problems have grown…Distributed ledger technology offers a potential technological solution…

Proxy voting is yet another area in which the nominee, or indirect, ownership system can breed inaccuracy. In the 2008 proxy contest for control of the board of Yahoo, a recount demanded by a shareholder revealed that almost 20% of the vote was miscounted. As Vice Chancellor Laster explained in his September 2016 speech, the default voting option is sometimes set to vote for management’s proposals, which adds to the difficulty of success in proxy contests because quirks in the system can cause votes to default back to vote in favor of management. This happened to T. Rowe Price in the Dell case, as T. Rowe Price checked three times to ensure its vote was against Dell’s management but the system actually recorded its vote in favor of management’s proposal by default. Vice Chancellor Laster continued,

Aside from overvoting, the complexity in the voting system creates opacity and the opportunity for miscalculated votes…As the SEC has explained, ‘Because the ownership of individual shares held beneficially is not tracked in the U.S. clearance and settlement system…imbalances occur.’ When those imbalances occur, ‘broker-dealers must decide which of their customers will be permitted to vote and how many shares each customer will be permitted to vote.’

In other words, one share does not equal one vote. Vice Chancellor Laster concluded,

The plumbing needs to be fixed. A plunger exists…With distributed ledgers, a central accountant like DTC becomes unnecessary. Custodians become unnecessary. Ownership lies only with beneficial owners. A single distributed ledger would allow straight-through accounting. It is a utopian vision of a share ownership system where there is only one type of owner: record owners.

The indirect system of share ownership evolved historically around the basic fact that most corporations in existence today were incorporated on paper and issued their shares on paper. In the case of public companies, Cede & Co., holds in its custody a single piece of paper—a “global security”—representing all (or nearly all) of the company’s issued shares.

Some of these paper documents have been digitized in recent years. But doing so merely digitized the labyrinthine workflows of the status quo, which trace their origins to the Wall Street paperwork crisis of the early 1970s. The technology limitations of 40 years ago that gave rise to the status quo are long gone, but status quo business processes remain. The true benefits of digitization will only reach the securities industry when its layers of settlement processes are finally streamlined, so that securities issuers and investors can again interact directly. The DBI may spark that change.

Benefits to Delaware

Why has Delaware been so forward-thinking to enable such an important change to the foundational infrastructure of corporate finance? Two reasons: leadership and value-added services.

When distributed ledger technology hit their radar screen in 2015, State officials immediately understood the ramifications for companies that register in the State. By being the first to adopt the technology, the State will maintain its leadership in corporate registry services. In addition to the State offering the most developed body of corporate and trust law, the Delaware Court of Chancery is widely recognized as the nation’s preeminent forum for dispute resolution for corporations. The Court of Chancery also has subject matter jurisdiction for technology disputes in the amount of $1 million, which makes it an ideal forum for disputes pertaining to blockchain technology. In addition, Delaware’s Rapid Arbitration Act fits well with the ethos of blockchain technology—namely, fast settlement of transactions—by providing an ideal regime for the speedy, efficient and relatively inexpensive resolution of disputes.

And Delaware’s registry services provide true value to businesses. State officials saw the opportunity to create even more value for businesses that choose Delaware for registry services if the State were to offer registries on a distributed ledger. Such registries include not just incorporation services, but also UCCs, land titles, personal property titles, birth/death certificates, professional licenses and many other new types of registries that the State may introduce as part of the DBI (for example, diamonds and other luxury goods). A certification from Delaware that something has been properly registered carries significant value in the business world. And if companies choose to access the imprimatur of Delaware on a distributed ledger instead of a piece of paper, it will carry even more value because companies can integrate it with other upstream technologies to streamline workflows. Potential users of Delaware’s distributed ledger service have already confirmed their willingness to pay more because it will save companies costs. It is win-win.

We look forward to engaging with the corporate law bar as the DBI reaches more milestones, and to providing these new services to Delaware’s business constituents. Stay tuned for many developments!

 

Happy Birthday Regulation CF (shame about the compliance failures)

So, one year ago today, Regulation CF went into effect. Small companies can make offerings up to $1 million (recently increased to $1.07 million) and roughly 325 companies have made Reg CF offerings so far. Roughly 80 companies have filed Form C-U to notify the SEC of the conclusion of their offering (they can also use Form C-U to report progress of the deal, so the raw numbers need refining). Another 50 or so companies have taken advantage of the fact that the SEC tells us that multiple closings are permitted once a company reaches its target offering amount, and so have received funds but have ongoing offerings.

We’re talking about modest success so far. Companies are finding it takes a while to raise the funds they are seeking and many offerings are still in progress, so overall success rates are going to go up in time. And several companies have had million-dollar raises.

The less-encouraging story in in the area of compliance. By our calculation, by May 1 perhaps 100 companies should have filed annual reports under Form C-AR (all the companies which had filed C-Us by that date and all companies which had sold some securities but not finished their raise). Again by our calculations, only two-thirds of the companies that should have filed did so. Not too impressive.

And that’s just measuring whether those companies filed, not looking at the content of their filings. We’ve been reviewing all the filings made on Form C, and evaluating their compliance with the disclosure requirement of Rule 201. Later this summer we’ll publish more detailed findings. But in the meantime, we are sad to report that compliance is not particularly good. It seems to be improving, which is the good news. But there are a number of areas where the disclosure requested by the SEC is not being made:

  •          Only one in four companies is providing a discussion of the company’s financial performance since the end of the financial statements included in the Form C, which can be as old as sixteen months.
  •           Four out of five companies include no discussion at all about how the proceeds of the offering will affect their liquidity and how long the proceeds will last.
  •           One quarter of the companies filing don’t include a description of all the securities they have issued.

The list goes on. I don’t think disclosure failure is an insurmountable problem; as discussed above there does seem to be some improvement. However, at a time when we are looking for more flexibility from the SEC, “please change the rules because we aren’t complying with the ones currently in effect” is not generally a winning argument. The answer to the issue of disclosure deficiency is clearly one is clearly education; the biggest areas of deficiency are where the SEC’s requirements may not be totally clear to issuers, and it’s an area where the intermediaries (funding platforms and brokers) can help. Filing deficiency may be a harder issue to address; often filing requirement only kick in when the intermediary is not longer involved.

But if we don’t solve both problems, as an industry it will be harder to get the regulatory flexibility we still need.

Source:

https://crowdcheck.com/blog/happy-birthday-regulation-cf-shame-about-compliance-failures?utm_campaign=buffer&utm_content=buffer3ae14&utm_medium=social&utm_source=linkedin.com

 

Open Letter to Real Estate Sponsors : Investors Deserve Better Quarterly Reports

By Mark Robertson CrowdFundBeat  Sr. Contributing Editor. President at CrowdDD, LLC,

This is an open letter to all real estate sponsors.  Investors want better reporting.  Concise, short, informative, and easy to read reports.  Unfortunately, most sponsors do poor job of communicating results with investors. I have over 50 equity crowdfunding investments and the quality of the quarterly reports varies wildly.

The poster child for good reporting is Praxis Capital lead by Brian Burke.  They have a one page report with graphs, relevant statistics, and a short write up of the past quarter’s results and commentary. They key features of their report are they inform the investor of the only 3 things investors truly care about.

  1. How much is MY distribution? What is the cash on cash return? What is it as a percentage of my investment? How does it compare to your projections for this quarter?
  2. The properties performance. Most importantly is the NOI. What is this quarters NOI compared to the projections made by the sponsor at the time of my investment?  What is occupancy compared to both last year’s quarter and compared to projections?
  3. If actual distributions are below projections or if NOI is below projections, we want to know why.  What we really want to know is how you plan to correct the shortfall and WHEN do you expect to get back on track.

Including the full income and balance sheet is great, but what we really want to know is the investment performing as you promised and where is MY DISTRIBUTION? In the end those two factors are all that really matter. Again, so it will sink in. How much money am I getting and are you meeting projections? We should know these 2 factors within 30 seconds of looking at the report.  The last thing we want to do is to dig and dig and hope to find this information.  

At the start of every update it should say: The project, life to date, is running xx% over/under to proforma.” and “For the last quarter the project was xx% over/under to proforma”. Unfortunately, I usually pull up the original offering materials and try to determine if the actual results are as projected.  Investors should not have to do this. That is the sponsors responsibility. Investors also appreciate guidance for the upcoming quarter or year based on market conditions. Be proactive and manage expectations.

Other Pet Peeves:

  1. It should never take longer than 45 days after a quarter to prepare the report
  2. Reporting that distributions for the quarter were $x00,000 with no context. I want to know what I am getting and if it’s what you projected. Don’t make me dig around to see if $x00,000 is good or not.
  3. Sending out the ach distribution without a clearly identifiable notation of who the ach is from. Email the report before the ach so we can expect the distribution.
  4. Justifying a quarters miss because of seasonality. Your projections should have accounted for seasonality. You knew the seasons were coming when you asked for my investment.
  5. Comparing results to budget and budget is not the proforma numbers or the projections at the time of the investment. Wrong on so many levels.

In informal poll of the 240 accredited members of the 506 Investor Group concur that inadequate reporting is one of the most vexing problems with investing in syndicated and crowdfunding real estate deals.  An industry standard like Praxis quarterly reports would go a long way to solving this issue. CrowdDD already has ratings reviews from actual investor.  We would be more than happy to host a sponsor template for investors to see how cash flow and NOI is tracking versus proforma projections.

Source:

https://www.crowddd.com/blog/view?id=Nzc=&ct=Open+Letter+to+Real+Esate+Sponsors++Investors+Deserve+Better+Quarterly+Reports

Crowdfunding and Cryptocurrencies

By Mark Roderick CrowdFunding Beat  Sr. contributing editor and crowdfunding attorney with Flaster/Greenberg PC.

Cryptocurrencies are hot. And often the sale of cryptocurrencies is referred to as Crowdfunding. Unfortunately, the use of “cryptocurrencies” and “Crowdfunding” together creates confusion about both, along with some pretty serious legal risks.

We use “Crowdfunding” to mean raising money for a business or other venture online. We say “donation-based Crowdfunding” when we’re talking about Kickstarter, where people ask for donations. We say “equity-based Crowdfunding” when we’re talking about raising money from investors, who receive a stock certificate or some other security.

A cryptocurrency is, well, hard to pin down. It’s a transaction registered in a distributed, secure database. Because it exists in limited quantities and is secure, it has value. Like anything of value, it can be used as a currency. For purposes of this post, the key feature of a true cryptocurrency is that is has value of itself, like a nugget of gold.

You use Crowdfunding to sell shares of stock. Obviously, the paper certificates representing the shares of stock have no value by themselves, they have value only to evidence ownership in the business that issued the certificates or, more exactly, in the cash flow the business is expected to generate. So it wouldn’t make sense to say “I’m selling nuggets of gold using Crowdfunding.” The nuggets of gold have an intrinsic value without reference to the cash flow of anything else, or at least you hope they do. I can go shopping with a cryptocurrency like Bitcoin or Ethereum, just as I can shop with US dollars or, historically, with gold.

This is where things get tricky and words matter. The blockchain – the technology underlying all cryptocurrencies – can be used for a lot of things other than cryptocurrencies. As it happens, one of the things the blockchain can be used for is to keep track of stock certificates. In fact, the blockchain works so well keeping track of stock certificates that it will undoubtedly be used by (or replace) all public stock transfer agents within the next five years.

What’s happening today is that companies are selling what they call “cryptocurrencies” that are really just interests in the future operations of a business, i.e., really just hi-tech stock certificates. Cool, they’re using blockchain technology to keep track of who owns the company! But that doesn’t mean what you’re buying is really a cryptocurrency and that you’re going to get rich like the early buyers of Ethereum.

Words are powerful, and the confusion around cryptocurrencies is deepened by the nomenclature. Sales of cryptocurrencies are often referred to as “initial coin offerings,” or ICOs, which implies a similarity to “initial public offerings,” or IPOs. Yet if we’re being careful, the two have nothing in common. In an IPO a company sells its own securities, which have value only based on the success of the company. In an ICO somebody sells a product that has intrinsic value of itself.

Ignoring the difference is going to land someone in hot water, probably sooner rather than later. A company that sells something it calls a cryptocurrency but is really just a share of stock is selling a security, even if that company has an address near Palo Alto. And a company that sells a security is subject to all those pesky laws from the 1930s. If you sell a cryptocurrency that is really just a hi-tech stock certificate, then not only do you risk penalties from the SEC and state securities regulators, you’ll also face lawsuits from your investors if things don’t go as planned.

How to know whether you’re selling a true cryptocurrency or a hi-tech stock certificate? Here are some tips:

  • If the value of the cryptocurrency depends on the success of the business, it’s a security.
  • If the value of the cryptocurrency depends on, or is backed by, real estate or other property, it’s a security.
  • If the cryptocurrency is marketed as an investment, it’s probably a security.
  • If the value of the cryptocurrency depends what the buyer does with it, rather than the success of the business, it’s probably not a security.
  • If the cryptocurrency merely gives the holder the right to participate in a group effort (g., the development of software), it’s probably not a security.
  • If you’re selling the cryptocurrency in lieu of issuing stock, it’s probably a security.

Paradise Ridge Hydrocarbons, Inc. (OTC Pink: PRGE) Jumps 50% After Acquiring Equity Crowdfunding Platform, StackCap.com

Crowdfund Beat News Wire,

Paradise Ridge Hydrocarbons, Inc. (OTC Pink: PRGE) is primarily engaged in the re-entry and re-working of existing oil & gas properties. Shares of the energy company are surging 50% on Monday, May 1, 2017. Over the past month, Paradise Ridge Hydrocarbons, Inc. saw average daily volume of 95,129 shares. However, volume of 205,639 shares or dollar volume of $129,552, has already exchanged hands on Monday.

Shares of Paradise Ridge Hydrocarbons, Inc. are jumping today, after the company announced it has diversified its business operations through the acquisition of StackCap.com, an equity crowdfunding platform. Furthermore, the company says it will utilize STACKCAP, Inc. to conduct further debt and equity financing services and platforms. Ultimately, the acquisition is scheduled to close on May 31, 2017. Here is the full press release detailing of the acquisition:

Paradise Ridge Hydrocarbons, Inc. Press Release:

AUSTIN, Texas, May 1, 2017 /PRNewswire/ –Paradise Ridge Hydrocarbons, Inc. (OTC Pink: PRGE) today announced that it has signed a definitive agreement to acquire equity crowdfunding platform stackcap.com owned by STACKCAP, INC.

Equity crowdfunding fuels innovation and growth by providing access to capital that can take businesses from ideas to viable products and real jobs. PRGE will utilize STACKCAP, INC. to provide debt and equity financing for a wide range of business opportunities which currently lack access to needed capital. “Under the Jumpstart Our Business Startups Act of 2012 the US government has helped by lowering the barrier to entry, and now we will do our part. Under the Trump administration, we believe this will continue to spur a small business revolution, empower more women and minorities and revive the American dream,” stated President Gordon Johnson.

The acquisition is scheduled to close prior to May 31, 2017. The terms of the transaction include the issuance of restricted Rule 144 PRGE common stock.

Forward Looking Statements:

This press release contains forward-looking statements that involve numerous risks and uncertainties. Actual results, performance or achievements could differ materially from those anticipated in such forward-looking statements as a result of certain factors, including those set forth in the Company’s filings with the Securities and Exchange Commission.