The Rise of Unregistered Securities

crowdcheck

The SEC issued a white paper titled “Capital Raising in the USA: An Analysis of the Market for Unregistered Securities Offerings, 2009‐2017.” This white paper presents some pretty interesting numbers. Capital formation through unregistered securities exceeds that from registered securities; 2017 saw unregistered securities raise over $3 trillion versus registered offerings’ $1.5 trillion. Also, according to […]

The post The Rise of Unregistered Securities appeared first on Lending Times.

crowdcheck

The SEC issued a white paper titled “Capital Raising in the USA: An Analysis of the Market for
Unregistered Securities Offerings, 2009‐2017
.” This white paper presents some pretty interesting numbers. Capital formation through unregistered securities exceeds that from registered securities; 2017 saw unregistered securities raise over $3 trillion versus registered offerings’ $1.5 trillion. Also, according to the report, the JOBS Act has had a booster effect on the ecosystem. This is evident by the hundreds of crowdfunding websites launched since its passing. Regulations CF, A+, and D have unshackled entrepreneurs and democratized fundraising. But a critical part of investing in unregistered securities is the due diligence behind whether the companies seeking the funding are genuine or not. CrowdCheck, incorporated in 2012, aims to verify the credibility of companies seeking such investments.

In a chat with CEO and Founder Sara Hanks, we uncovered how CrowdCheck has become the go-to player for due-diligence, compliance, and disclosure.

The Problem With Unregistered Securities

Hanks understood the need for building the trust layer between online investor and issuer since investors will buy shares in unknown companies online. Moreover, there is a list of legal requirements that a capital raising company and an investor need to meet to ensure everything is above board and handled according to these regulations.

CrowdCheck specializes in online capital raising. It serves the entrepreneur, the crowdfunding platform, and the investor in ensuring that the transaction is handled according to current laws and all necessary approvals are in place. From handling drafting and disclosures for Reg D, A+, and CF to filing the relevant notices, CrowdCheck is a one-stop shop. The company has executed 40 Reg A+, 50 Reg D, and about 450 Reg CF offerings.

The Relevant Regulations

Regulation A+

This regulation allows companies to generate income under two tiers representing two different types of investments.

  • Tier 1 – A company is permitted to offer a maximum of $20 million in any one year. The issuing company must also provide an offering circular, which must be filed with the SEC and subject to a vetting process by the commission and securities regulators relevant to the offering. Companies issuing under Tier 1 are not required to produce reports frequently. Instead, they are only required to issue a report on the final status of the offering.
  • Tier 2 – A company can offer up to $50 million in any one-year period. Though an offering circular is required and is subject to review and vetting by the SEC, it doesn’t have to be qualified by any state securities regulators. Companies issuing under Tier 2 must produce continual reports on the offering as well as its final status.

The offering can be marketed to both accredited and non-accredited investors.

Regulation CF Crowdfunding

The company must be incorporated in the US.

  • Allows only $1 million in fundraising.
  • An investor is limited in the amount to be invested in crowdfunding securities in any one-year period. If either the annual income or net worth of the investor is less than $100,000, the investor is limited to the greater of $2,000 or 5% of the lesser of the annual income or net worth. If greater, limited to 10% of the lesser of annual income or net worth, to a maximum of $100,000.

Regulation D

Rules under 506(b)

  • The company cannot use advertising to market securities.
  • No maximum fundraising limit.
  • Securities can be sold to an unlimited number of accredited investors and up to 35 non-accredited investors.

Rules under 506(c)

A company can generally advertise the offering and still be deemed to be in compliance with the exemption requirements if:

  • All the investors are accredited investors.
  • The company should review various documents like tax returns, W-2s, bank and brokerage statements, credit reports, etc. to verify that investors are accredited investors.
  • Companies that comply with the above requirements do not have to register their securities offering with the SEC.

Insights from CrowdCheck

Suitability

  • Reg CF is most suitable for complete startups. It is a cost effective way of raising capital due to the low threshold and regulatory requirements for fund raising. CrowdCheck offers complete services for this segment for just $5000.
  • The investee company needs to decide if it is happy with hundreds of shareholders or would just like to focus on a few accredited investors. Reg A+ is thus suited for companies looking to IPO in a few years.
  • Reg A+ is slightly more expensive than Reg D due to the requirement of SEC compliance. CrowdCheck offers a complete Reg A+ package for $60,000 whereas Reg D fees range from $25,000 to $40,000.

Platforms

There are multiple platforms available in the market, but the entrepreneur needs to choose carefully. Some specialize in a particular industry or particular regulation funding. Hanks believes StartEngine, Wefunder, Seed Invest, Next Seed, Micro Ventures, and Net Capital are the market leaders in the space.

Crowdfunding success is difficult to measure as startups usually have a low minimum threshold. Sites like Kickstarter are different from Wefunder as they do not provide any financial interest in the company being funded.

Numbers (as of Mid- 2018)

  • Reg CF has seen 960 offerings with 390 completed. Many of them are still under process.
  • The average amount raised via Reg CF is $236,000.
  • Reg A+ has seen 325 filings and 232 have qualified to raise funding.
  • Reg A+ has helped companies raise $1.1 billion, and 108 fundraisings are completed with the average fundraising around $10 million.

Conclusion

Hanks has 30 years in the corporate and securities field. Prior to CrowdCheck, she was general counsel of the bipartisan congressional oversight panel for TARP. The company has a core team of 19 people out of which six are full-time employees in core management, and others are paid consultants having backgrounds in securities law and finance.

As investors become more comfortable with online crowdfunding, the quality of companies looking to raise capital has improved. Many startups are skipping VC money to test crowdfunding. CrowdCheck acts as an important “check” to ensure the sanctity of the process. The entire ecosystem, from entrepreneurs to investors to platforms, depend on their validation for making online capital raising work.

Author:

Written by Heena Dhir.

The post The Rise of Unregistered Securities appeared first on Lending Times.

What is 506(c), and What Does It Mean for Fundraising?

recorded capital commitments

Regulation D is a set of rules under which an issuer can sell its securities without having to register with the SEC. Rule 506 under Regulation D has been the most widely used means of raising capital in the US. Rule 506 was basically bifurcated into two separate rules — 506 (b) and 506 (c) […]

recorded capital commitments

Regulation D is a set of rules under which an issuer can sell its securities without having to register with the SEC. Rule 506 under Regulation D has been the most widely used means of raising capital in the US. Rule 506 was basically bifurcated into two separate rules — 506 (b) and 506 (c) — after the passing of Title II of the Jumpstart Our Business Start-ups (JOBS) Act in September 2013. 506 (b) is merely the extension of the old Rule 506, and 506 (c) is the new section that has completely revolutionized the world of private investing.

Under rule 506 (b), companies are free to accept backing from accredited investors and 35 non-accredited investors for an unlimited amount. Under rule 506(c), companies can sell to accredited investors only. On top of that, they need to verify that each investor is accredited.

An accredited investor is one who has a net worth of $1,000,000 excluding his primary residence, or if he has made $2,000,000 on an annual basis in the past two years.

So what is the advantage of this new rule? It allows for general solicitation.

506(b) does not permit general solicitation. The issuer needs to prove a pre-existing relationship with investors. This reduces the pool of investors a company can target. With general solicitation allowed under 506(c), start-ups can leverage the internet, TV, radio, and other media to attract a larger base of investors. This has “democratized” investing and the ability to raise capital. A company offering securities need not have any prior relationship with investors. Rather, they can publicly promote their capital-raising offer.

Crowdnetic, now FinMkt, tracked 6,063 investment crowdfunding private offerings under JOBS Act Title II 506(c) rules, which have combined recorded capital commitments (“RCC”) of approximately $870.0 million in the two years between September 23rd, 2013 (when Title II rules went into effect) and September 23, 2015 (the date of the report).

There is not an ounce of doubt that Rule 506(c) has brought a lot of upside for the issuers as they can broaden their reach by advertising their offering. The issuing company can raise more capital at a much faster pace without relying on the traditional gatekeepers that earlier helped them to find suitable investors. From the perspective of the investor, under rule 506(c), the advertised offering benefits them, as well. They now have a much larger choice available and can get on board a startup much earlier in its life as compared to waiting for an IPO.

Effect of 506(c) changes

There is an additional burden of verifying investors and making sure they meet the SEC’s definition of “Accredited Investor.” Many companies have sprung up to help start-ups outsource this tedious legal due diligence.

Startups have been using social media to attract users and customers since at least a decade. Now, they are able to leverage their skill set to attract money for their ventures. We are used to hearing about CAC (i.e. Customer Acquisition Cost); we will soon be reading about CAI – Cost of Acquisition of Investor. This metric will become a key success factor for start-ups looking to grow aggressively, and it allows them to even sidestep venture capitalists for funding.

Research by Crowdnetic shows that investors are comfortable investing in startup equity, thus highlighting that markets and investors have accepted this new rule with open arms.

What does it mean for alternative lenders?

This rule is a boon for marketplace lenders. They have proved adept at bringing thousands of lenders onto their platforms. P2P lenders have generally been a happy lot due to higher risk-adjusted returns they’ve been able to generate through platforms. The company should be able to tap this base for equity fundraising, as well. If you’ve invested $50,000 through SoFi, you might be predisposed to invest $10,000 in its equity.

And not only start-ups, even VCs and accelerators are taking note of the rule and its implied implications. 500 Startups has recently filed a Form D under 506( c ) for a fintech fund targeting a raise of $25 million. It is a prominent accelerator and has invested over $350 million in 1800 companies. This shows that the entire ecosystem of fundraising is poised for an upheaval with the 506(c) rule.

Conclusion

Rule 506 will break the hegemony of investment bankers and VCs over the fundraising process. A startup doing well can target its own user base for accredited investors rather than having to pay sky-high fees or dilute control to VCs. The startup community has been extremely receptive to the change, and you can see multiple platforms launched for the sole purpose of helping thousands of start-ups raise funding from a wider pool of investors. It is easy to see that 506(c) has been a win-win for all involved.

Author:

Written by Heena Dhir.