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.

Wednesday September 21st 2016, Daily News Digest

Wednesday September 21st 2016, Daily News Digest

News Comments Today’s main news:  Cloud Lending, Crowdnetic, and eOriginal combine forces to launch a complete turn-key product. Today’s main analysis: Very interesting bank API data and charts. Today’s main thought provoking articles:  Why wouldn’t 75% of banks buy fintech companies ? United States Cloud Lending, Crowdnetic, and eOriginal combine forces to launch a complete […]

Wednesday September 21st 2016, Daily News Digest

News Comments

United States

Malaysia

United States

DigitalLEND Connects Borrowers and Lenders Through Rapid Deployment-Ready Customizable Solution, ( Press Release Rocket), Rated: AAA

Cloud Lending Solutions, Crowdnetic and eOriginal today announced the debut of DigitalLEND.

Ready for rapid deployment, the customizable and integrated DigitalLEND solution allows lenders to move online quickly and capture market share in this growing sector.

Cloud Lending Solutions : A suite of SaaS products that includes loan origination, loan management, lease servicing, marketplace lending and collections built natively on the Salesforce platform.

Crowdnetic: Lending Gateway facilitates the delivery of competitive pre-qualified loan offers from multiple lenders via API.

eOriginal: Enables businesses to go beyond simple electronic signature functionality to manage the entire lifecycle of a digital transaction in a fully electronic environment.. Vaulting, Transaction, and Transferable Records Services, including securitization of financial assets.

25% of global banks would buy a fintech company, (Business Insider), Rated: A

 

4 charts on the state of banking APIs, (Tradestreaming), Rated: AAA

In Europe, PSD2 regulation, which goes into effect January 2018, will require banks to provide open access to customer, transaction and payment information via APIs. In the UK, the Open Banking Working Group has recommended the creation of an Open Banking Standard that will make it possible for banking data to be shared and used securely. Banks are getting their API strategies in order.
Most major technology companies, like Facebook and Google, use APIs as a pillar of their strategies.

API adoption is gaining momentum, with many banks in the process of API implementation.

he rise of APIs can also be seen in API request data from Xignite, a financial API company.

Though banks are starting to explore the use of APIs, they are still far behind other industries. In apigee’s State of API’s 2016 report, financial services do not even make it to the legend.

If, to quote Chris Skinner, “a bank is just a technology company trying to keep up,” it looks like banks still have a long way to go.

WTF is a bank API? ( Tradestreaming), Rated: AAA

Banks are beginning to open up their infrastructure to third parties, not unlike the way Amazon has done for e-commerce companies. APIs, or application programming interfaces, are the hooks and software used by programmers to build applications that connect to other firms’ technology. Banks with APIs enable fintech firms to build apps that utilize their infrastructure, like checking account balances.

Many banks have varying versions of APIs available. BBVA, a multinational bank based in Spain, has embraced the API movement and has a series of open APIs available. Open means that these APIs are made freely available to any firm that wants to use them. Other banks, like Barclays, for example, have APIs available for their partners, but they’re closed, made available only to partners of the bank and given to members of bank accelerators.

APIs make it easier for new fintech apps and programs to focus on creating a good user experience while they essentially outsource the underlying banking features.

MPOWER Featured in Paper by Federal Reserve Bank of Philadelphia Payment Cards Center, (Press Release Rocket), Rated: AAA

Here is the Philly Fed paper.

The paper summarizes a workshop facilitated by MPOWER at the Federal Reserve Bank of Philadelphia earlier this year.

In a discussion paper issued today, the Federal Reserve Bank of Philadelphia Payment Cards Center (PCC) features MPOWER Financing and explores the company’s innovative way of assessing and managing credit risk. The report concludes that MPOWER meets a lending need by providing additional private student loan options, leveraging a forward-looking manner of assessing credit risk based on a student’s potential.

“Because MPOWER’s underwriting model is based on a borrower’s future potential versus past performance, it unlocks possibilities for many students who may not qualify for other federal or private loans.”

In fact, the report points out that while federal student loans are available to any U.S. citizen who has been accepted to an accredited higher education institution, the evolving marketplace is demanding new options as student loan need skyrockets. From 2004 to 2014, student loan borrowers grew 92 percent and loan debt in the U.S. tripled, resulting in a massive $1.16 trillion borrowed. Coupled with the more than one million foreign students enrolled at U.S. institutions who are ineligible for U.S. government loans, new lending sources have become vital to a student’s educational future.

During the event, MPOWER shared more about its business, underwriting model, and position in the student lending space. Diving into the rationale behind MPOWER’s forward-looking loan approach, the report summarizes key insights from the workshop and details MPOWER’s role in student lending.

Marketplace Lender P2Binvestor Provides MM Asset-Backed Credit Facility to Urban Lending Solutions, (Yahoo Finance), Rated: AAA

P2Binvestor (P2Bi), a marketplace lender for asset-based working capital, today announced the close of a $10 million credit facility with Urban Settlement Solutions, LLC (DBA Urban Lending Solutions), a company established by CEO Charles Sanders in 2002. This facility does not include any equity, warrants, or convertible features.

P2Binvestor (P2Bi) is a marketplace lender that provides revolving lines of credit of up to $10 million per B2B borrower.

Urban Lending Solutions and its affiliates are leaders in providing outsourced services to the mortgage industry including mortgage fulfillment,  loss mitigation, and valuation services. The company has been ranked in the top 20 of Black Enterprise Magazine’s BE 100s: The Nation’s Largest Black Businesses for the last three years.

Urban Lending Solutions needed a partner that believed in its business model and opportunities for continued profitable growth,” said Charles Sanders, CEO of Urban Lending Solutions, “and we are quite pleased to find and work with a lending partner that understands us and is as nimble, timely, creative and effective in meeting our needs as we are with our customers.”

RealtyShares Surpasses $ 200 Million Raised Through Real Estate Crowdfunding, (Business Wire), Rated: A

Comment: RealtyShares probably means  to use the sign > and not < . Saying you have less than 25k investors is not really useful.  Saying you have more than 24k investors ( likely what they meant to say) is a much better statement. Same for the rest of the infographic statements. Fun infographic otherwise.

In addition to this milestone, RealtyShares also recently announced that it has closed a $30 million line of credit through an institutional partner, which will allow the company to pre-fund every debt deal, as well as select equity investments, before making them available to investors through its marketplace. The credit line allows the platform to put its own balance sheet towards funding projects, bringing a new level of commitment to the investments listed on the platform and better alignment between RealtyShares and its base of accredited investors.  It also provides Sponsors with more predictability around the funding of their projects, an important aspect of any real estate transaction.

Lending Club: Invest In The Notes, Not The Company, (Seeking Alpha), Rated: A

Comment: please see our comments in line. I think it’s interesting to listen to the arguments but the path to the conclusion is unclear to me.

I believe LC is very similar to Visa (NYSE:V) and MasterCard (NYSE:MC) in the respect that they essentially charge a toll. This drastically limits the downside risk to their balance sheet.

1. Competition – The business of making personal loans is extremely saturated. LC is not only competing with another peer to peer lenders like Prosper, but they are also competing with banks and other financial institutions. Many of these companies have also been in the space forever like Wells Fargo (NYSE:WFC), Discover (NYSE:DFS), Citibank (NYSE:C), Bank of America (NYSE:BAC), etc. While LC claims they have the “secret sauce” when it comes to originations, one could arguably ask what differentiates their originations from the traditional lenders since they all use the same traditional scoring metrics when originating loans.

2. Economic Downturn – What happens to LC notes if/when an economic downturn happens?

3. Profits – This is the big one to me. LC has been around since 2006 and has yet to really be profitable. [ Comment: I think that on the contrary : showing the growth they showed while having multiple profitable quarters as they had in 2015 and early 2016 is an impressive. ]

My advice would be for investors to purchase notes off the Lending Club platform rather than the stock of the company, at least until the company proves they can actually make money. [Comment: I am not sure I follow. Point 1 above, on the contrary, means that buying the stock is better than buying the notes. Point 3 indeed mean it’s better to buy the notes. But point 2 means it’s not a good idea to buy anything at all. ]

Malaysia

SC to announce list of peer-to-peer financing by year-end, ( The Star), Rated: A

The Securities Commission is targeting to announce the list of peer-to-peer (P2P) financing before year-end. [Comment: I am not sure what list of p2p financing means, a list of p2p financing companies authorized ? Regulations ? Deals done ?]

Chairman Tan Sri Ranjit Ajit Singh said that there has been an “overwhelming” interest applying to run P2P lending platforms. “We are looking to make the announcement before the end of the year, we have received an overwhelming response,” he told reporters at the sideline of Private Equity (PE) Forum 2016.

“Deal making has also been on a steady incline since 2012, with RM365mil worth of investments made by venture capital and PE firms in 2015, which is an increase of 59%,” he said.

Over the years, the SC has pursued proactive initiatives to ensure that the right incentives and structure are in place to facilitate venture capital and private equity activity.

One such measure was establishing a tax exemption framework that allows qualifying venture capital/private equity firms who have invested significantly in seed or early-stage companies to enjoy tax-free income, he added.

“Malaysia currently ranks 11th out of 125 countries assessed in the Venture Capital & PE Country Attractiveness Index, which measures investor-focused indicators such as economic activity, depth of the capital market, as well as the level of investors protection and corporate governance,” Ranjit said.

Author:

George Popescu