By: Jim Verdonik
I'm an attorney with Ward and
Smith PA. I also write a column about business and law for American Business Journals,
have authored multiple books and teach an eLearning course for entrepreneurs.
You can reach me at JFV@WardandSmith.com or JimV@eLearnSuccess.com. Or you can check out my eLearning course at http://www.elearnsuccess.com/start.aspx?menuid=3075 or http://www.youtube.com/user/eLearnSuccessor or you can purchase my books
at http://www.amazon.com/Jim-Verdonik/e/B0040GUBRW
There's been a lot written lately about the SEC's proposed crowdfunding rules and new Rule 506 (c).
But most of the articles don't address the bottom line issue: Which exemption is best for most companies that are trying to raise capital?
Here's the bottom line answer: New Rule 506 (c) provides much greater capital raising flexibility than both the proposed crowdfunding rules and traditional private placement exemptions.
Only Rule 506 (c) offerings have all the following advantages that affect your ability to communicate to a wide audience on a cost efficient basis:
- Allow you to use social media, advertising and other solicitations with the only limit being that you are not allowed to commit fraud. Social media is a cost efficient tool for attracting investors if you know how to use it.
- Allow maximum flexibility about what you disclose to investors and how you disclose it, subject only to the requirement that you not commit fraud.
- Do not require financial statements that have been reviewed or audited by independent accountants no matter how much money you raise.
- Provide an exemption from state rules that require pre-sale filings and reviews by state securities administrators, which can cause delays and extra offering expenses.
- Allow you to raise any amount of capital.
- Have no post-sale filing requirements other than filing Form D with the SEC and some states.
The one downside to Rule 506 (c) offerings is that you must sell only to accredited investors and take reasonable steps to verify that all your investors are accredited. See my blog post on July 18, 2013 that discusses the accredited investor verification process.
Accredited investor verification is a small price to pay for all the advantages Rule 506 (c) offerings provide.
Financial statement requirements in crowdfunding offerings and Rule 506 (b) and 505 offerings that include non-accredited investors can double or triple your capital raising expenses. Crowdfunding's requirement that you must continue to file reports with the SEC for an indefinite time period after you raise money is also a cost burden. And you can use social media in crowdfunding offerings only if you limit yourself to a notice that is a lot like the traditional "tombstone" ads you see in the Wall Street Journal. BORING doesn't sell in social media. In return for all these limits, the crowdfunding rules will permit you to raise small amounts of money from many investors without worrying whether the investors are accredited. That's not a great deal compared to the short-term and long-term costs of complying with the crowdfunding rules.
So, does crowdfunding offer no benefits?
As discussed above, Rule 506 (c) offerings
give you great flexibility in what you say, how you say it and what social
media and other advertising and solicitation tools you use. Choices and alternatives are generally good
things, but they can present problems.
Using social media effectively is a skill that not every business
has. If you are not effective in how you
use social media, your sales effort will fail.
The one stop shop approach that provides all the technology and
regulatory compliance will be attractive to some people.
Some people like to do the work to
renovate their own homes. Others prefer
to hire a contractor to do it for them.
They either lack the skills to do it themselves or they don't have the
time. For that they pay a higher price. Some people will decide to pay the SEC's regulatory
price required to use the proposed crowdfunding exemptions.
The primary benefits of crowdfunding
platforms is that they will offer a clear pathway for investors and businesses
to meet. This will be particularly true
of crowdfunding platforms that specialize by industry. They will attract investors that are interested
in that particular industry.
Think of it like cable TV channels. If you want the news, you know what channels
specialize in news. The same goes for
movies, history, travel and cooking.
Investors seeking certain types of deals will gravitate to crowdfunding
platforms that specialize in their type of deal. That's a valuable service.
Of course, having the best of both
crowdfunding platforms channel to investors and Rule 506 (c) flexibility is
what most people will probably choose.
There is no reason why you have to accept
the restrictions of the SEC's crowdfunding rules to take advantage of
crowdfunding platform services. If you
comply with Rule 506 (c)'s accredited investor verification rules, you will be
able to do Rule 506 (c) offerings through crowdfunding platforms. Indeed, until the SEC's proposed crowdfunding
rules become effective, these hybrid offerings types of offerings will be the
only deals you can do through crowdfunding platforms.
Crowdfunding platforms will be one of many
types of technology and marketing services people operate to facilitate 506 (c)
offerings. That will allow businesses
raising capital to use social media in creative ways to drive people to their
crowdfunding platform offering instead of being limited to ineffective tombstone
advertisements. Another benefit of
combining Rule 506 (c) with crowdfunding platforms will be that you can avoid
the SEC's proposed requirement that you use only one crowdfunding
platform. Rule 506 (c) contains no such
restriction. So, you can use multiple
channels to communicate with investors.
Combining crowdfunding technology with
Rule 506(c) offerings will present some regulatory and technical challenges to
the intermediaries who operate crowdfunding platforms, but it will offer many benefits
to businesses raising capital.
Of course, no single exemption is best in every circumstance for every company trying to raise capital.
Here's a table that shows the requirements for eight different offering exemptions, including proposed crowdfunding rules and traditional Rule 506 (b) offerings.
Judge for yourself which type of offering exemption gives you the best deal:
SEC SECURITIES OFFERING EXEMPTIONS
|
||||||||
Crowd Funding
(Proposed Regulations not in effect)
|
Rule 506 (c)
|
Rule 506 (b)
(if have all Accredited Investors)
|
Rule 506 (b)
(if include any non-accredited investors)
|
Rule 505
(if have all Accredited Investors)
|
Rule 505
(if include any non-accredited investors)
|
Rule 504
|
Section 4 (2)
|
|
Social Media and Other Advertising
Permitted
|
Yes, but only limited advertising
outside the intermediary's portal
|
Yes, limited only by anti-fraud rules
|
No
|
No
|
No
|
No
|
No
|
No
|
Exemption from State Securities Filings
Before Sale
|
Yes (1)
|
Yes(1)
|
Yes (1)
|
No
|
No
|
No
|
No
|
No
|
Allows Sales to Non-Accredited Investors
|
Yes
|
No
|
Yes
|
Yes
|
Yes
|
Yes
|
Yes
|
Yes
|
Accredited investor Verification
Required
|
No
|
Yes
|
No
|
No
|
No
|
No
|
No
|
No
|
Dollar Limits
|
$1 million in 12 months
|
No
|
No
|
No
|
$5
million
|
$5 million
|
$1 million in 12months
|
No
|
Specific Disclosure Rules Apply
|
Yes, very structured disclosure
|
No, only anti-fraud rules apply
|
No, only anti-fraud rules apply
|
Yes, very structured disclosure(2)
|
No, only anti-fraud rules apply
|
Yes, very structured disclosure
(2)
|
No, only anti-fraud rules apply
|
No, only anti-fraud rules apply
|
Audited Financial Statements Required
|
Yes unless less than $100,000 (3)
|
No
|
No
|
Yes(4)
|
No
|
Yes (4)
|
No
|
No
|
Required to file with SEC
|
Yes
|
Form D (5) (6)
|
Form D (5)
|
Form D (5)
|
Form D (5)
|
Form D(5)
|
Form D (5)
|
No
|
Post-Offering Reporting Obligations
|
Yes, burdensome post offering filings
|
Form D
Amendments
(5)
|
Form D Amendments
(5)
|
Form D Amendments
(5)
|
Form D Amendments
(5)
|
Form D Amendments
(5)
|
Form D Amendments
(5) |
No
|
Integration
Risks with other Offerings
|
Unclear (7)
|
Yes (7)
|
Yes (7)
|
Yes (7)
|
Yes (7)
|
Yes (7)
|
Yes (7)
|
Yes (7)
|
Limits on Amounts any Single Investor Can Invest
|
||||||||
(1)
Post- sale filing
requirements of states are not pre-empted. Fraud provisions of state laws are not
pre-empted.
(2)
Rule 502 (b) requires
to the extent material to an understanding of the issuer, its business and the
securities being offered the information required by Part II of Form 1-A of
Regulation A, but special rules apply to public reporting companies and foreign
private issuers.
(3)
Proposed rules require
for offerings greater than $500,000, audited financial statements, but (i) for
offerings $100,000 or less, issuers can substitute their income tax return and
financial statements certified by the issuer's principal executive officer, and
(ii) for offerings between $500,000 and $500,000, issuers can substitute
reviewed financial statements.
(4)
Rule 502 (b) requires to the extent material
to an understanding of the issuer, its business and the securities being
offered three different audit requirements depending on the size of the
offering: (i) for offerings up to $2,000,000, the financial statements required
by Article 8 of Regulation S-X, except that only the balance sheet as of a date
not more than 120 days before the offering begins must be audited, (ii) for
offerings up to $7,500,000. audited financial statements that a "small
reporting company" would be required to file in a registration statement
on Form S-1, but if the issuer cannot obtain audited financial statements
without unreasonable effort or expense, then only the issuer's balance sheet,
which shall be dated within 120 days of the start of the offering, must be
audited, and (iii) for offerings over $7,500,000, the financial
statement required in a registration statement on the form that the issuer
would be entitled to use, but if the issuer cannot obtain audited financial
statements without unreasonable effort or expense, then only the issuer's
balance sheet, which shall be dated within 120 days of the start of the
offering, must be audited. Special rules
apply to issuers that are limited partnerships.
(5)
Rule 503 (a) requires filing Form D within 15
calendar days after the first sale. Amendments
must be filed to reflect changes and to correct mistakes.
(6)
Proposed rule change would require issuers in
a Rule 506 (c) offering to file Form D 15 days before the first offer is made
and to file advertising the same day the advertising occurs.
(7) Integration poses the biggest risk for businesses that are active in capital raising. Integration is a concept the SEC and state securities regulators use to combine what are nominally two or more securities offerings into one securities offering. Integration can destroy your exemptions. It is unclear how the SEC will deal with crowdfunding and other offerings that are either being conducted at the same time or within six months of one another.
(7) Integration poses the biggest risk for businesses that are active in capital raising. Integration is a concept the SEC and state securities regulators use to combine what are nominally two or more securities offerings into one securities offering. Integration can destroy your exemptions. It is unclear how the SEC will deal with crowdfunding and other offerings that are either being conducted at the same time or within six months of one another.
If you would like to learn more
about learning how to grow your business or other issues important to your
success, you can reach me at JFV@WardandSmith.com or JimV@eLearnSuccess.com. Or you can check out my eLearning course at http://www.elearnsuccess.com/start.aspx?menuid=3075 or http://www.youtube.com/user/eLearnSuccess or you can purchase my books at http://www.amazon.com/Jim-Verdonik/e/B0040GUBRW
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