By Jason Stark
We know how difficult and time consuming capital raising is for a new startup, and South Florida is no exception. It takes vital time from a founder’s schedule. You of course should try the local investor groups like Endeavor, the Knight Foundation, AGP Miami, New World Angels and Tamiami Angels. However, those efforts may not net you the vital funding you need.
What else can you do? Give up? Of course not. In the glacial world of the securities laws, we now have CROWDFUNDING. Well, that at least is the word on everyone’s mind. I will help clarify distinction between Crowdfunding (which finally begins on May 16, 2016), and using Internet portals to raise through traditional accredited investor offerings. You may find that you may be really interested in raising through an Internet portal, but not through Crowdfunding.
Below I describe various pre-IPO fundraising options. The Rule 506(c) offering may be the sweet spot for your capital raise. Rule 506(c) permits general solicitation (advertising), which allows an Internet portal to communicate your offer to its accredited investor base, but without your company jumping through all the hoops required under Regulation Crowdfunding.
By “Internet portal”, I mean an online marketplace that facilitates the sale of securities. Examples include SeedInvest, Circle-up and Crowdfunder. This differs from Kickstarter (which allows companies to fundraise through the pre-sale of a product or outright donations), by permitting the actual sale of stock through the Internet.
A year ago, I had worked with clients on zero Internet portal deals. Over the past few months, we’ve seen them more and more frequently. Clients that were not able to find adequate funding elsewhere have found new life through small Rule 506 rounds using Internet portals.
Pre-IPO Fundraising Options under the Securities Laws
Raising money through Internet portals requires compliance with the same securities laws as traditional fundraising. Below is a brief description of the most commonly used exemptions, and a cost/benefit analysis of each.
Rule 506(b) is the typical exemption used in venture capital deals that was available long before JOBS Act 506(c) and Regulation Crowdfunding. It permits raising unlimited capital from accredited investors (generally, a person with $200k income ($300k with a spouse) or $1 million in assets, excluding the value of such person’s home). Under this exemption, an issuer may sell its securities to accredited investors and up to thirty-five sophisticated non-accredited investors (however, if you have even one non-accredited investor, you will need to provide disclosure documents (i.e., now you must prepare an offering memorandum with financial statements and we’re looking at a more expensive round)).
Rule 506(c) is similar to the traditional 506(b) accredited investor offering. The major benefit to 506(c) is advertising the round (which allows an Internet portal to reach out to its investors). The additional requirements compared to 506(b) are reasonable: a simple Form D must be filed 15 days in advance of the deal instead of after the deal; and accreditor investor status must be verified using records like W-2’s, tax returns and bank statements (under 506(b), you could rely on self-reporting by the investor). The Internet portal should already have the procedures in place to verify accredited investor status, and therefore, if you are raising through an Internet portal, it should not be too much more difficult to conduct a 506(c) offering than a 506(b).
Regulation Crowdfunding allows the sale of securities to almost anyone, and not just the small minority of accredited investors. A major benefit. However, there are significant new requirements not required for a 506 offering, including the following:
- * Maximum of $1 million raised through crowdfunding in any 12-month period.
- * Reporting and financial disclosure requirements (information regarding the offering, the company and its financials), for rounds over $100k, financial statements that in some cases are reviewed by an accountant and in others, audited, plus ongoing disclosure requirements.
- * Limits to the amount an investor may invest through Crowdfunding based on income.
- * Limited advertising (only may directing to the funding portal and limited factual terms).
- * The issuer must be a U.S. company.
Other Offerings. There are a few other private offering methods that you might consider, but that are not available through Internet portals. Regulation S may be used if the offering is made entirely to non-U.S. citizens/residents and the securities are offered outside the U.S. Regulation A+ is often used for larger rounds, given that it requires certain offering documents and filings (somewhat like a mini-IPO – also expensive compared to 506 offers).
For more specifics on these exemptions, check with your attorney. See also: https://www.sec.gov/answers/rule506.htm regarding Regulation D, Rule 506(b) and 506(c); https://www.sec.gov/news/pressrelease/2015-249.html regarding Regulation Crowdfunding; and https://www.investor.gov/news-alerts/investor-bulletins/investor-bulletin-accredited-investors for a description of accredited investors.
Deciding whether to fund raising through an Internet Portal
When deciding whether to fund raise through an Internet portal, you must weigh the benefit of quicker access to investors and valuable time savings (locating and speaking with such investors, networking, meeting with Angel groups, etc.) against the associated fees (some combination of cash and equity). An Internet portal develops its own database of accredited investors - a very helpful resource you could not hope to replicate. Regarding services, some Internet portals are more involved and help run and champion the round, while others are more like LinkedIn for investors and just provide access. Make sure to do your research on the Internet portal’s network of accredited investors, the services provided and the fees.
Internal portals can be a great way to raise money. Certainly explore all your options, but using an Internet portal can save you quite a bit of your precious time and sanity, and that may well be worth the cost. Don’t get caught up in the whole “Crowdfunding” concept. Traditional offerings to accredited investors may well provide an easier fundraising avenue with significantly less hoops to jump through, and may be accomplished through an Internet portal, the same as for Crowdfunding.
Jason Stark is a partner at Private Advising Group, P.A., a law firm in Miami. Jason is an attorney (and also is a non-practicing certified public accountant) who advises emerging and growth companies. He can be reached at Jason@private-advising.com. The information in this article is provided for informational purposes only and does not constitute legal advice. You should not act or rely on any information contained in this article without first seeking the advice of an attorney.