FinLaw: Technology Driven Crowd-Capital Formation: From Crowdfunding to Regulation A+
See FactRight.com posting by Scott Andersen and George Georgiades at http://blog.factright.com/technology-driven-crowd-capital-formation-from-crowdfunding-to-regulation-a
Recent regulatory reforms along with the rapid innovation in and availability of financial technology have created new opportunities for private and public capital formation. The JumpStart Our Business Startups (JOBS) Act of 2012 introduced historic reforms to modernize our private capital markets with the goal of increasing access to capital by small to medium size enterprises as well as providing nonaccredited investors with opportunities to invest in private offerings.
The new exemptions from securities registration created under the JOBS Act are not just for startups and small financings, but can be used as a stepping stone to public listing. Just recently, we saw the listing of Myomo Inc. (NYSE: MYMO) on New York Stock Exchange and Adomani Inc. (NASDAQ: ADOM) on Nasdaq Capital Market following completion of their Regulation A+ offerings. Before the JOBS Act, Regulation A was a dormant and infrequently used tool for small issuers to raise capital. Now we see it as a basis for many issuers to raise capital by launching a mini-IPO.
Access to new pools of investors
The ability to generally solicit and publicly market private placement and other JOBS Act offerings has created new and interesting opportunities to use social media, funding platforms, radio, television and other forms of media to market private offerings. With over 900 million monthly active users on Facebook Messenger (as of April 2016) and over 200 million monthly active users on WeChat, investment banking professionals need to consider the opportunities contained in online communication channels. Issuers are seizing the opportunity to convert users of their products or services, services providers, social media followers and community members into investors. Through technology, broker-dealers are able to leverage an issuer’s database of followers and customers to convert into investors as well as use traditional distribution channels such as syndication and recommendations to account holders.
General solicitation is a hallmark of these new offerings
Title II of the JOBS Act brought much needed reform to Regulation D in form of Rule 506(c), permitting for the first time since 1933 the general solicitation of private placement offerings. Eliminating the requirement of a pre-existing and substantive relationship through Rule 506(c), issuers and intermediaries are free to use public advertising to solicit prospective investors, provided, however, that the issuer must take reasonable steps to independently verify that each investor in the offering is an accredited investor. Unlike offerings made pursuant to Rule 506(b), the issuer cannot solely rely on an investor representation that he or she is accredited. The rules provide a number of methods (safe harbors) that an issuer can take to verify that the investor meets one of the enumerated requirements of Rule 501, including review of the subscriber’s tax returns, credit reports or simply obtaining a letter from the investor’s CPA. Service providers such as Verify Investor, LLC have emerged that undertake this responsibility. The ability to leverage technology to quickly and independently verify investor tax filings, for example, which can be done either by encrypted communication with the prospective investor or by direct request to the IRS, has reduced friction and encouraged issuers seeking to tap new investors to pursue general solicitation. We have seen private placement offerings of up to $200 million leverage this exemption with success.
Funding options for smaller issuers
Title III of the JOBS Act introduced crowdfunding, which permits issuers to raise up to $1,070,000 in a twelve-month period from both accredited and non-accredited investors. All offerings must be conducted through a broker-dealer or crowdfunding portal. A crowdfunding portal is a new type of SEC registered intermediary and FINRA member that is permitted to receive transaction based compensation for its services. All offerings are conducted online through the broker-dealer or crowdfunding portal’s online portal. However, registered crowdfunding portals cannot solicit investors, recommend the purchase of securities, hold funds or provide any investment advice. Broker-dealers are permitted to solicit and recommend and consider other fundraising methods for an issuer, including the possibility of doing simultaneous capital raises using other exemptions (such as hybrid Regulation D and crowdfunding offerings) which is a growing trend. Although this offering exemption is intended for smaller enterprises, it can be a useful litmus test to determine crowd interest for an issuer interested in doing larger offerings under Regulation A+.
Hybrid offering models have emerged which combine multiple exempt offerings with crowd-direct marketing and traditional broker-dealer syndication, including institutional and retail investment through traditional sales channels. For example, SeedInvest LLC, a New York based brokerage firm and funding platform, is a leader in concurrent Regulation Crowdfunding and Regulation D offerings, allowing issuers to benefit from accessing non-accredited investors as well as accredited investors. We are also seeing a growth in the use of Regulation D offerings along with Regulation A+ offerings.
BrewDog, a crowdfunding success story
The interest in soliciting non-accredited investors is largely driven by issuers that seek access to capital and to leverage the marketing to their own customers or users. This strategy was very successfully employed by BrewDog Inc., a Scottish microbrewery, that after having difficulties raising capital from traditional financing sources, turned to the crowd in the UK. The “Equity For Punks” program sought to both raise capital and to create brand ambassadors loyal to BrewDog’s products and mission. The strategy resulted in over 50,000 shareholders investing in the company over several financings. In April 2017, the firm received a reported $1.2 billion-dollar valuation with an investment by TSG Consumer Partners, a US private equity firm. The company’s estimated 1,329 initial investors are reported to have received a 2,800% return on their investment.
Regulation A+: the mini-IPO
Title IV of the JOBS Act reformed the antiquated and forgotten Regulation A rules. Reg A+, also referred to as a mini-IPO, permits private issuers to raise up to $50 Million in a 12-month period from both accredited and non-accredited investors. It is divided in to two tiers, allowing the issuer to pursue either state merit review and/or SEC review depending on the size of the offering. A unique feature of Regulation A+ is that it is a freely tradeable security upon issuance. According to FactRight’s Reg A+ research, since June 2015, 203offering statements for such offerings were filed, and 143 were qualified by the SEC. Real estate was and continues to be the most dominant industries, particularly with the introduction of the “eREIT,” as well as financial services.
Regulation A+ is viewed as a stepping-stone to becoming a fully reporting company because of its less burdensome structure with respect to Dodd-Frank compliance and ability to become fully reporting by simply filing a Form 8-A. This strategy was used with great success by Myomo Inc. a commercial stage medical robotics company, which closed its $7.9 million offering underwritten by TriPoint Global Equities, LLC and is the first Reg A+ offering to list on the New York Stock Exchange. Similarly, Adomani Inc., a manufacturer of zero-emission electric and hybrid vehicles and replacement drivetrains, closed its Regulation A+ offering in the amount of $14.261 million underwritten by Boustead Securities LLC and is the first Regulation A+ offering to trade on the Nasdaq Capital Markets. We have also seen a number of real estate sponsors successfully using Reg A+ to raise capital with the introduction of the eREIT, a rebranding of the non-traded REIT, allowing non-accredited investors to take advantage of real estate investment opportunities.
How broker-dealers and financial intermediaries are driving offering success
Brokerage firms across the country are evolving into fintech platforms recognizing both the demand by investors to invest in private placements and issuers to conduct private securities transaction online. Earlier this year, it was reported that Boustead & Co. acquired FlashFunders Inc, affiliated with FinTech Clearing, LLC, a registered broker-dealer and one of the first crowdfunding portals to receive approval from FINRA. WR Hambrecht + Co., a broker-dealer famous for its involvement in the initial public offerings by Google Inc. and Apple Inc., has updated its corporate website to allow for offerings to be posted along with the electronic processing of subscriptions. JumpStart Securities LLC, a broker-dealer based out of Atlanta, provides issuers and other broker-dealers with compliance services and has served as executing broker-dealer for a number of notable Regulation A+ offerings, including BrewDog Inc.
Banking and compliance professionals continue to evaluate both the opportunities presented by the JOBS Act reforms along with the compliance issues raised by online finance. Technology has allowed broker-dealers to evolve into modern fintech platforms and to execute frictionless and an efficient offering, clearing and settlement process. Typical tracking and back-office compliance functions are now done through technology. For example, FundAmerica LLC is a leading provider of technology software and tools for JOBS Act offerings which are transacted through its InvestNow® button technology. All subscription agreements are executed online, funds transferred online directly into escrow. Basic compliance reviews such as initial anti-money laundering verifications are done electronically with exceptions flagged for further review by compliance personnel. Since these various activities are done electronically, the broker-dealer has a record of its activities, ranging from offering materials being distributed to investors to time-stamped compliance reviews, which are valuable both during routine regulatory examinations and potential litigation.
Brokerage firms continue to feel the pressure of both increasing competition for their services and rising costs largely due to the regulatory burden. The JOBS Act has provided both issuers and brokerage firms new ways to access the private capital markets. With these reforms, broker-dealers are rising to the challenge to meet new demands by investors and issuers on how they raise capital, causing new hybrid offering models to develop and a reevaluation of how transactions are executed in the age of technology driven finance.
Scott Andersen is principal at finLawyer.com. He has also been Deputy Regional Chief Counsel at FINRA, Enforcement Director at FINRA and the NYSE, Co-Chief of the Securities Prosecutions Unit of the NY Attorney General’s office, and Asst. Attorney General for the State of NY. In these roles, he has investigated, prosecuted and supervised criminal, civil and regulatory enforcement actions for over nineteen years. He concentrates his practice on SEC, FINRA and state regulatory defense and securities regulatory counseling, as well as working with crowdfunding portals, funding platforms, broker-dealers and fintech providers on regulatory compliance matters He can be reached at sandersen@finLawyer.com.
George S. Georgiades is an experienced securities lawyer and founder of Georgiades & Associates (www.AltFinEsq.com), a boutique securities law firm based in New York City focusing its practice on alternative finance transactions such as Crowdfunding, Regulation A+, and other technology-driven financings. His prior experiences range from serving as in-house counsel to a leading middle-market broker-dealer, regulatory counsel to a multibillions-dollar real estate investment fund and capital markets associate at a leading New York City corporate finance law firm. He can be reached at firstname.lastname@example.org.
The information and materials in this article are provided for general informational purposes only and are not intended to be legal advice. The issues discussed include complicated areas of law and legal advice should be obtained from a securities attorney about your specific circumstances.