The Need for Compliant and Safe Online Capital Formation

In the State of the Union address given by President Joe Biden on February 7th, 2023, he remarked: “Every time somebody starts a small business, it’s an act of hope.” This followed a statement citing the record 10 million Americans who applied to start a new business within the past two years. The President also remarked that Vice President Kamala Harris would continue her work to ensure that these businesses can access the capital they need to thrive. But what does this look like? 

 

As he shared in his speech, there are already major changes to the economy underway. From increasing taxes on capital gains to boosting infrastructure spending, many of Biden’s plans are focused on driving domestic growth. But one area that needs more attention is online capital formation – particularly how to do so in a compliant and safe way. The sheer number of Americans applying for small business startups sheds a light on an urgent need to provide access to capital for these entrepreneurs. 

 

The Benefits of Online Capital Formation

 

In 2012, President Obama signed the Jumpstart Our Business Startups (JOBS) Act into law. This legislation was designed to make it easier for small businesses to raise capital by loosening specific regulations. Most notably, it enhanced Reg A+ and created Reg CF which allows companies to receive investments from everyday people, sometimes referred to as retail investors. The exemptions from SEC registration have since expanded to increase the amount of capital that can be raised by private companies. As a result, more companies have begun to see Reg A+ and Reg CF as viable alternatives to traditional VC and private equity funding, like medtech, real estate, and cannabis companies.

 

The exemptions have also allowed for capital to be raised online, reducing barriers for entrepreneurs as well. Online capital formation has the potential to provide a great benefit to entrepreneurs by providing access to investment opportunities that they can use to scale their businesses faster and more efficiently. This expansion of capital availability can also help drive economic growth across industries, as well as help create jobs in tech and start-ups. Furthermore, it will allow investors to diversify their portfolios and access new markets.

 

Gary Gensler’s Remarks to the Small Business Capital Formation Advisory Committee

 

In a separate speech also delivered on February 7th, Gary Gensler of the SEC discussed the importance of private funds and their advisers. He noted, “the people whose assets are invested in private funds often are teachers, firefighters, municipal workers, students, and professors.” While addressing the Small Business Capital Formation Advisory Committee, Gensler stated that “there may be somewhere in the range of $250 billion in fees and expenses each year” for private funds. This is money that portfolio companies, like small businesses, do not get to use. He called for greater transparency, efficiency, and competition between intermediaries to help both investors and the companies who benefit from these funds.

 

The Need for Compliance and Safety

 

Although online capital formation can be beneficial for entrepreneurs, investors, and the economy at large, it is important that measures are taken to ensure compliance with laws and regulations. This is especially true for private funds and their advisers, as Gensler discussed. The SEC is focused on protecting not just the investor, but also the companies that are seeking capital.

 

To do this, there must be rigorous enforcement of laws and regulations that govern online capital formation. Companies need to ensure that they understand disclosure requirements so that investors can make informed decisions. Additionally, safeguards must be put in place to protect against data misuse and cyber-security risks that can occur when seeking capital online.

 

The Biden Administration’s Role

 

President Biden has expressed his commitment to creating an environment where entrepreneurs can access the capital they need to grow their businesses. He is in support of the JOBS Act and other key initiatives that have been put in place to help small businesses. Additionally, he has directed his Administration to focus on creating more jobs, including ones in tech and alternative energy sectors.

 

For entrepreneurs to access capital more efficiently and safely, online capital formation must be optimized with compliance in mind. This can be done through the implementation of strong regulations, while also encouraging innovation within the sector.

 

What You Need to Know About RegA+

If you are an entrepreneur looking to raise funds, you may have heard of Regulation A+, often referred to simply as Reg A+. This alternative to traditional venture capital, private equity, or other funding sources allows companies to sell securities to the public without going through the lengthy and costly process of registering with the SEC. Since it was expanded in 2012 with the JOBS Act, Reg A+ continues to evolve, facilitating increased capital formation for companies within the private capital market.

 

What is Reg A+?

 

The goal of Reg A+ is to make it easier and less expensive for small businesses to access capital while still providing investors with the protection of an SEC-qualified offering. The offering is exempt from complete SEC registration, allowing companies to raise up to $75 million in capital, with certain restrictions and requirements. To qualify for this exemption, a company must file an offering statement (Form 1-A) with the SEC that includes all pertinent information about the business and the offering. The company must also provide ongoing disclosure about its business, including financial statements and other material information.

 

Who is Reg A+ for?

 

Reg A+ is aimed primarily at small and medium-sized businesses looking to raise funds from the public, but larger companies can also use it. Because there are fewer restrictions and requirements than traditional SEC registration, Reg A+ offers a more affordable option for companies that do not have access to venture capital or other significant funding sources. Because Reg A+ is such a robust option for companies looking to raise capital, many companies stay private longer instead of going public through an IPO. 

 

Advantages of Reg A+

 

Beyond lower costs than going public, Reg A+ offers additional benefits for issuers and investors alike. It is a unique opportunity for investors to get involved with early-stage companies since the offering allows both nonaccredited and accredited investors to invest. At the same time, these investors can benefit from the potential for higher returns and the ability to diversify their portfolios. Investors also benefit from SEC oversight, which aims to protect them and ensure that they are investing in legitimate investment opportunities. Investors may also have options for liquidity, as securities purchased through a Reg A+ offering can be traded on a secondary market.

 

Reg A+ benefits companies because it offers a relatively simple and cost-effective way to access the public markets while accessing an increased pool of potential investors than a traditional offering. Unlike conventional VC or private equity funding routes, issuers can also retain more ownership over their business while finding investors who share the vision for the mission and direction of the company. Issuers can also benefit enormously from building brand advocates out of their investors, which can, in turn, inspire new investors or customers. 

 

Reg A+ offers an excellent alternative for small businesses looking to raise capital without going through the lengthy and costly process of registering with the SEC. With a maximum offering cap of $75 million, Reg A+ can be used for companies of all sizes and offers investors the opportunity to access early-stage companies that they may not otherwise have access to. 

KoreClient Spotlight: Wealthcasa

For many people, investment properties come with a price tag that is cost-prohibitive to everyday investors. However, as Reg A+ sees wider use in the real estate market, it opens up new opportunities for investors.

 

Wealthcasa also aims to make real estate accessible to everyday investors through a Reg A+ offering. Cesare Bauco, CEO of Wealthcasa, says that “the whole [idea] behind Wealthcasa is to be a vehicle for the average person to get into the [real estate] investment market.” This allows people who may not fit the criteria of a traditional investor to invest in real estate. “Reg A+ was very intriguing when it was brought to light to us,” added Bauco. This gives people who may not have had the opportunity to invest in real estate before the chance to invest in Wealthcasa. “We thought this would be a good opportunity to raise funds that way and bring along Americans that normally can’t get into that.”

 

“Our parent company, located in Canada, is a new home builder by trade, with over 20 years of development and construction experience and 800 units currently under development in the greater Toronto area. We like to position ourselves where we can actually enter the US markets in many areas; we have been scouting opportunities, like Florida, Tennessee, and California,” said Bauco. This experience will lend itself well to developing the planned communities. 

 

Once the first Wealthcasa property has been developed, the company also seeks to offer a rent-to-owner program, giving people other ways to get into the real estate market. This program allows people to rent a home and build equity in the home. Eventually, usually after 5-7 years, they will either have the ability to purchase the unit themselves. Or, if they are not in a position to buy, the accumulated value of the asset will be shared with that buyer-renter.

 

Ultimately, Wealthcasa wants to create a platform for people to become investors in the real estate market by offering an accessible way and a rent-to-owner program that will allow renters to build equity over time.

______________________________________________________________________________________________

Regulation A Disclaimer

This communication may be deemed to be a solicitation of interest under Regulation A under the Securities Act of 1933, in which case the following applies:

  • No money or other consideration is being solicited, and if sent in response, will not be accepted;
  • No offer to buy the securities can be accepted and no part of the purchase price can be received until the offering statement is qualified, and any such offer may be withdrawn or revoked, without obligation or commitment of any kind, at any time before notice of its acceptance given after the qualification date;
  • A person’s indication of interest involves no obligation or commitment of any kind; and
  • An offering statement, which would include a preliminary offering circular, has not yet been filed with the SEC.

What are the Differences Between Regulations A, CF, D, and S?

When it comes to raising capital, there are various ways you can raise money from investors. And while they all have their own specific compliance requirements, they all share one common goal: to protect investors while still providing them with opportunities to invest in private companies. Let’s look at the four most popular types of equity crowdfunding; through Regulation A, CF, D, or S. 

 

Regulation A+

 

Offering size per year: Up to $75 million

Number of investors allowed: Unlimited, as long as the issuer meets certain conditions.

Type of investor allowed: Both accredited and non-accredited investors.

SEC qualification required: Reg A+ offerings must be qualified by the SEC and certain state securities regulators and must also file a “Form 1-A”. Audited financials are required for Tier II offerings.

 

This type of crowdfunding is popular because it allows companies to raise up to $75 million per year in capital and is open to accredited and non-accredited investors. Offering the ability to turn current customers into investors and brand ambassadors (like several JOBS Act regulations promote) can bring a company tremendous value and help to grow the business. A Reg A raise is excellent for companies that have a wide customer base or need to raise a large amount of capital. Compared to other regulations, Reg A+ is a bit more complex and time-consuming to implement. Yet, it still offers a great deal of potential with the ability to market the offering to a wide pool of potential investors.

 

Regulation CF

 

Offering size per year: $5 million

Number of investors allowed: Unlimited, as long as the issuer meets certain conditions.

Type of investor allowed: Both accredited and non-accredited investors

SEC qualification required: The offering must be conducted on either an SEC-registered crowdfunding platform or through a registered broker-dealer. Audited financials are required for companies looking to raise more than $1,235,000. Companies must fill out a “Form C.”

 

Compared to other regulations, Reg CF is one of the most popular due to its lower cost and ease of implementation. Regulation CF offers companies the ability to raise up to $5 million per year and allows accredited and non-accredited investors to invest in the company. Companies that need a smaller sum of capital while still leveraging the power of marketing can benefit from utilizing this type of regulation. 

 

Regulation D

 

Offering size per year: Unlimited

Number of investors allowed: 2000

Type of investor allowed: Primarily accredited investors, with non-accredited investors only allowed for 506(b) offerings.

SEC qualification required: Reg D offerings do not need to be registered with the SEC but must still meet certain filing and disclosure requirements.

 

A Reg D offering must follow either Rule 506(b) or 506(c). Both allow up to 2000 investors but differ slightly in that 506(b) offerings allow up to 35 non-accredited investors. Additionally, 506(b) offerings do not permit general solicitation. This means that companies will have to rely on their own network of investors to reach their goals. While this type of offering is more restrictive than others, it can be attractive to companies that need a smaller sum of capital and have access to a network of accredited investors. 

 

Regulation S

 

Offering size per year: Unlimited

Number of investors allowed: 2000

Type of investor allowed: Foreign (non-US) accredited and non-accredited investors

SEC approval/qualification required: Reg S offerings are not subject to SEC rules, but they must follow the securities laws in the countries issuers seek investors from.

 

An excellent complement to Reg D, Reg S allows companies to raise capital from foreign and non-U.S. investors. This regulation was made for big deals, allowing companies to reach a larger and more diverse pool of investors. Reg S is great for companies looking to raise a large amount of capital or to break into foreign markets. Issuers must be careful not to make the terms of the offerings available to US-based people.

 

Depending on the size of your offering, the number of investors you’re looking to attract, and the type of investor you want, one regulation may be better suited for your needs than another. Still, it is important to consult with a professional when making these decisions to ensure that you meet all necessary compliance requirements.

The SEC Can Stop Your Regulation A Offering At Any Time

The SEC has two powerful tools to stop your Regulation A offering anytime.

Rule 258

Rule 258 allows the SEC to immediately suspend an offering if

  • The exemption under Regulation A is not available; or
  • Any of the terms, conditions, or requirements of Regulation A have not been complied with; or
  • The offering statement, any sales or solicitation of interest material, or any report filed pursuant to Rule 257 contains any untrue statement of a material fact or omits to state a material fact necessary to make the statements made, in light of the circumstances under which they are made, not misleading; or
  • The offering involves fraud or other violations of section 17 of the Securities Act of 1933; or
  • Something happened after filing an offering statement that would have made Regulation A unavailable had it occurred before filing; or
  • Anyone specified in Rule 262(a) (the list of potential bad actors) has been indicted for certain crimes; or
  • Proceedings have begun that could cause someone on that list to be a bad actor; or
  • The issuer has failed to cooperate with an investigation.

If the SEC suspends an offering under Rule 258, the issuer can appeal for a hearing – with the SEC – but the suspension remains in effect. In addition, at any time after the hearing, the SEC can make the suspension permanent.

Rule 258 gives the SEC enormous discretion. For example, the SEC may theoretically terminate a Regulation A offering if the issuer fails to file a single report or files late. And while there’s lots of room for good-faith disagreement as to whether an offering statement or advertisement failed to state a material fact, Rule 258 gives the SEC the power to decide.

Don’t worry, you might think, Rule 260 provides that an “insignificant” deviation will not result in the loss of the Regulation A exemption. Think again: Rule 260(c) states, “This provision provides no relief or protection from a proceeding under Rule 258.”

Rule 262(a)(7)

Rule 262(a)(7) is even more dangerous than Rule 258.

Rule 258 allows the SEC to suspend a Regulation A offering if the SEC concludes that something is wrong. Rule 262(a)(7), on the other hand, allows for suspension if the issuer or any of its principals is “the subject of an investigation or proceeding to determine whether a. . . . suspension order should be issued.”

That’s right: Rule 262(a)(7) allows the SEC to suspend an offering merely by investigating whether the offer should be suspended.

Effect on Regulation D

Suppose the SEC suspends a Regulation A offering under either Rule 258 or Rule 262(a)(7). In that case, the issuer is automatically a “bad actor” under Rule 506(d)(1)(vii), meaning it can’t use Regulation D to raise capital, either.

In some ways, it makes sense that the SEC can suspend a Regulation A offering easily because the SEC’s approval was needed in the first place. But not so with Regulation D, and especially not so with a suspension under Rule 262(a)(7). In that case, the issuer is prevented from using Regulation D – an exemption that does not require SEC approval – simply because the SEC is investigating whether it’s done something wrong. That seems. . . .wrong.

Conclusion

As all six readers of this blog know, I think the SEC has done a spectacular job with Crowdfunding. But what the SEC giveth the SEC can taketh away. I hope the SEC will use discretion exercising its substantial power under Rule 258 and Rule 262(a)(7).

 

This post was written by KorePartner Mark Roderick and the original post can be found here. Mr. Roderick is an attorney at Lex Nova Law, where he leads the firm’s Crowdfunding and Fintech practice. He writes a widely-read blog at CrowdfundingAttorney.com and is a featured speaker at Crowdfunding and Fintech events across the country, including New York, Texas, Chicago, and Silicon Valley. Mark is one of the most prominent Crowdfunding and Fintech lawyers in the United States. He represents portals, issuers, and others across the country and around the world.

What is a Fund and How Can it Utilize RegA+?

In the traditional sense of a fund, you may be thinking of something like a hedge fund, or other sort of entity that invests in smaller portions of other entities. However, these types of funds are not able to raise capital using Regulation A. So when it comes to RegA+ exemptions, what is a fund and how does it work?

In 1940, the Investment Company Act was passed into law, regulating how investment companies are organized and they types of activities they are permitted to conduct. This law also specifies the requirements for various types of funds, including open or closed-end mutual funds. However, under Regulation A, companies that fall under this definition of an investment company are prohibited from using the exemption to raise investments.

For a “fund” to utlize RegA, it is required to have an exemption from being an investment company. Some rules do apply here, such as the exemptions of having less than 100 investors or having certain qualified investor are not applicable. In the case of Regulation A+, a common exemption is that the fund is not investing in securities. Instead, it may be investing in assets such as real estate or collectibles.

Other considerations must be taking into account when trying to have the offering qualified by the SEC, such as being able to explain how investors will be getting their money back. For RegA+, funds must also have a business plan in place. For example, they must define the types of companies they are looking to invest in or acquire, especially by defining which companies specifically.

However, the process is generally complex, and requires careful planning and discussions with legal advisors to ensure that the raise is done compliantly and according to SEC regulations.

Can I Use My IRA for Private Company Investments?

Individual retirement accounts (commonly shortened to IRAs) allow flexibility and diversity when making investments. Whether investing in stocks, bonds, real estate, private companies, or other types of investments, IRAs can be useful tools when saving for retirement. While traditional IRAs limit investments to more standard options, such as stocks and bonds, a self-directed IRA allows for investments in things less standard, such as private companies and real estate. 

 

Like a traditional IRA, to open a self-directed IRA you must find a custodian to hold the account. Banks and brokerage firms can often act as custodians, but careful research must be done to ensure that they will handle the types of investments you’re planning on making. Since custodians simply hold the account for you, and often cannot advise you on investments, finding a financial advisor that specializes in IRA investments can help ensure due diligence. 

 

With IRA investments, investors need to be extremely careful that it follows regulations enforced by the SEC. If regulations are not adhered to, the IRA owner can face severe tax penalties. For example, you cannot use your IRA to invest in companies that either pay you a salary or that you’ve lent money to, as it is viewed by the SEC as a prohibited transaction. Additionally, you cannot use your IRA to invest in a company belonging to either yourself or a direct family member. If the IRA’s funds are used in these ways, there could be an early withdrawal penalty of 10% plus regular income tax on the funds if the owner is younger than 59.5 years old. 

 

Since the IRA’s custodian cannot validate the legitimacy of a potential investment, investors need to be responsible for proper due diligence. However, since some investors are not aware of this, it is a common tactic for those looking to commit fraud to say that the investment opportunity has been approved by the custodian. The SEC warns that high-reward investments are typically high-risk, so the investor should be sure they fully understand the investment and are in the position to take a potential loss. The SEC also recommends that investors ask questions to see if the issuer or investment has been registered. Either the SEC itself or state securities regulators should be considered trusted, unbiased sources for investors.

 

If all requirements are met, the investor can freely invest in private companies using their IRAs. However, once investments have been made, the investor will need to keep track of them, since it is not up to their custodian. To keep all records of investments in a central location, investors can use KoreConX’s Portfolio Management, as part of its all-in-one platform. The portfolio management tool allows investors to utilize a single dashboard for all of their investments, easily accessing all resources provided by their companies. Information including key reports, news, and other documents are readily available to help investors make smarter, more informed investments. 

 

Once investors have done their due diligence and have been careful to avoid instances that could result in penalties and taxes, investments with IRAs can be beneficial. Since it allows for a diverse investment portfolio, those who choose to invest in multiple different ways are, in general, safer. Additionally, IRAs are tax-deferred, and contributions can be deducted from the owner’s taxable income. 

Investing in Startups 101

This article was originally written by our KorePartners at StartEngine. You can view the post here

The high-speed world of startups, and the risks of investing in them, are well documented, but startup investing can be complicated and there is a lot of information you should know before making your first investment.

This article will try to answer the question “why should you invest in a startup?” by giving you information about the process and what to expect from investing in an early-stage business.

Why invest in startups?

Through equity crowdfunding, you can support and invest in startups that you are passionate about. This is different than helping a company raise capital via Kickstarter. You aren’t just buying their product or merch. You are buying a piece of that company. When you invest on StartEngine, you own part of that company, whether it’s one you are a loyal customer of, a local business you want to support, or an idea you believe in.

Investing in startups means that you get to support entrepreneurs and be a part of the entrepreneurial community, which can provide its own level of excitement. You also support the economy and job creation: in fact, startups and small businesses account for 64% of new job creation in the US.

In other words, you are funding the future. And by doing so, you may make money on your investment.

But here’s the bad news: 90% of startups fail. With those odds, you’re more than likely to lose the money you invest in a startup.

However, the 10% of startups that do succeed can provide an outsized return on the initial investment. In fact, when VCs invest, they are looking for only a few “home run” investments to make up for the losses that will compose the majority of their portfolio. Even the pros expect a low batting average when investing in startups.

This is why the concept of diversifying your portfolio is important in the context of startup investing. Statistically, the more startup investments you make, the more likely you are to see better returns through your portfolio. Data collected across 10,000 Angellist portfolios supports this idea. In other words, the old piece of advice “don’t put all your eggs in one basket” holds true when investing in startups.

Who can invest in startups?

Traditionally, startup investing was not available to the general public. Only accredited investors had access to startup investment opportunities. Accredited investors are those who:

  • Have made over $200,000 in annual salary for the past two years ($300,000 if combined with a spouse), or
  • Have over $1M in net worth, excluding their primary residence

That meant only an estimated 10% of US households had access to these opportunities. Equity crowdfunding changes all of that and levels the playing field. On platforms like StartEngine, anyone over the age of 18 can invest in early-stage companies.

What are you buying?

The Breakdown of Securities Offered via Reg CF as of December 31, 2020

When you invest in startups, you can invest through different types of securities. Those include:

  • Common stock, the simplest form of equity. Common stock, or shares, give you ownership in a company. The more you buy, the greater the percentage of the company you own. If the company grows in value, what you own is worth more, and if it shrinks, what you own is worth less.
  • Debt, essentially a loan. You, the investor, purchase promissory notes and become the lender. The company then has to pay back your loan within a predetermined time window with interest.
  • Convertible notes, debt that converts into equity. You buy debt from the company and earn interest on that debt until an established maturity date, at which point the debt either converts into equity or is paid back to you in cash.
  • SAFEs, a variation of convertible note. SAFEs offer less protection for investors (in fact, we don’t allow them on StartEngine) and include no provisions about cash payout, so you as an investor are dependent upon the SAFE converting into equity, which may or may not occur at some point in the future.

Most of the companies on StartEngine sell a form of equity, so the rest of this article will largely focus on equity investments.

How can a company become successful if they only raise $X?

Startup funding generally works in funding rounds, meaning that a company raises capital several times over the course of their life span. A company just starting out won’t raise $10M because there’s no indication that it would be a good investment. Why would someone invest $10M in something totally unproven?

Instead, that new company may raise a few hundred thousand dollars in order to develop proof-of-concept, make a few initial hires, acquire their first users, or reach any other significant business developments in order to “unlock” the next round of capital.

In essence, with each growth benchmark a company is able to clear, they are able to raise more money to sustain their growth trajectory. In general, each funding round is bigger than the previous round to meet those goals.

When do companies stop raising money? When their revenue reaches a point where the company becomes profitable enough that they no longer need to raise capital to grow at the speed they want to.

What happens to my equity investment if a company raises more money later?

If you invest in an early funding round of a startup and a year or two later that same company is raising more money, what happens to your investment? If things are going well, you will experience what is known as “dilution.” This is a normal process as long as the company is growing.

The shares you own are still yours, but new shares are issued to new buyers in the next funding round. This means that the number of shares you own is now a smaller percentage of the whole, and this is true for everyone who already holds shares, including the company’s founders.

However, this isn’t a problem in itself. If the company is doing well, in the next funding round, the company will have a higher valuation and possibly a different price per share. This means that while you now own a smaller slice of the total pie, the pie is bigger than what it was before, so your shares are worth more than they were previously too. Everybody wins.

If the company isn’t growing though, it leads to what is known as a down round. A down round is when a company raises more capital but at a lower valuation, which can increase the rate of dilution as well as reduce the value of investors’ holdings

How can I make money off a startup investment?

Traditionally, there are two ways investors can “exit” their investment. The first is through a merger/acquisition. If another company acquires the one you invested in, they will often offer a premium to buy your shares and so secure a controlling ownership percentage in the company. Sometimes your shares will be exchanged at dollar value for shares in the acquiring company.

The other traditional form of an exit is if a company does an initial public offering and becomes one of the ~4,000 publicly trading companies in the US. Then an investor can sell their shares on a national exchange.

Those events can take anywhere from 5-10 years to occur. This creates an important difference between startup investing and investing in companies on the public market: the time horizon is different.

When investing in a public company, you can choose to sell that investment at any time. However, startup investments are illiquid, and you may not be able to exit that investment for years.

However, equity crowdfunding can provide an alternative to both of these options: the shares sold through equity crowdfunding are tradable immediately (for Regulation A+) and after one year (for Regulation Crowdfunding) on alternative trading systems (ATS), if the company chooses to quote its shares on an ATS. This theoretically reduces the risk of that investment as well because the longer an investment is locked up, the greater the chance something unpredictable can happen.

Conclusion

Investing in startups is risky, but it is an exciting way to diversify your portfolio and join an entrepreneur’s journey.

The Evolution of Reg A+

During the recent Dare to Dream KoreSummit, David Weild IV, the Father of the JOBS Act, spoke about companies going from public to private, access to capital Reg A+, the future of small businesses raising capital, and the future of the broker-dealer system. The following blog summarizes his keynote address and what Wield believes will be the future of raising capital for small businesses. 

 

Reg A+’s Creation

The JOBS Act, passed in 2012, helped address a significant decrease in America’s IPOs. “When I was vice-chairman of NASDAQ, I was very concerned with some of the market structure changes that went on with our public markets that dropped the bottom out of support for small-cap equities,” said Weild. “80% of all initial public offerings in the United States were sub $50 million in size. And in a very short period of time, we went from 80%, small IPOs to 20%, almost overnight.” The number of operating public companies decreased from about nine thousand to five thousand. The changes in the market significantly restricted smaller companies from growing, unable to go public because of prohibitive costs and other expenses. 

 

Effect on Small Business

After years of lobbying and the passage of the JOBS Act, only one of the seven titles went into effect instantaneously: RegA+. With this new option for raising capital, startups could raise $50 million in money without filing a public offering. The previous maximum was $5 million; this would eventually be increased to $75 million. It also expanded the number of shareholders a company can have before registering publicly, which is essential as companies can raise money from accredited and non-accredited investors through this regulation. RegA+ and the other rules have had a significant impact on the way startups do business. This has been a significant benefit for small businesses, as it has allowed them to raise more money without going through the hassle and expense of becoming a public company. 

 

Reg A+ into the Future

The capital raising process was digitized by taking the investment process and making it direct through crowdfunding, removing economic incentives for small broker-dealers who could not make their desired commission on transactions. This resulted in many of them consolidating out of business and leaving a gap in the private capital market ecosystem that supports corporate finance. Changes to the JOBS Act are beginning to reintroduce incentives for broker-dealers, which will continue to shape the future of private investments as it will continue to facilitate the growth of a secondary market. Wield’s thoughts on the future of capital raising marketing are that the market is not yet corrected, but it is on track. He said: “I would tell you that there’s a great appetite in Washington to do things that are going to improve capital formation.”

 

Getting more players like broker-dealers involved in the RegA+ ecosystem will do nothing but benefit the space. In his closing remarks, Wield said that this would provide for a “greater likelihood that we’re going to fund more earlier stage businesses, which in turn gives us the opportunity to create jobs and upward mobility. Hopefully, since much entrepreneurial activity is focused on social impact companies to solve great challenges of our time, whether it’s in life sciences, and medicine, or climate change, you know, I firmly believe that the solutions for climate change are apt to come from scientists and engineers who’ve cracked the code on cutting emissions or taking CO2 out of the atmosphere. And so from where I said, getting more entrepreneurs funded is going to be important to have a better chance of leaving a respectable environment for the next generation.”

Meet the KorePartners: Eric Fischgrund of FischTank PR

With the recent launch of the KoreConX all-in-one RegA+ platform, KoreConX is happy to feature the partners that contribute to its ecosystem. 

 

For nearly 15 years, Eric Fischgrund has been involved in the communications and marketing industry. He says: “ I have a degree in Communications Journalism and have always been a writer at heart, so public relations was a natural career match for me.” Continuing to learn every day from his clients has always enticed him to continue in his career path, as “constantly learning client subject matter and determining how to deliver their message to the market, provides me with an ongoing (and free!) education.” He prides himself on his ability to understand his clients’ businesses and apply a unique skill set to achieve results.

 

Passionate about both the public relations industry and investment space, Eric is excited about the future and the opportunities it will bring for both companies and investors. He says: “Entrepreneurs need capital and main street investors deserve high growth opportunities, so this is two birds and one stone. I also enjoy working in emerging industries, such as sustainability, renewables, cleantech, IIoT and IoT, healthcare tech, cannabis, and others. So many innovators in these sectors are utilizing equity crowdfunding to grow their business.” 

 

Through the introduction of RegA+, companies have access to a fundraising route that is favorable to small startups as well and allows a wider pool of investors access to high-growth investment opportunities. Eric says: “Historically, it’s taken significant capital, legal costs, marketing and communications requirements, and more to raise capital. Similarly, the venture capitalists, private equity firms and individual high net worth investors are the ones presented with the highest growth investment opportunities.” RegA+ levels the playing field, eliminating these problems. “It enables entrepreneurs to raise capital online, grow their brand simultaneously,” while allowing main street investors to make investments for as low as a few hundred or thousand dollars. 

 

Despite the incredible opportunity RegA+ presents, Eric feels that there is much misinformation circulating about how to raise capital. He says: “Professionals that don’t understand the nuances of the regulation can too easily take advantage of entrepreneurs, innovators, and investors, which hurts all of us. This is why I’m encouraged by the KoreConX platform bringing the experts together.” Establishing a partnership with KoreConX was a perfect fit, as FischTank works to partner with strong businesses and companies. “We also strive to make the world a better place, and many of the innovators and companies we work with are developing technologies and services that do just that,” Eric said.

 

For companies that are looking to raise capital, working with a PR agency is important for their success. When potential investors are looking to learn more about a company they have an interest in investing in, one of the first things they will do is Google it. “If there is plenty of editorial search results, especially on the first page, and constant news, the company is going to appear credible and appealing,” Eric said. Additionally, effective PR can also be utilized from a marketing perspective. “Press coverage not only attracts attention but it can be used as sales/marketing tools for investor outreach and relations functions.” At FischTank, they provide a wide variety of public relations and marketing services to their clients. They take care of media and press coverage, email marketing, social media, and content writing so that you can raise capital effectively and successfully. 

 

Why do I need Blue Sky registration for Secondary Trading?

Through the Regulation A+ exemption, securities issuers can raise up to $75 million as of March 2021. This creates a significant opportunity for the everyday investor to make investments in private companies and for the companies to benefit from the large number of investors that exist within this space. Unlike securities purchased on a national securities exchange, like the NASDAQ or New York Stock Exchange, investors in private companies have been somewhat limited in their options for liquidity.

 

This created the need for a secondary market on which investors could sell shares to other interested buyers, rather than waiting for the company to go public through an IPO to sell their shares. However, when it comes to enabling investors to be able to access secondary market platforms for their shares, there are a few things issuers need to consider.

 

First, just as the original offering has to comply with the Blue Sky laws in the states they choose to do business in, secondary market trading falls under the same requirements. For offerings that fall under the Tier 1 Reg A+, offerings are required to meet the blue sky requirements in each state and must be reviewed and registered by the state and the SEC. For Tier 2 offerings, the offering preempts Blue Sky laws and does not require review and registration. Some states also require issuers to work with a broker-dealer for the offering, so issuers should pay careful attention to that requirement when preparing their offering.

 

Similarly to complying with the laws governing raising capital, issuers must also comply with the laws that govern secondary trading markets in the states they are looking to make secondary trading available in. Since Blue Sky laws vary between jurisdictions, it can be difficult for issuers to maintain compliance with the laws in each state. In this case, issuers can file for “manual exemption” of the Blue Sky laws, accepted in numerous states. This means that issuers can qualify for secondary trading as long as they meet disclosure requirements, like meeting financial standards and ensuring that key company information is listed in a national securities manual.

 

While meeting compliance requirements to offer secondary trading to investors may seem like a challenging task, working with a broker-dealer can ensure you are meeting all requirements. As an issuer, once you can offer secondary trading, your investors will benefit from liquidity options for their shares.

What Forms of Alternative Finance are Available?

Starting a business can be difficult. Most young companies enter the scene with little capital to help them grow. Taking a loan out from the bank is a good start, but some options can end in higher rewards without a loan hanging over your head. These are alternative finance options, like raising seed capital from friends and family, angel investors, or crowdfunding. Today, we will explore forms of alternative finance available to you as a private company and where in the life cycle of your business they may appear. 

Friends and Family

In the early stages of your company’s business life cycle, raising capital from family and friends is a great place to start securing safe, additional funding if you are able. When your family and friends are early investors, they are not required to register as such, making it easy for them to help your growing company. In this stage of your company’s development, entrepreneurs will want to retain as much equity as possible. Friends and family investors make this possible without needing to give up part of a growing company. 

As you begin to accelerate your business plans, there are several avenues available that can help you raise significant capital and increase your valuation if (or when) you plan to offer your company later on the public market.

Angel Investors or Venture Capital Firms

As a private company, one of the traditional ways for you to raise capital is through an angel investor, a wealthy individual, or a venture capital firm, a group of investors that invest in companies on behalf of their clients to make them money. Both of these investors will generally invest early, requiring equity and hoping for a successful return on investment later on. 

Peer-to-Peer Lending 

Peer-to-peer lending is a pretty straightforward form of alternative finance. Typically, through online platforms, investors can enter a pool of lenders, which a borrower can pull from and then repay. This form of investment cuts out the bank as the middleman, which opens up access to companies that may not have good credit. 

Crowdfunding

Crowdfunding is a great mechanism for investments that build a company’s proof of concept because crowdfunding success relies on having a product or service people want or believe in. As the name would imply, crowdfunding is sourcing small investments from a large number of investors and falls into one of two categories rewards-based or equity-based offerings. 

Rewards-Based Crowdfunding

Rewards-based crowdfunding is an investment that expects compensation in the form of the product a company is producing. A good platform for this form of crowdfunding is Kickstarter. You will often see independent video game developers or small business owners looking to raise capital for a particular product and offer rewards based on how much an investor invests. 

Equity-Based Crowdfunding or Regulation CF

Regulation CF is a crowdfunding tool regulated by the SEC signed into law in 2012. However, it has recently expanded to allow more investing opportunities. The JOBS Act allows non-accredited investors to invest in private companies in exchange for equity in the company. More specifically, for investors with either a net worth or annual income less than $107,000, investments in Reg CF offerings are limited to $2,200 or 5% of the greater of their annual income or net worth. 

This tool allows companies to raise as much as $5 million in 12 months from many investors. In 2020, 358,000 investors participated in Reg CF campaigns. 

Regulation A+

Another method of allowing companies to have non-accredited investors invest in their companies is Regulation A+, by exempting the offering from SEC registration. Many companies have begun to offer securities through the RegA+ exemption following a successful RegCF raise. Proceeding this way will elevate your chances of raising more money, up to $75 million annually, because the Regulation CF will show potential investors that the products or services offered by the company are of great interest to many individuals. It is important to note that non-accredited investors are limited to investing 10% of their annual income or net worth, whichever is greater.

 

There are many avenues of alternative finance to investigate before going to a traditional financing option as a private company. We encourage you to look into all of these types and see which is right for you and your business. 

 

Reg A and Reg CF Issuers: Time to Count Your Shareholders!

Reg A and Reg CF have been around for a few years now and we are finding that some of our clients, especially those that have made multiple offerings, are getting to the point where they need to consider the implications of Section 12(g) of the Securities Exchange Act, which requires companies to become registered with the SEC when they meet certain asset and investor number thresholds.

Let’s start with the requirements of Section 12(g). It says that if, on the last day of its fiscal year, an issuer has assets of $10 million and a class of equity securities held of record by either 2,000 persons or 500 persons who are not accredited investors, it has to register that class of securities with the SEC.

Drilling down on each of those elements:

  • Assets: This is gross, not net, and it will include any cash that a company has raised in an offering but not spent yet.
  • Class of equity securities: Issuers with multiple series of preferred stock or multiple series in a series LLC will need to talk to their lawyers about what constitutes a separate “class.”
  • Held of record: Brokers or custodians holding in “street name” count as a single holder of record. Crowdfunding SPVs created under the SEC’s new rules also count as one holder, and as discussed below, there are special, conditional, rules for counting Reg A and Reg CF investors.  But check with your lawyers whether you need to “look through” SPVs formed for the purpose of investing in Reg D offerings.
  • Accredited status: Issuers are probably going to have to make assumptions as to the accredited status of their investors unless they maintain that information separately, and assume investors in Reg D offerings are accredited, and investors in Reg A and Reg CF offerings are not.
  • Registering a class of securities in effect means filing a registration statement with all relevant information about the company and becoming a fully-reporting company. This includes PCAOB audits, quarterly filings, proxy statements, more extensive disclosure and all-round more expensive legal and accounting support.

Since becoming a fully-reporting company is not feasible for early-stage companies, both Reg A and Reg CF are covered by conditional exemptions from the requirements of Section 12(g). The conditions for each are different.

Issuers need not count the holders of securities originally issued in Reg A offerings (even if subsequently transferred) as “holders of record” if:

  • The company has made all the periodic filings required of a Reg A company (Forms 1-K, 1-SA and 1-U);
  • It has engaged a registered transfer agent; AND
  • It does not have a public float (equity securities held by non-affiliates multiplied by trading price) of $75m, or if no public trading, had revenues of less than $50m in the most recent year.

Issuers need not count the holders of securities issued in Reg CF offerings (even if subsequently transferred) as “holders of record” if:

  • The company is current in its annual filing (Form C-AR) requirements;
  • It has engaged a registered transfer agent; AND
  • It has total assets of less than $25m at the end of the most recent fiscal year.

It’s important that the issuer’s transfer agent keep accurate records of which exemption securities were issued under, even when they are transferred. As of March 15, 2021, Reg CF also allows the use of “crowdfunding vehicles”, a particular kind of SPV with specific requirements for control, fees, and rights of the SPV in order to put all of the investors in a Reg CF offering into one holder of record. This is not available for Reg A, and still comes with administrative requirements, which may make use of a transfer agent still practical.

If an issuer goes beyond the asset or public float requirements of its applicable conditional exemption, it will be eligible for a two-year transition period before it is required to register its securities with the SEC. However, if an issuer violates the conditional exemption by not being current in periodic reporting requirements, including filing a report late, then the transition period terminates immediately, requiring registration with the SEC within 120 days after the date on which the issuer’s late report was due to be filed.

It’s good discipline for companies who have made a few exempt offerings and had some success in their business to consider, on a regular basis, counting their assets and their shareholders and assess whether they may be about to lose one or both of the conditional exemptions and whether they need to plan for becoming a public reporting company.

Are You Ready to Raise Capital?

Whether you’ve raised capital in the past or are preparing for your first round, being properly prepared will help your company secure the funding it needs. Proper preparation will make investors confident that you are ready for their investments and have a foundation in place for the growth and development of your company. So if you’re looking to raise money, what must you do to be ready for raising capital?

 

From the start, any company should keep track of shareholders in its capitalization table(commonly referred to as the cap table). Even if you have not yet raised any funds, equity distributed amongst founders and key team members should be accurately recorded. With this information kept up-to-date and readily available, negotiations with investors will be smoother, as it will be clear how much equity can be given to potential shareholders. If this information is unclear, deals will likely come with frustrations and delays.

 

Researching and having knowledge of each investor type will also help prepare your company to raise money. Will an angel investor, venture capital firm, crowdfunding, or other investment method be suited best for the money that is being raised? Having a clear answer to this question will help you better understand the investors you’re trying to reach and will help you prepare a backup option if needed.

 

Once your target investors have been decided and you have a firm grasp on the equity you’re able to offer, preparing to pitch your company to them will be a key step. Having a pitch deck containing information relevant to your company and its industry will allow you to convince investors why your business is worth investing in. Additionally, preparing for any questions that they may ask will ensure investors that you are knowledgeable and have done the research to tackle difficult problems.

 

Before committing to raising capital, you should make sure that your company has an established business model. Investors want to see that you have a market for your product and are progressing. If investors are not confident that the product you’re marketing has a demand, it will be less likely they will invest. Investors will also want proof that the company is heading in the right direction and the money they invest will help it get there faster.

 

Once you have determined that your company is ready for investors, managing the investmentsand issuing securities will be essential. To streamline the process and keep all necessary documents in one location, KoreConX’s all-in-one platform allows companies to manage the investment process and give investors access to their securities and a secondary market after the funding is completed. With cap table management, the all-in-one platform will help companies keep track of shareholders and is updated in real-time, ensuring accuracy as securities are sold.

 

Ensuring that your company has prepared before raising capital will help the process go smoothly, with fewer headaches and frustrations than if you went into it unprepared. Investors want to know that their money is going to the right place, so allowing them to be confident in their investments will ensure your company gets the funding that it needs to be a success.

Effective Date of the Amendments to Reg CF and Reg A

The amendments to Reg CF, Reg A, and other rules relating to capital formation utilizing exempt offerings have finally been published in the Federal Register, with an effective date of March 15, 2021.

Meet the KorePartners: Andrew Corn, CEO of E5A Integrated Marketing

With the recent launch of the KoreConX all-in-one RegA+ platform, KoreConX is happy to feature the partners that contribute to its ecosystem.

 

From the first project he worked on while still in college, Andrew Corn has been involved in financial marketing. After his first analyst’s presentation, “and then second, and then fifth, I decided to drop out of college and focus on that full time. Soon after, I wrote my first IPO roadshow, built a company around that, and a few years later, also started working for money managers,” Andrew said. After selling that company, Andrew went to work for a publishing company specializing in investingas the chief marketing officer.

 

Then, for 9 years, Andrew left the marketing industry and created a multi-factor model used to analyze the stocks available on US exchanges to select them for separately managed accounts, and he and his team designed the index behind six ETFs, eventually selling that company to a bank, where he served as the chief investment officer. “When E5A was born, it was born as an investment house, and then I got sucked back into marketing in 2012 and switched E5A over into a marketing firm in 2013,” Andrew recounted. At E5A, they acquire investors through systematic, data-driven marketing.

 

For companies that are looking to raise capital, marketing plays an incredibly important role. For RegA+ offerings, a company’s first target is typically its existing network of customers. However, a marketing firm such as E5A can help companies to understand the behavior and demographics of current customers. Knowing how customers behave will allow companies to targetpeople that are demographically and behaviorally just like their current customers.

 

With RegA+ offerings, the majority of the money will be raised through marketing. “The beauty of that is that it’s passive,” Andrew says, “we can look at entirely new groups of prospects who are the most likely people who would be interested in investing in a company like yours. Sometimes we can find them through behavior or demographics, hopefully, it’s a combination of both.” Once potential investors have been found, marketing agencies can come up with the messaging platform that will raise money through these investors. Companies are often surprised that their existing network raises little money, but the investors they can gain through marketing helps them reach their goals.

 

Through the use of marketing, Andrew is excited about how companies benefit from acquiring investors at scale. “If you’re a restaurant chain, you want as many people to know about it as possible. If you have a direct-to-consumer product, you want many people to know about it. So a byproduct of raising capital is promoting the brand or the business.” Both investors and the companies get more engaged as information is put out regularly.

 

With RegA+ allowing investors of all wealth, income and experience levels to participate, the restriction allowing only accredited investors is lifted. Additionally, Andrew believes that increasing the limit from $50 to $75 million will greatly improve the regulation since oftentimes companies require more funding. With IPOs on both the New York Stock Exchange or the NASDAQ often over $100 million, he believes increasing the cap to as much as $200 million in a few years would be better for companies looking to utilize RegA+.

 

For its clients, E5A is a “turnkey marketing company, so we do everything from messaging platforms to data-targeting to media buying and optimization, message testing, web development, etc.” Andrew expects that E5A will be held to a standard of success being measured by the amount of money raised. While looking to maintain as much control of the outcome, E5A also understands that many of the companies they work with have their own marketing or IT departments, and try to share as much work with them as possible and include them in the process.

 

E5A looks to work with companies that have a high probability of success, which requires an ecosystem of legal, accounting, technology, broker/dealer, consulting, and marketing services. Andrew says, “We feel that Oscar and the KoreConX team are putting together a world-class network of service providers who are experts in each of their individual tasks. We are glad to participate.

Warrant Issuers, Keep Your Offering Statement Evergreen

An increasing number of issuers have been using Regulation A to make continuous offerings of units, consisting of a combination of equity, often common stock, and warrants to purchase the same equity at a future date.  Under the Securities Act, the units, the shares of stock, the warrants and the shares of stock issuable upon exercise of the warrants are separate securities whose offer and sale must be registered on a registration statement or covered by an exemption from registration such as Regulation A.  That is why offering statements under Regulation A list each of these individually and why the SEC requires the validity opinion filed as an exhibit to the offering statement to cover all of them (See Staff Legal Bulletin No. 19, available at https://www.sec.gov/interps/legal/cfslb19.htm ).

 

Most warrants that are part of these structures are exercisable for more than a year after their date of issuance, often up to 18 months.  Since the exercise of the warrant and payment of the exercise price for the underlying shares is a new investment decision by the warrant holder, the offering statement covering the underlying warrant shares must continue to be qualified under Regulation A in order for the new shares to be covered by the exemption from registration. That means that an issuer must keep the offering statement “evergreen,” or qualified for at least 2 to 3 years to cover those exercises, even if the offering of the units is completed before the first anniversary of qualification.   Most Regulation A offerings permit rolling closings.  The effective date of a warrant is typically the date on which a closing is held and a warrant is issued to an investor.  For example, if an issuer commences a Regulation A offering on the date its offering statement is qualified (let’s say February 1, 2021) and holds its first closing of units on March 1, the warrants issued in that closing are exercisable until September 1, 2022, well past the anniversary of qualification.  Assuming the offering stays open for at least 9 months and the final closing is held on November 1, 2021, the warrants issued in that final closing are exercisable until May 1, 2023.

 

Under the securities laws, registration statements for continuous offerings are kept updated, or “evergreen,” when an issuer complies with its reporting obligations under the Exchange Act by filing timely periodic reports such as their annual report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K.  However, since the analogous periodic reports under Regulation A are filed under the Securities Act, their filing does not keep the offering statement evergreen.  If an offering is to extend more than one year from qualification, issuers conducting continuous offerings need to file post qualification amendments (“PQA”)  in accordance with Rule 252(f)(i) every 12 months after the qualification date to update the offering statement, which includes incorporating the financial statements from the periodic reports filed during the previous 12 months.  If the original offering statement was scheduled to terminate before the warrant exercise period ended, the PQA would also need to extend the termination date. A PQA in those circumstances renders the offering statement un-qualified and subject to a possible new SEC review, which means an issuer may continue to make offers (so long as the financials are not stale yet) but may not make sales, such as the issuance of warrant shares upon exercise of warrants, until the SEC re-qualifies the offering statement (See our blog post on updating continuous offerings: https://www.crowdcheck.com/blog/updating-continuous-offerings-under-regulation).  Using our example above, the issuer of units would need to at a minimum file a PQA in sufficient time before February 1, 2022 to allow for a possible Staff review and comment period to meet the annual requirement under Rule 252.  Moreover, if the unit offering lasts more than 6 months after the original qualification date, an issuer should anticipate having to file a second PQA in early 2023 to cover the exercise of warrants issued in the last closing of the offering.

 

Warrant issuers should also keep in mind some additional steps they will need to take.   The subscription agreement and the warrants themselves will need to include additional reps, warranties and covenants, such as a covenant to keep the offering statement evergreen.  Plus, even after qualifying the PQA with the SEC, the issuer will need to insure that it is current with state notice filings, which typically need to be renewed every 12 months as well.

Foreign Issuers Using Regulation A and Regulation CF

For some reason, this issue has been coming up a lot lately. Our usual response to the question “Can non-US issuers make a Regulation A or Reg CF offering?” is to point to the rules:

  • Rule 251(b)(1) says Regulation A can only be used by “an entity organized under the laws of the United States or Canada, or any State, Province, Territory or possession thereof, or the District of Columbia, with its principal place of business in the United States or Canada.”
  • Reg CF Rule 100(b) says Reg CF may not be used by any issuer that “is not organized under, and subject to, the laws of a State or territory of the United States or the District of Columbia.”

Slightly different formulations, as you can see, and note that Reg CF doesn’t say that the company needs to have its primary place of business here. But both exclude non-US or Canadian companies.

But we are getting a lot of pushback and “what if?” questions, so here are responses to a few of the most common:

  • What if we redomicile to the US? Well ok, that might work for Reg CF. It might work for Reg A too, if your management changes their domicile too (you need a bona fide principal place of business here). However, have you considered the tax consequences in your original home jurisdiction? Also, note that you’ll still need two years audited or reviewed financial statements, in US GAAP and audited or reviewed in accordance with US auditing requirements (US GAAS).

 

  • What if we form a subsidiary and it makes the offering? Yes, you can form a subsidiary here (it’ll have to have its principal place of business here too, for Reg A) and it can raise money under Regulation CF. But the money it raises here has to be legit used for the sub’s own purposes. It can’t be upstreamed to the parent, because that would likely make the parent a “co-issuer” that needs to also file a Form C or 1-A and can’t. So the sub needs to be planning to undertake its genuine own business. Even then, if it’s not a new business but just taking over some part of the parent’s business, then the sub might need to produce financials (again, using US GAAP and US GAAS) from the parent’s business or the part of business it’s taking over, because that’s a “predecessor.”

 

  • What if we create a holding company in the US? Yes, although the same issues come up. If using Reg A, you need to move your principal place of business here. For either exemption, the foreign company that is now your subsidiary will be the “predecessor” company and so again we have the need for two years’ audited or reviewed financials using US GAAP and US GAAS.

 

  • What if we create a new company that licenses the foreign company’s product or service? This may be the most promising option, but it’s really going to depend on facts and circumstances. Proceeds of the offering have to be used for the new company’s operations, in the case of Regulation A the company’s primary place of business has to be here, and you’ll have to look carefully at whether there are any predecessor issues.

Can I Use My IRA for Private Company Investments?

Individual retirement accounts (commonly shortened to IRAs) allow flexibility and diversity when making investments. Whether investing in stocks, bonds, real estate, private companies, or other types of investments, IRAs can be useful tools when saving for retirement. While traditional IRAs limit investments to more standard options, such as stocks and bonds, a self-directed IRA allows for investments in things less standard, such as private companies and real estate. 

 

Like a traditional IRA, to open a self-directed IRA you must find a custodian to hold the account. Banks and brokerage firms can often act as custodians, but careful research must be done to ensure that they will handle the types of investments you’re planning on making. Since custodians simply hold the account for you, and often cannot advise you on investments, finding a financial advisor that specializes in IRA investments can help ensure due diligence. 

 

With IRA investments, investors need to be extremely careful that it follows regulations enforced by the SEC. If regulations are not adhered to, the IRA owner can face severe tax penalties. For example, you cannot use your IRA to invest in companies that either pay you a salary or that you’ve lent money to, as it is viewed by the SEC as a prohibited transaction. Additionally, you cannot use your IRA to invest in a company belonging to either yourself or a direct family member. If the IRA’s funds are used in these ways, there could be an early withdrawal penalty of 10% plus regular income tax on the funds if the owner is younger than 59.5 years old. 

 

Since the IRA’s custodian cannot validate the legitimacy of a potential investment, investors need to be responsible for proper due diligence. However, since some investors are not aware of this, it is a common tactic for those looking to commit fraud to say that the investment opportunity has been approved by the custodian. The SEC warns that high-reward investments are typically high-risk, so the investor should be sure they fully understand the investment and are in the position to take a potential loss. The SEC also recommends that investors ask questions to see if the issuer or investment has been registered. Either the SEC itself or state securities regulators should be considered trusted, unbiased sources for investors.

 

If all requirements are met, the investor can freely invest in private companies using their IRAs. However, once investments have been made, the investor will need to keep track of them, since it is not up to their custodian. To keep all records of investments in a central location, investors can use KoreConX’s Portfolio Management, as part of its all-in-one platform. The portfolio management tool allows investors to utilize a single dashboard for all of their investments, easily accessing all resources provided by their companies. Information including key reports, news, and other documents are readily available to help investors make smarter, more informed investments. 

 

Once investors have done their due diligence and have been careful to avoid instances that could result in penalties and taxes, investments with IRAs can be beneficial. Since it allows for a diverse investment portfolio, those who choose to invest in multiple different ways are, in general, safer. Additionally, IRAs are tax-deferred, and contributions can be deducted from the owner’s taxable income. 

SEC Proposes Relief for “Finders”

I have long (oh so long) been one of those urging the SEC to give some clarity with respect to the status of “finders.” See here for the latest piece.

Early-stage companies raising funds very often reach out to a guy who knows some guys who have money and have invested in startups in the past. If the first guy wants to be compensated by reference to the amount of money his contacts are able to invest, he may well have violated the broker registration requirements of the Securities Exchange Act of 1934. And it’s not only him who needs to be worried; if a startup raises funds through someone who should have been registered as a broker and wasn’t, their sales of securities may be subject to rescission – buying the securities back, with interest.

Nonetheless, startups are so strapped for money (and often don’t understand the requirements of the law) that they do this all the time.

Industry participants have been asking the SEC for guidance in this area for decades, and now the SEC has come up with some simple proposals that should be of use to the startup community.

The SEC is proposing to exempt two classes of finders, Tier I Finders and Tier II Finders, based on the types of activities in which they are permitted to engage, and with conditions tailored to the scope of their activities. The proposed exemption for Tier I and Tier II Finders would be available only where:

  • The issuer is not a reporting company under the Exchange Act;
  • The issuer is seeking to conduct the securities offering in reliance on an applicable exemption from registration under the Securities Act;
  • The finder does not engage in general solicitation;
  • The potential investor is an “accredited investor” as defined in Rule 501 of Regulation D or the finder has a reasonable belief that the potential investor is an “accredited investor”;
  • The finder provides services pursuant to a written agreement with the issuer that includes a description of the services provided and associated compensation;
  • The finder is not an associated person of a broker-dealer; and
  • The finder is not subject to statutory disqualification at the time of his or her participation.

Tier I Finders. A “Tier I Finder” is defined as a finder who meets the above conditions and whose activity is limited to providing contact information of potential investors in connection with only one capital raising transaction by a single issuer within a 12-month period, provided the Tier I Finder does not have any contact with the potential investors about the issuer. A Tier I Finder that complies with all of the conditions of the exemption may receive transaction-based compensation (in other words, compensation based on the amount raised) for the limited services described above without being required to register as a broker under the Exchange Act.

Tier II Finders. The SEC is also proposing an exemption that would permit a finder, where certain conditions are met, to engage in additional solicitation-related activities beyond those permitted for Tier I Finders. A “Tier II Finder” is defined as a finder who meets the above conditions, and who engages in solicitation-related activities on behalf of an issuer, that are limited to:

  • Identifying, screening, and contacting potential investors;
  • Distributing issuer offering materials to investors;
  • Discussing issuer information included in any offering materials, provided that the Tier II Finder does not provide advice as to the valuation or advisability of the investment; and
  • Arranging or participating in meetings with the issuer and investor.

A Tier II Finder wishing to rely on the proposed exemption would need to satisfy certain disclosure requirements and other conditions: First, the Tier II Finder would need to provide a potential investor, prior to or at the time of the solicitation, disclosures that include: (1) the name of the Tier II Finder; (2) the name of the issuer; (3) the description of the relationship between the Tier II Finder and the issuer, including any affiliation; (4) a statement that the Tier II Finder will be compensated for his or her solicitation activities by the issuer and a description of the terms of such compensation arrangement; (5) any material conflicts of interest resulting from the arrangement or relationship between the Tier II Finder and the issuer; and (6) an affirmative statement that the Tier II Finder is acting as an agent of the issuer, is not acting as an associated person of a broker-dealer, and is not undertaking a role to act in the investor’s best interest. The Commission is proposing to allow a Tier II Finder to provide such disclosure orally, provided that the oral disclosure is supplemented by written disclosure and satisfies all of the disclosure requirements listed above no later than the time of any related investment in the issuer’s securities.

The Tier II Finder must obtain from the investor, prior to or at the time of any investment in the issuer’s securities, a dated written acknowledgment of receipt of the Tier II Finder’s required disclosure.

A Tier II Finder that complies with all of the conditions of the proposed exemption may receive transaction-based compensation for services provided in connection with the activities described above without being required to register as a broker under the Exchange Act.

A finder could not be involved in structuring the transaction or negotiating the terms of the offering. A finder also could not handle customer funds or securities or bind the issuer or investor; participate in the preparation of any sales materials; perform any independent analysis of the sale; engage in any “due diligence” activities; assist or provide financing for such purchases; or provide advice as to the valuation or financial advisability of the investment.

This exemption would not affect a finder’s obligation to continue to comply with all other applicable laws, including the antifraud provisions of federal and state law. Additionally, regardless of whether or not a finder complies with this exemption, it may need to consider whether it is acting as another regulated entity, such as an investment adviser.

The exemption is really aimed at the guy at the golf club who has accredited buddies he can introduce the startup to. It would be available to natural persons only (not companies) and the finder couldn’t undertake general solicitation (he should know the people he is introducing to the startup; if he has to go searching for them, he’s essentially acting as a broker. The “no general solicitation” and “natural person” conditions means that the proposed exemption doesn’t help clarify the regulatory status of non-broker online platforms.

We are a little disappointed that so many of the comment letters on the proposal have been negative. We do understand that there is a great deal of clarification needed with respect to what it means to be in the business of a broker. And the SEC needs to work closely with the states in this area. But we at CrowdCheck are pleased that the SEC has provided some clarity in this area.

Reg A+ Webinar: The Highlights

In our last webinar, we’ve talked about a very complex topic in the startup industry: The Regulation A+.

For those of you who have never heard of it (no shame in learning, folks), Regulation A+, or Reg A, is a section of the JOBS Act that allows private companies to raise up to $ 50 Million while offering shares to the general public.

This can have a profound impact on how startups work. Unfortunately, there’s still a great deal of confusion surrounding the topic.

That’s why we brought in Sara Hanks, a top attorney with over 30 years experience in the corporate and securities field and Founder of CrowdCheck, and Darren Marble, Co-Founder and CEO of Issuance, with extensive experience in the capital raising process.

Here are some highlights of the discussion:

Sara Hanks: Regulation A+ is a popular name for a series of amendments to existing laws there were made in 2015. The Regulation A was an exemption for full regulation with the SEC, that permits a company to make a public offering, without the restrictions on the security being sold, but not to go through the full SEC process. So it’s an exemption for a public offering.

And that’s important because it’s public, the securities that are sold are not restricted, they can be free traded, if you can find a place for them to trade, you can trade them immediately, after the qualification of the offering. The companies who can use Reg A are U.S. or Canadian companies.

Darren Marble: The most interesting question to me is what companies are ideal candidates to use the Reg A Securities exemption as a capital raising tool. And just because you might be eligible to do a Reg A offer doesn’t mean you should. You know, if there’s a cliff that’s 50 feet above the ocean and you’re on that cliff, and you can see the ocean, doesn’t mean you should dive in. You probably need to be a professional diver.

I say that you don’t choose Reg A, Reg A chooses you. And what I mean by that is I think the Reg A exemption discriminates in that aspect. They will save a very particular type of issuer and it will punish or harm another type of issuer.

We also talked about:
– Marketing strategies that need to be considered for a Reg A+
– Who qualifies for it?
– What are the benefits?
– What does the Due Diligence look like?
– What liability is there for the issuer?
– What liability is there for any who promotes the offering?

To watch the full webinar, click here.

You can also watch the full version of our previous webinars:

Digital Securities Webinar

Marketing Your Raise Webinar