crowdfunding from the start-up’s perspective

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CROWDFUNDING FROM THE START-UP’S PERSPECTIVE

CROWDFUNDING 2016 SERIESPremier date: April 13, 2016

Premier Date: April 13, 2016

crowdfunding from the start-up’s perspective

crowdfunding 2016 series

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meet the facultyPANELISTS

Alex Davie Riggs Davie PLCCharles Sidman ECS Capital Partners and AngelsAndrew Stephenson CrowdCheck

MODERATOR

Dave Freedman Financial Journalist and Author

© 2016 DailyDAC, LLC d/b/a/ Financial Poise™


Practical and entertaining education for business owners and executives, accredited

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about this webinarStartups and early-stage companies have a new array of options for raising growth capital, each option with a different set of regulations, requirements, raise limits, and investor restrictions. In 2015, the SEC finalized rules for Title IV of the JOBS Act (Regulation A+ offerings) and Title III (equity crowdfunding). Those exemptions come on top of recently finalized Title II (which permits general solicitation under Regulation D), rewards-based crowdfunding (like Kickstarter), and intrastate securities exemptions in at least 26 states. This webinar boils them down to their fundamental distinctions, and explores how a startup should evaluate those options and select the best method (or two or more parallel methods) of raising capital.

about this seriesIn 2015, the securities crowdfunding galaxy expanded at warp speed, threatening to collide with larger, stodgier galaxies and disrupt whole solar systems.

Title IV of the Jumpstart Our Business Startups Act, launched in the summer of 2015, created Regulation A+ (also known as the mini-IPO). Then the SEC issued final rules under Title III of the JOBS Act, finally opening up equity crowdfunding for all (including non-accredited) investors. The market of potential investors thus went from less than 10 million to more than 100 million Americans. In this webinar series, some of the USA’s top crowdfunding experts explore the expanding securities crowdfunding galaxy.

As with all Financial Poise webinars, each episode in the series is designed to be viewed independently of the other episodes, and listeners will enhance their knowledge of this area whether they attend one, some, or all of the programs. © 2016 DailyDAC, LLC d/b/a/ Financial Poise™ 7

episodes in this series

EPISODE #1 Crowdfunding from the Investors Perspective

3/9/2016

EPISODE #2 Crowdfunding from the Start-Up’s Perspective

4/13/2016

EPISODE #3 Securities Crowdfunding for Intermediaries 5/11/2016Dates above are premier dates All webinars also available On Demand through West LegalEd Center and Vimeo



Securities-based CrowdfundingUsing a broad definition of crowdfunding, we include the following five kinds of securities-based crowdfunding (all are open to non-accredited investors except Reg D offerings):

• Peer-to-peer lending (P2P), a.k.a. marketplace lending• Regulation D offerings Rule 506(c) accredited investors only• Intrastate securities exemptions (now in 26 states and DC)*• Title III securities crowdfunding (will launch May 16, 2016)**• Title IV Regulation A+ “mini-IPOs” (launched in June 2015)

* Intermediary platform required in AZ, IN, IA, KY, MN, MS, NJ, TX, WI** Intermediary platform required for all Title III offerings


Debt-based CrowdfundingDebt-based crowdfunding emerged as a for-profit investment vehicle in 2006 in the USA, and a year earlier in the UK. Peer-to-peer (P2P) lending platforms were the earliest form of debt-based crowdfunding. P2P lets borrowers apply for unsecured loans and, if accepted by the platform, borrow money from “the crowd,” then pay it back with interest. More recently P2P has been called marketplace lending because institutional investors are overwhelming individual investors on many P2P platforms.

P2P platforms take a percentage of the loan amounts (a one-time charge) from the borrower and a loan servicing fee (either a fixed annual fee or a one-time percentage of the loan amount) from investors. The application process is free for borrowers. Investors earn interest on each loan (or package of similar loans), assuming the borrowers make timely payments.

Regulation D offering platforms, which emerged in 2011 in the USA, list both debt and equity offerings. So debt-based crowdfunding now includes P2P and Reg D platforms, and will soon (May 2016) include Title III funding portals.


Marketplace Lending (P2P & P2B)Lending Club, the largest P2P platform in the USA, launched in 2007 and went public in 2014. • As of 9/30/15, Lending Club had issued loans totaling $13.4 billion.• The top two purposes reported by borrowers on Lending Club were refinancing (49%) and

credit card payoff (19%). Reported loans for “business” purposes amounted to only 1%.• Interest charged to borrowers by Lending Club ranged from 7.72% (Grade A) to 23.5% (Grade

G) – on loans issued before January 30, 2014. (Source: https://www.lendingclub.com/info/demand-and-credit-profile.action)

Kabbage (kabbageplatform.com) is a P2B lending platform, i.e., peer-to-business. Based in Atlanta, it launched in 2011.• Kabbage says it has loaned more than $1 billion to over 50,000 businesses.• Borrowers must be in business at least 1 year. Can apply to borrow $2k to $100k for 6 or 12

months. • Monthly interest rate 1.5% to 12%. Origination fee $1,200 (for 6 months) or $2,100 (for 12

months).• Kabbage makes loans through Celtic Bank, a Utah-chartered industrial bank (member FDIC).

http://www.kabbageplatform.com/

Equity CrowdfundingOfferings that Are Popularly Known as ‘Equity Crowdfunding’

Online Launch Raise Limit in

1 Year Investor Status Investment Limit

CF Intermediary Required?

Reg A+ Tier 1 2015 $20 million All investors No limit No

Reg A+ Tier 2 2015 $50 million All investors Depends on income/worth No

Reg D Rule 506(c) 2013 No limit Accredited only No limit NoIntrastate Equity Crowdfunding

2013 (Georgia was first)

Ranges $1m to $4m All investors Depends on

income/worthVaries with

stateTitle III Equity Crowdfunding2 2016 $1 million All investors Depends on

income/worthYes: online

portals1

1. Issuers must use either non-broker-dealer funding portals or broker-dealer platforms, both of which must be registered with the SEC and FINRA.2. This is “true” equity crowdfunding, in the parlance of crowdfunding professionals, governed by Title III of the JOBS Act and Regulation CF.

Note that Reg D Rule 506(b) is not included in this table, although 506(b) offerings may be listed on a Reg D offering platform. Because the issuer must have a “substantive, pre-existing relationship” with each investor, we do not consider such investors to be a “crowd.”


Crowdfunding Securities

• Straight debt• Straight equity (preferred stock, LLC

shares, etc.)• Convertible debt (starts as debt, converts to

equity – maybe)


Regulation D, Rule 506As a result of Title II of the JOBS Act, the SEC split Rule 506 into two parts.

• “Traditional” private offerings under Rule 506(b) may not use general solicitation. Off-platform, up to 35 non-accredited investors may participate. On Internet-based offering platforms, only accredited may participate, companies must have substantive pre-existing relationships with investors, and investors can self-certify their accredited status. [This is not crowdfunding.]

• Rule 506(c) removes the ban on general solicitation and advertising. That is, issuers can publicize details of their offerings outside of the platform where the offering is listed. Only accredited investors may participate, and issuers must take “reasonable steps” to verify their AI status. [We do call this crowdfunding, although accredited investors are not exactly “the crowd.”]


First 2 Years of General SolicitationRule 506(c) permits general solicitation for Regulation D offerings. Only accredited investors may participate. In the first two years of general solicitation (Sept 23, 2013, through Sept. 23, 2015):

1. About 9% of Reg D offerings used the Rule 506(c) exemption. [source: Offerboard]

2. Roughly 100,000 accredited investors participated in private capital markets for the first time. That’s a ~50% increase over the number of AIs who participated each year before 2013. [Doug Ellenoff]

3. The SEC reported at least $10 billion in 506(c) activity in the first year, and rapidly increasing amounts since. Rule 506(c) offerings are not required to be listed on web-based platforms. [Charles Sidman]

4. On the 18 major equity offering platforms tracked by Crowdnetic, 6,063 distinct 506(c) offerings recorded capital commitments of approx. $870 million. [Crowdnetic is the source for #4 thru #7]

5. The sectors with the highest number of successful 506(c) offerings tracked by Crowdnetic were services, technology, financial, consumer goods, and healthcare (out of 8 sectors total). The sectors with the highest success rates were financial, energy, healthcare, materials, and commerce & industry. The industries with the highest recorded capital commitments were real estate and oil & gas (out of 10 industries total).

6. 69% of 506(c) offerings tracked by Crowdnetic were equity, 20% were convertible debt, 9% were straight debt. The rest included revenue share, royalty, real estate, and SAFE.

7. Although equity was the most frequently used security type, it had a low success rate (21%). The securities types with the highest success rate were real estate (81%) and revenue share & royalty (63%). Convertible debt’s success rate was 36%, straight debt 31%. SAFE was the lowest (15%).


Title IV: Regulation A+

Title IV of the JOBS Act of 2012 expands the moribund Regulation A exemption by increasing the raise limit from $5 to $50 million. Non-accredited investors could participate in Reg A offerings before 2012, and they still can under Title IV but with certain limits.

In addition to the expanded raise limit, Title IV preempts blue sky review (i.e., no need for approval by every state in which the offering is made) for “Tier 2” offerings. Blue sky review is still required for “Tier 1” offerings under $20 million.

Non-accredited investors in Tier 2 offerings are limited (on an annual basis) to 10 percent of their income or net worth, whichever is greater. All investors can invest an unlimited amount in Tier 1 offerings.


Title IV: Regulation A+

Issuers of Reg A+ offerings are allowed to “test the waters,” measuring potential interest by investors, before undertaking the obligations of an offering.

Reg A+ is nicknamed the “mini-IPO,” as issuers are required to go through a scaled-down registration process and file a prospectus-like document called an “offering circular” with the SEC.

The benefits of Reg A+ for seed-stage and startup companies seem limited mainly because Tier 1 offerings up to $20 million still require blue sky review and compliance, which can be costly and time-consuming, in addition to the SEC filing process.


Title III CrowdfundingTitle III of the JOBS Act, along with SEC rules issued in 2015, establish the following structure for equity crowdfunding, which will launch in May 2016. (For a thorough discussion of Title III and SEC rules, see CrowdCheck’s memo of Nov. 2015: http://bit.ly/1XE8c44.)

• Issuers may raise up to $1 million in a 12-month period. (Congress may increase that limit.) Issuers may concurrently raise capital in Reg D and Reg A+ offerings (known as parallel offerings).

• Yearly investment limits for investors depend on their net worth and income – range from $2,000 to $100,000.

• For raises above $500,000 issuers must show audited financial statements, except for first-time Title III issuers.

• Issuers must list offerings on intermediaries known as funding portals and broker-dealer platforms.

• Portals and platforms may use objective and subjective criteria for accepting/rejecting applications submitted by issuers.

• Portals and platforms must provide communication channels that let investors engage in (a) discussions with each other, and (b) Q&A with issuers.

• Each investor buys shares in the issuer directly. Portals may not aggregate investors into special-purpose vehicles.


http://bit.ly/1XE8c44

Intrastate Equity CrowdfundingIntrastate securities exemptions allow all investors, including non-accredited, to invest in startups and private companies that are based in their state. As of February 2016, here are the states that have enacted (through legislation) or promulgated (through regulation) intrastate securities exemptions:

• These states have broad intrastate securities exemptions that allow, but do not require, offerings to be listed on crowdfunding portals: Alabama, Colorado, District of Columbia, Florida, Georgia, Illinois, Kansas, Maine, Massachusetts, Michigan, Montana, Oregon, South Carolina, Tennessee, Vermont, Virginia, Washington.

• The following states have narrow intrastate crowdfunding exemptions that require offerings to be made on crowdfunding portals: Arizona, Indiana, Iowa, Kentucky, Minnesota, Mississippi, New Jersey, Texas, Wisconsin.

For details on each state (including raise limits and investment limits) see http://www.freedman-chicago.com/ec4i/Intrastate-Securities-Exemptions.pdf


http://www.freedman-chicago.com/ec4i/Intrastate-Securities-Exemptions.pdf


Financing Options for StartupsOption Advantages DisadvantagesOFF-PLATFORM Commercial loans Community-oriented, build relationship with lender Must have reliable cash flow and/or collateralAngel investors Strategic investors, negotiable deal terms (vs. CF) Angels may be hard to find in smaller citiesVenture capital Smart money, bigger pile of capital VCs usually want fast growth, management

control; focus on tech, healthcareON-PLATFORM Rewards-based CF Not regulated by SEC, huge audience Mainly arts, entertainment, gadgetsPeer-to-peer (marketplace) lending

Fast approval, lower interest rates than banks for unsecured loans

Funding limit often less than $35k; repayment period 3-5 years

Regulation A+ “Mini-IPO” raises up to $50 million without blue sky review (Tier 2), test the waters

Requires SEC filing (“offering circular”) & approval

Regulation D, Rule 506(b) Traditional “quiet deals,” companies must have substantive pre-existing relationships with investors, accredited investors can self-certify on-platform

No general solicitation

Regulation D, Rule 506(c) General solicitation OK Issuer must verify accredited investor statusTitle III (Reg CF) Attract many affinity investors, including unlimited

non-accreditedRaise limit $1 million, expensive reporting requirements, crowded capitalization table

Intrastate Raise limits higher than Title III in 16 states ($4 million in IL)

In-state investors only

More About The Faculty D

[email protected] FREEDMAN

David M. Freedman has worked as a journalist since 1978, primarily in the fields of business, law, and personal finance. He has served on the editorial staff of The Value Examiner (NACVA) since 2005, focusing on business valuation and forensic accounting. He is a columnist for Accredited Investor Markets (AIMkts.com). Dave is a coauthor of Equity Crowdfunding for Investors: A Guide to Risks, Returns, Regulations, Funding Portals, Due Diligence, and Deal Terms (Wiley & Sons, 2015).



ALEX [email protected]

Alexander J. Davie is a corporate and securities attorney in Nashville, Tennessee. Many businesses look to Alex as their outside “general counsel” for day-to-day legal needs as well as their trusted adviser on high-stakes transactions such as capital raising, partnership buyouts and disputes, technology transactions, and mergers and acquisitions. His first goal is to provide clients with responsive service and candid and decisive legal advice for the difficult choices they often face. Alex frequently works with technology companies, including startups and emerging growth companies, and with private investment funds such as private equity, venture capital, and hedge funds.



CHARLIE [email protected]

Charles Sidman earned a PhD at Harvard and had a full career of scientific research and teaching at Harvard Medical School, the Basel (Switzerland) Institute for Immunology, the Jackson Laboratory in Bar Harbor, Maine (where he still resides), and as a retired professor of Molecular Genetics, Biochemistry and Microbiology at the University of Cincinnati College of Medicine. He also earned an MBA from the University of Cincinnati, and was adjunct Professor of Management in its College of Business.

Today he manages the innovative venture fund ECS Capital Partners, which he started, and continues as an active angel investor and founding member of the Angel Capital Association. He is past president of the Crowdfunding Professional Association, the non-profit umbrella trade group for the crowdfunding industry.




ANDREW [email protected]

Andrew D. Stephenson, VP of Product Management and Strategy for CrowdCheck, has a wealth of experience assisting companies with online offerings of securities. Since joining CrowdCheck in January 2013, he has conducted numerous due diligence reviews, drafted disclosure materials, and helped companies identify and work through issues with their corporate governance and securities law compliance. Andrew leads a team of analysts and regularly contributes to the national dialog surrounding innovation in capital formation.

Before joining CrowdCheck, Andrew was involved with evaluating internal company communications and reports as part of complex civil litigation matters. He has also worked for the United States Congress, where he evaluated and drafted policy on a range of issue areas.

Andrew graduated cum laude from the University of California, Hastings College of the Law. He is a member of the State Bar of California and the District of Columbia Bar. Andrew is also a happy husband, father, San Francisco Giants fan, and music lover.

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Published in June 2015

More information at http://www.ec4i.com

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Important Notes

• THE MATERIAL IN THIS PRESENTATION IS FOR GENERAL EDUCATIONAL PURPOSES ONLY.

• IT SHOULD NOT BE CONSIDERED LEGAL, INVESTMENT, FINANCIAL, OR ANY OTHER TYPE OF ADVICE ON WHICH YOU SHOULD RELY.

• YOU SHOULD CONSULT WITH AN APPROPRIATE PROFESSIONAL ADVISOR TO DETERMINE WHAT MAY BE BEST FOR YOUR INDIVIDUAL NEEDS.