STARTUP CROWDFUNDING: WHAT YOU NEED TO KNOW NOW

Kiran Lingam 1billionangels.com

David Rose CEO, Gust.com

DISCLAIMER

This slide deck and its accompanying presentation is not a substitute for professional legal advice. The opinions expressed herein are the solely the opinions of the authors and not of any law firm, employer or organization affiliated with the author. Nothing in this blog shall create an attorney-client relationship, nor is it a solicitation to offer legal advice. If you ignore this warning and convey confidential information in a private message or comment, there is no duty to keep that information confidential or forego representation adverse to your interests. Seek the advice of a licensed attorney in the appropriate jurisdiction before taking any action that may affect your rights.

• Legislative History

• Title I: IPO On-Ramp

• Title II: General Solicitation and Advertising

• Title III: Crowdfunding

• Title IV: Regulation A+ Offerings

• Title V: Maximum Shareholder Limit

The JOBS Act

TYPES OF CROWDFUNDING

Unregulated Regulated

Non-equity, creative project (Kickstarter)

Accredited Investor - Reg D (Microventures)

Charitable Donation (Causes)

Equity (or Debt) Crowdfunding (Crowdcube)

• Reg D offering; legal after July 4, 2012

• Advertising allowed if all purchasers are accredited or QIB

• Must take "reasonable steps" to verify accredited status

• Maximum shareholder limit increased to 2,000

• No individual or aggregate size limits

• Example: Medical device company raises $10,000 each from 1,000 doctors for a total round of $10,000,000 by advertising in medical journal.

Accredited Investor Financing

• No transaction fees unless registered broker-dealer

• Cannot hold customer funds or securities

• Can charge fees for "ancillary services" (diligence, standard documents, shareholder management)

• Broker-Dealer Platform: Microventures,

• Non Broker-Dealer Platforms: Angelist, Gust

Accredited Investor Financing

• SEC has until January 1, 2013 to implement rules; not legal yet!

• New securities exemption

• Raise up to $1 million per year from an unlimited number of (unaccredited) investors

• Must use a funding portal or broker

• Maximum individual investments. For an investor with annual income or net worth:

• <$100,000, the greater of $2,000 or 5% of their annual income or net worth

• >= $100,000, the greater of 10% of their annual income or net worth, up to$100,000

Crowdfunding

• Identifying information of issuer, directors, officers and 20% owners

• Business plan

• Financial statements (based on size of offering)

• Transaction details

• Price or method of determining price (reverse auction ok)

• Target financing amount, financing deadline and regular progress updates

• Use of proceeds

• Risk factors

• Description of Ownership Structure (including dilution and other risks)

Issuer Disclosure

• No advertising of financing except for notices directing investors to the broker or funding portal

• No compensation for third parties to solicit investment through the portal unless such compensation is disclosed in communication

• Must file annual financial statements and result of operation reports with SEC and investors

• Must provide Investors with final right to rescind investment after all disclosure and final terms prior

Issuer Restrictions

• An intermediary in a "crowdfunding transaction" (e.g. a website)

• Must register with SEC and become a member of FINRA

• No broker-dealer registration

• Can take transaction based fees (e.g. percentage of financing)

• Crowdfunding Portals (that are not broker-dealers) may not:

• Offer investment advice

• Solicit purchasers, sales or offers to buy securities displayed on it site

• Compensate employees, agents or others for such solicitation or based on sale of securities

• Hold, manage, possess, or handle investor funds or securities

Crowdfunding Portals

• Make issuer disclosures available to SEC and investors at least 21 days prior to any sale

• Take measures to reduce risk of fraud, including background checks on each director, officer and 20% owner

• Ensure that no funds are provided to issuer until target offering amount is met

• Take appropriate steps to protect privacy

• Directors, officers, employees of portals may not hold equity in issuer listed on its site

Crowdfunding Portals

• Must take reasonable steps to ensure investors to not violate individual investment limitations across all portals

• Charged with implementing investor protections as directed by SEC, including ensure each investor

• reviews investor-education information with standards established by SEC • positively affirms understanding of risk • answers questions demonstrating knowledge of risk

• Cannot buy potential investor lists or information

• May compensate third parties to solicit investors if such compensation is disclosed in the solicitation

Crowdfunding Portals

• Crowdfunding securities restricted for 1 year, except sales to the issuer or accredited investors or for estate planning

• Does not apply towards 2,000 shareholder limit unless transferred (pending SEC clarification)

• No restriction on types of interests: common stock, preferred stock, convertible notes

• Holding company structure (pending SEC rules)

Crowdfunding Securities

• Liability for untrue statement (or omission) of material fact

• Burden of proof on issuer to show issuer did not know, and in exercise of reasonable care, could not have known

• Crowdfunding investor may recover investment less proceeds

• Directors, officers, offerors and sellers are personally liable

• Class action suits?

• D&O Insurance?

Liability

• Broker-dealer

• Investment Advice

• Software (insource or outsource)

• Vertical / Differentiation

• Issuer Diligence

• Investor Verification

So you want to create a portal?

Should I Crowdfund my startup?

Pros Cons

• Customer Base

• Community

• Access to Capital

• Future Financing

• Liability

• Disclosure

• Costs

• Rise of the Super Angel

• Gust and Angelist direction

• Portal proliferation followed by consolidation

• Fraud mitigated by crowd

• Democratization of Capital

• Effect on venture capital

• "Mom and Pop" Crowdfunding

Predictions

• Crowdfunding is not legal yet! January 1, 2013

• General solicitation to accrediteds is not legal yet! July 4, 2012

• Simultaneous crowdfunding and angel financing?

• Cannot crowdfund an investment company (no blind pooling)

• Notice of crowdfunding offering

• Subsidiaries or related companies

• Listing on multiple portals

Frequently Asked Questions

QUESTIONS?Kiran Lingam

kiranlingam@gmail.com Twitter : 1billionangels

David Rose CEO, Gust.com