Tips for Crowdfunding for Business 2019
Crowdfunding offers entrepreneurs to raising capital or money from social networks such as Facebook, LinkedIn, Twitter, and elsewhere. This blog explores the 20+ best Tips for Crowdfunding for Business in 2019.
Is Crowdfunding Right for Your Company?
Generally, if you want to engage in traditional project crowdfunding (raising money for a specific project as opposed to raising money for a company), there isn’t much preparation involved. All you have to do is:
Select the right crowdfunding portal (one that specializes in the type of project you want to launch)
Develop a short description of the project, how much money you need, why you deserve it, and the minimum amount you want to raise within a specific timeframe
Post the description online
Wait for the money to roll in
There is no requirement that you have expertise or experience in the type of project (although as a practical matter it is difficult to obtain financing online without that) or even that you have a clear vision or prototype of the project once it’s developed. All you need is an idea or even just a dream, and if you catch the imagination of enough people online, you can get crowdfunded.
However, that will not be the case with crowdfunding under Title III of the JOBS Act.
Crowdfunding Is Not for Everyone
Although theoretically any type of company, at any stage of development, can seek crowdfunding under Title III, as a practical matter only select companies will be able to do so effectively.
If you are thinking about launching a crowdfunding campaign under Title III, you will need to ask yourself three specific questions:
1. Is my company the right type of company to receive investments through crowdfunding?
2. Does my company meet the requirements of the JOBS Act and Regulation Crowdfunding?
3. Am I willing to put up with dozens, if not hundreds, of demanding, immature, possibly crazy individual investors with unrealistic expectations if our Title III crowdfunded offering is successful?
Let’s take a closer look at each of these questions so you can figure out if Title III crowdfunding is right for you.
Is Your Company Right for Crowdfunding?
The good news is that Title III crowdfunding opens the private equity markets to companies that traditionally have had trouble finding early-stage investors in the past. For example:
Companies organized as LLCs or other pass-through legal entities
Companies engaged in retail, service, or other industries that don’t involve high technology
Companies that are looking to franchise their concepts
Companies whose business models are not scalable, such that each dollar of investment produces only a limited amount of revenue or profit
The bad news is that only a relatively small number of companies will be able to qualify for crowdfunded offerings of their securities under Regulation Crowdfunding. There are two primary reasons for this.
First, the cost of putting together the offering statement, financial statements, and other documents required by the SEC and the funding portals that will manage the offerings will probably be beyond the reach of most start-ups or concept companies that haven’t yet put together a solid business plan.
Second, because of the tremendous liability Regulation Crowdfunding imposes on funding portals, most of these portals will be extremely nervous about dealing with a company that they suspect doesn’t have its act together yet.
As an accountant friend of the author put it, “No one will want to be the first portal that gets sued or prosecuted by the SEC because they were negligent in picking the right issuers or reviewing their offering materials.”
As an issuer, you can expect that most funding portals will be looking at your company and your written documents with an electron microscope, looking for even the tiniest flaws that may expose them to liability.
That said, if your management team is disciplined and willing to put in long hours on legal and accounting paperwork, there is no reason why even a concept company (one with little more than an idea, although a well-articulated one with a high likelihood of success if proper funding is obtained) cannot obtain crowdfunded capital under Title III.
Before you consider seeking Title III crowdfunded money, your company needs to put together a solid business plan.
Hundreds of blogs have been written on the subject of business plans, a few of which are listed in the “Suggestions for Further Reading” section near the end of this blog, but putting together a solid business plan boils down to answering twelve specific questions:
1. What is the product or service we are looking to develop?
2. Who are the customers for our product or service, and what needs and wants do they have that our product or service will answer?
3. Why will customers buy our product or service (in other words, how will our product or service appeal to the fears and passions of the targeted markets)?
4. How will we get our message across to our targeted markets and get the product or service into people’s hands (in other words, what advertising and promotion tools will be used to market and distribute our product or service)?
5. Who are our competitors, both direct (people and companies doing the exact same thing) and indirect (people and companies doing a different type of thing that solves the same customer problems our product and service does or that renders our product and service obsolete)?
6. Why is our product or service better than any competing product or service on the market or soon to be on the market?
7. Do we have the right people on our management team to develop our product or service and get it into the market in a reasonable amount of time?
8. Are the people on our management team and advisory board (an informal collection of business mentors) likely to impress potential investors with their credentials and expertise?
9. What are the resources (money, office space, equipment, people,
professional services, time) we will need to launch this product or service, and how much will we have to spend on each resource during the first one to two years of our operations?
10. When will this company break even (generate enough revenue from sales to cover basic operating expenses on an ongoing basis) and thereby become self-sustaining?
11. If our company is successful, what will our exit strategy be (launch an IPO or sell out to a large public corporation interested in acquiring our product or service)?
12. What are the legal and economic risks involved in this business, can we ensure against them, and if so, how much will that insurance cost?
Okay, that’s probably about fifteen or sixteen questions, and other, more-specific subquestions fall under each of the ones above, but you get a general idea.
If you and your company don’t have compelling answers to each of these questions and cannot articulate them in a written business plan, your company is not ready for Title III crowdfunding. It’s that simple.
Qualifying Under the JOBS Act and Regulation Crowdfunding
To qualify for crowdfunding under Regulation Crowdfunding, the issuing company must be incorporated or organized under the laws of a U.S. state or territory. Unincorporated businesses cannot qualify for Title III crowdfunding.
The vast majority of Title III issuers will be C corporations and LLCs.
Public companies do not qualify for Title III crowdfunding under Regulation Crowdfunding, nor do companies based in foreign countries (although foreign companies can invest in U.S.-based crowdfunded offerings).
Companies that have engaged in any of the “bad acts” described in Rule 506(d) of Regulation D and companies whose principals have engaged in any bad acts are disqualified from Title III crowdfunding.
As are issuers who concluded successful Title III crowdfunded offerings in the past but failed to file the required annual reports and other documents required to be delivered to crowdfunded investors on an ongoing basis.
Investment companies (such as mutual funds and hedge funds) do not qualify for Title III crowdfunding, as otherwise there is a risk Wall Street firms would form crowdfunded pools of crowdfunded companies, or create holding companies that would invest in dozens if not hundreds of crowdfunded companies.
This is unfortunate in some respects, as enabling investors to pool their investments in a single entity that would coordinate communications between a crowdfunded company and its investors would probably be a beneficial thing and would eliminate many of the “time vampire” issues of investor communications.
But as this prohibition is contained in Title III of the JOBS Act itself (not Regulation Crowdfunding), there is probably nothing the SEC can do to correct that as this blog goes to press.
Blank-check or shell companies formed for unspecified purposes or to acquire other companies cannot make offerings under Title III.
Any company seeking crowdfunding under Title III must have an actual business plan, not a speculative one or one couched in alternative terms (for example, “if we raise $100,000 we will do X, but if we raise $250,000 we will do Y instead”).
However, it is possible that Title III crowdfunded offerings may be tiered based on the amount of money raised and the planned use of proceeds at different levels of investment (for example, “if we raise $100,000 we will do X, but if we raise $250,000 we will be able to do Y and Z as well”).
Foreign companies cannot take advantage of Title III crowdfunded offerings. Regulation Crowdfunding is not clear on this point, but that may include U.S.-based subsidiaries of overseas companies.
Finally, public companies cannot make Title III crowdfunded offerings. If they could, there would be no need for SEC registration of public offerings, would there?
Handling Your Crowd of Investors If the Offering Is Successful
This biggest challenge in Title III crowdfunded offerings of securities and the biggest potential obstacle to the development of a viable crowdfunded securities market have nothing to do with the offering process itself but rather what happens after a successful crowdfunded offering is completed.
Once your company successfully completes a Title III crowdfunded offering, it can’t just pocket the money and say “See ya!” to the dozens or perhaps hundreds of individuals and companies that invested in the offering.
Once you sell a piece or percentage of your company to an investor (voting common or preferred stock for a corporation, voting membership interests for an LLC), they have the right to receive notice of investor meetings and vote on any matter for which investor approval is required by state law where the company is incorporated or organized.
Even if a company’s crowdfunded investors are issued nonvoting securities (non-voting common or preferred stock for a corporation, nonvoting membership interests for an LLC), Regulation Crowdfunding requires they be given annual reports and other financial statements, and state corporation and LLC law often requires they be given advance notice of certain major decisions affecting the company.
If you fail to give them the required notice, that failure may invalidate the decision, even though the holders of your voting securities voted overwhelmingly in favor of the measure you proposed to them.
Even if your crowdfunded investors have no rights at all under your state corporation or LLC law, there is nothing to prevent them from calling your office day and night asking silly questions, making unrealistic or inappropriate demands on your company, or offering unsolicited (and sometimes stupid) advice.
That is the price of having an outside investor in your company, of course, but that price is a lot higher in a crowdfunded offering of securities, for two reasons:
1. There are an awful lot more of them.
2. They are less sophisticated than investors in traditional accredited-investor private offerings of securities and therefore more likely to act unpredictably, irresponsibly, or unprofessionally.
Investors can be time vampires, requiring an inordinate amount of your management time that is much better spent developing and launching your company’s products and services.
Most public companies have several employees devoted exclusively to shareholder communications or investor relations. As a start-up or early-stage company, you cannot afford to dedicate employees to those tasks.
Yet if you ignore your investors, even if Regulation Crowdfunding technically allows you to do so, you do that at your peril.
It’s no secret that the Internet can sometimes be a very volatile, nasty, and dangerous place, where little problems and hiccups can be blown quickly and exponentially out of proportion by a negative, viral campaign on social media launched by one angry, self-appointed vigilante or a handful of them.
Probably the worst thing that can happen to a company that has successfully raised money via Title III crowdfunding is to see its crowdfunded investors turn into a disgruntled lynch mob that says nasty things about the company and its management online.
If you do decide to launch a Title III crowdfunding campaign for your start-up or early-stage company, you will have to decide if you are willing to put procedures in place to manage and communicate with your crowd after the offering is over. If you are not, then Title III crowdfunding is not for you.
Stick with accredited investors or traditional friends-and-family offerings. Your elderly Aunt Irma who loaned you $5,000 isn’t likely to go viral on Yelp.com because she wasn’t invited to your company picnic.
Preparing Your Company for a Crowdfunded Offering
Having decided that your company is a good candidate for a Title III crowdfunded offering, you will need to do several things before you begin drafting your offering statement, contacting funding portals.
Choose the Right Legal Entity
Regulation Crowdfunding requires that an issuer of crowdfunded securities be “incorporated or organized.” Unincorporated businesses such as sole proprietorships and partnerships do not qualify for crowdfunding.
That leaves only three types of legal entities that legally qualify for Title III crowdfunding:
1.Regular or C corporations
2.Subchapter S corporations
3.Limited liability companies
Regular or C Corporations
A corporation is a taxable entity; when you form a corporation it is as if you have had a baby and the baby pays taxes from the day it’s born. It’s called a C corporation because it is taxed under Subchapter C of the Internal Revenue Code of 1986.
What’s Good About a C Corporation? In two words: limited liability. Generally, the owners of a C corporation (called shareholders or stockholders) are liable only for the amounts they contribute (or agree to contribute) as capital to the corporation but will still be liable for their own negligence or stupidity.
EXAMPLE 1: A and B are shareholders of ABC Corporation. A runs over someone with his car while on the corporation’s business. The injured party may sue the corporation and win a judgment up to the number of the corporation’s assets (because that’s all it has).
The injured party may sue A in his individual capacity and take A’s house away. But the injured party cannot sue B in any way unless it can be shown that B contributed actively in some way to the injury (for example, B served A too much liquor, which caused A to be intoxicated at the wheel).
EXAMPLE 2: A and B are shareholders of ABC Corporation. ABC Corporation enters into a contract with a supplier to buy ten thousand widgets and then discovers that it doesn’t have enough money to pay for the widgets.
ABC Corporation breaches the contract, and the supplier uses. The supplier may sue the corporation and win a judgment up to the number of the corporation’s assets, but the supplier cannot sue A or B, even if A or B actually signed the contract as an officer or employee of ABC Corporation.
What’s Bad About a C Corporation? C corporations are expensive to form. Legal expenses and filing fees are usually between $1,000 and $1,500 to form a corporation in most states.
They are also expensive to keep alive: if a corporation fails to pay taxes for X consecutive years or fails to file a report (and pay a fee) every Y years with the secretary of state's office, the attorney general comes along and dissolves the corporation (and your limited liability along with it).
To add insult to injury, you are not informed that this has been done, so you continue blissfully doing business, thinking you have a corporation when you really don’t.
If you don’t use the corporation and treat it with respect, you lose the corporation. People suing you for something your corporation did will always try to argue they didn’t know they were dealing with a corporation.
If you conducted business in your own name, wrote checks from your own checking account, and accepted money in your own name that should have gone to the corporation, you can’t argue it was really the corporation that should be sued and not you personally. Lawyers call this piercing the corporate veil.
C corporations involve lots of paperwork
When you have a corporation, you don’t do anything; the corporation does everything. This means that for a corporation to do anything, the shareholders have to prepare written documents authorizing the directors of the corporation to do the thing, and the directors have to prepare written documents authorizing the officers of the corporation to do the thing.
Resolutions are a pain in the neck, but if you don’t do them you will be tempting the courts to say you didn’t treat your corporation with the proper respect so creditors are allowed to get at your personal assets.
Dealing with taxes is somewhat complicated when you have a C corporation. Because corporations are taxable entities, they file their own returns (IRS Form 1120, due March 15 of each year for a calendar year corporation) and pay taxes separately from the owners (albeit at a lower rate than you do, in most cases). This means that any income a corporation earns is taxed twice.
EXAMPLE: XYZ Corporation has two stockholders, A and B, and makes $100 in net income for a particular year. The corporation pays 15 percent to Uncle Sam as federal income tax and blogs the remaining $85 as net after-tax earnings.
XYZ Corporation then resolves (remember those minutes?) to pay A and B the $85 in the form of a dividend, and distributes $42.50 to each of A and B.
A and B, each has to report that $42.50 as income on Form 1040 for the year and pay taxes on that $42.50 at his or her individual rate.
The result? If A and B are in the top tax bracket, that $100 in corporate income has dwindled to about $26 in each of A’s and B’s hands after federal income taxes. Add state and local taxes to this calculation, and the tax bite becomes much larger.
The C Corporation as a Crowdfunding Vehicle. If you are planning to raise capital in an accredited-investors-only offering under SEC Rule 506(c) and Title II of the JOBS Act, you are almost certainly going to have to organize your company as a C corporation. Why? There are two basic reasons:
1. Professional investors and angel investors normally like to receive preferred stock in the companies they invest in, and S corporations, as we can see below, cannot issue preferred stock. While LLCs can legally issue preferred membership interests, the mechanics are quite cumbersome and awkward to draft in legal language.
2. When sophisticated or professional investors see the LLC designation after a company name, they tend to think “small-time, mom-and-pop, will never grow big.”
This is a false view, as there is nothing in the law to prevent an LLC from growing big or even eventually going public. The bias against LLCs, however irrational, is strongly felt within the investment community.
Accordingly, a new business that plans to seek venture capital or private equity funding (angel money) within the first one to two years of its existence should be set up as a corporation, preferably in a state like Delaware that offers a number of advantages to venture-capital-backed companies.
C corporations are also an ideal vehicle for a Title III crowdfunded offering because of the limited liability they offer and the opportunity to create a special class of securities for your crowdfunded investors. Also, as a matter of optics, many people in the investing community take corporations more seriously than they do LLCs.
Subchapter S Corporations
An S corporation is the same as a regular or C corporation with one important difference: it is not taxed by the federal government. This means that the S corporation is taxed just like a general partnership: profits, losses, and other tax benefits flow through to the corporation’s shareholders and are taxed on their individual Form 1040 tax returns.
But with the powerful advantage that stockholders in an S corporation have limited liability, unlike partners in a general partnership, who are personally liable for everything that happens in the partnership business.
However, some state and local governments (including New York City) do not recognize S corporations. This means that S corporations with offices in such states or municipalities are taxed twice at the state or local level.
What’s Good About an S Corporation? As a C corporation, there is a limited liability: shareholders are not personally liable for the debts and obligations of the corporation.
Moreover, the corporation is not taxed by the federal government, although it does file its own tax return (Form 1120-S, due on March 15 each year; virtually all S corporations are required to use the calendar year for accounting purposes).
Taxation is also favorable. Because the S corporation does not pay taxes, profits, losses, and other tax benefits flow through to the corporation’s shareholders, who report these on their personal Form 1040 federal income tax returns.
What’s Bad About an S Corporation? Because S corporations are taxed like partnerships, S corporations have what is called a phantom income problem.
This means that, unlike C corporation shareholders, who are taxed only on amounts the corporation distributes or pays out to them, S corporation shareholders must also pay taxes on their pro rata (proportionate) share of the corporation’s profits and losses that were not distributed to them.
EXAMPLE: XYZ Corporation, a subchapter S corporation, had $100,000 in taxable income this year. The corporation has two shareholders, A and B. A owns 60 percent of the corporation’s shares, and B owns 40 percent.
The corporation did not distribute any cash or dividends to either shareholder. At the end of the year, A must report $60,000 as income on his federal income tax return (60 percent of $100,000), and B must report $40,000 (40 percent of $100,000) as income on his federal income tax return.
Subchapter S corporations were originally designed only for small businesses; they were never intended to go big or launch an IPO. Accordingly, S corporations have lots of icky little rules to comply with if they don’t want to be taxed as a regular or C corporation.
(Note: if the IRS takes away your S corporation status you don’t—repeat, don’t—lose your limited liability; the worst thing that happens is that you’re taxed as a regular or C corporation).
Only natural human beings can be stockholders in an S corporation (no corporations, LLCs, or trusts, with only one or two limited exceptions). S corporations can’t have more than one hundred stockholders (that alone puts Title III crowdfunding out of reach for S corporations).
S corporations can have only one class of common stock (no preferred stock, which alone puts Title II accredited-investor-only financing out of reach for S corporations).
The shareholders of an S corporation must be U.S. citizens or green card holders (permanent resident aliens of the United States).
The S Corporation as a Crowdfunding Vehicle. Generally, it’s a bad idea. Most accredited investors involved in a Title II private placement under Rule 506(c) want to receive preferred stock or some other form of senior security, which S corporations cannot issue as they are limited to a single class of security.
The one-hundred-investor limit and the prohibition on foreign and corporate shareholders will also put Title III crowdfunding out of reach for S corporations.
If your business is currently organized as an S corporation, you should discuss with your accountant or tax adviser the possibility of opting out of an S corporation and becoming a C corporation before launching any sort of crowdfunded offering.
Keep in mind; however, that if you do convert to C corporation status and the crowdfunded offering goes nowhere, you will not be able to elect to be taxed again as an S corporation for three consecutive tax years.
Limited Liability Companies (LLCs)
Since the early 1990s, the LLC has become the legal entity of choice for many small businesses and early-stage technology start-ups. What is an LLC? Well, it’s basically an S corporation without all the icky little rules that make S corporations unattractive for a lot of folks.
What’s Good About an LLC? Owners of an LLC (called members) have limited liability. If A and B are members of an LLC and B runs someone over with her car while on LLC business, B may lose her house, but A will not lose his house unless A actively contributed to the injury.
Like partnerships, LLCs are simple to operate. There is no need to prepare resolutions or minutes to authorize people to do things (although banks and some other folks may still require you to do resolutions because they haven’t gotten the idea yet)—they just do them. If the idea of doing legal paperwork makes you want to gag, the LLC is the legal entity for you.
The costs of starting up an LLC are likely to be much less than forming a C corporation or an S corporation—$400 to $600 in most states.
LLCs are taxed like partnerships, so there is no double taxation of an LLC’s income. Everything flows through to the owners of the LLC, who report their shares of the LLC’s income on their personal federal income tax returns, the same as shareholders in an S corporation.
However, as was the case with S corporations, owners of an LLC must pay taxes on phantom income the LLC earns that is not distributed to them in the form of cash.
If you are doing a lot of overseas business, the LLC format may give you an edge on your competition. Most foreign business organizations (such as the German GmbH and the Italian S.r.l.) are a lot closer in structure to an LLC than they are to a partnership or corporation;
With an LLC, you can give your managers the same titles as their European or Asian counterparts (Europeans especially cannot understand that in America one can be a “director” of a corporation and have absolutely no power to bind the corporation; in Europe, business organizations are managed by their “directors,” not by officers or mere employees).
What’s Bad About an LLC? Really not a lot. While not actually flawless, LLCs are the closest thing to a perfect business organization the law has come up with to date. Limited liability, favorable tax treatment, and easy to operate: who could ask for more?
There are a few negatives, however.
It may be difficult for existing businesses to convert to LLC status: corporations and their shareholders incur double taxation upon liquidation, while general and limited partnerships formed to acquire or hold title to real estate (as many are) may incur transfer taxes and other fees on converting to an LLC.
If your business is high tech or will seek outside capital within the first twelve to eighteen months of operations, be aware that many investors (wrongly) associate LLCs with small business, mom-and-pop, no growth potential.
While this perception is unfair, it is widespread, and you may want to consider becoming a C corporation instead (preferably in a high-visibility state like Delaware).
LLCs are not recommended for businesses that will have physical locations in New York State. When New York adopted its LLC statute in 1994, it included a burdensome publication requirement that drives up the costs of forming a New York LLC.
LLCs in New York are required to publish a legal notice in two newspapers—one daily and one weekly—in each county in New York where the LLC maintains an office of the business.
In most upstate counties, the cost of doing this publication is in the $200 to $300 range. In New York City, however, the cost can be upward of $2,000 to $3,000.
Also, LLCs located in New York City are subject to that city’s unincorporated business tax. Overall, it may be less expensive to form a corporation or S corporation in New York State than an LLC.
A growing number of states are imposing special taxes or minimum taxes on LLCs and other unincorporated business organizations. For example:
California and Rhode Island have a minimum $800 income tax on LLC profits, payable even if the LLC had no profits.
Connecticut requires domestic and foreign LLCs to pay a business entity tax of $250 every two years whether or not they make money.
The LLC as a Crowdfunding Vehicle. One of the main goals of the JOBS Act was to expand the private equity market to companies that could not obtain financial support under the previous rules. The vast majority of issuers seeking traditional venture capital were high-tech ventures organized as corporations.
But in theory, there is no reason why an LLC couldn’t raise capital under either Title II or Title III of the JOBS Act. In recent years, some attorneys have pioneered the creation of corporate mimic LLCs for their clients.
These LLCs continue to be taxed as if they were partnerships and are otherwise subject to the LLC statutes, which generally are more flexible and less restrictive than the corporation laws, but they are structured to look exactly like corporations. For example:
The corporate mimic LLC would be structured with “units of membership interest” (think shares of stock), which could be voting or nonvoting. The LLC could be authorized to issue “preferred” units of membership interest with terms and provisions identical to those of preferred stock in a corporation.
The LLC would be managed by a board of managers (think the board of directors).
The board of managers could delegate some of its responsibilities to officers with specific job titles and duties, just as in a corporation.
The LLC’s organizational document, called an operating agreement, could provide that the LLC could incorporate any time the board of managers felt it was appropriate by merely swapping each unit of membership interest for one share of stock of the same class in the new corporation.
If you are organized as an LLC or desire the flexibility and informality of the LLC way of life, speak to your attorney about setting up a corporate mimic LLC that walks, talks, and swims like a corporation but isn’t really (or legally) one.
The Bottom Line on Legal Entities
If you and your advisers cannot decide on the best form of legal entity to engage in a Title II accredited-investor-only offering or a Title III crowdfunded offering, form your company as a C corporation. That structure gives you the most flexibility in putting together the offering and limiting the rights of your investor crowd once the offering is completed.
It is also what most sophisticated investors expect, and you will spend less time explaining the finer points of “Series B preferred equity units of membership interest” in an LLC.
If your company is currently organized as an S corporation, convert to a C corporation prior to launching the offering, as it will be virtually impossible for your company to maintain its S corporation status unless you restrict your crowd to fewer than one hundred individual investors who are U.S. citizens or green card holders.
Even then, you may have to give these folks voting shares of common stock in your corporation, which will not only dilute your ownership of the corporation but also your ability to manage the corporation’s business without outside interference from the crowd.
Still, Have Questions?
For a more thorough discussion of each of these entities and the advantages and disadvantages of each, consult the detailed outline titled “Demystifying the Business Organization” available as a free download from the author’s website at www.cliffennico.com.
This document will answer almost all of the legal and tax questions you should be asking when forming a legal entity for your business.
Decide Where to Incorporate, or Consider Reincorporating Somewhere Else
Generally, corporations and LLCs are best advised to incorporate in the state where their physical offices are located or where the business activities will actually be conducted. There is usually no point in incorporating in another state.
If your business is located in state X and you incorporate in state Y, your income will still be subject to state X taxes, so the state Y corporation or LLC will have to register as a foreign corporation or foreign LLC in state X and so end up being taxed by two states instead of one.
A corporation or LLC that wishes to take advantage of Title III crowdfunding may wish to reconsider that decision, however. Bringing on board dozens if not hundreds of crowdfunded investors changes the way corporations are governed, for better or worse, and it helps to be incorporated or organized in a state that has the most conducive rules for crowdfunded offerings of securities.
Here are some of the legal issues you will need to think of when selecting the right state of incorporation prior to launching a crowdfunded offering.
Franchise Taxes on Authorized Shares
When forming a corporation in virtually any state, you will be required to pay a tax (commonly called a franchise tax—on the permission, or franchise, of doing business with limited liability) when filing your articles of incorporation with the state.
This tax is based on the number of authorized shares of stock you designate in your articles of incorporation.
So, for example, in a particular state the tax could be one cent per share for the first ten thousand shares, one-half of one cent for the next ninety thousand shares, one-quarter of one cent for the next four hundred thousand shares, and one-tenth of one cent thereafter.
There is almost always a minimum franchise tax that must be paid, and sometimes (in nicer states) a maximum franchise tax as well.
This is traditionally one of the main reasons entrepreneurs like to incorporate their businesses in Delaware. Like virtually all states, Delaware has a franchise tax, but it allows corporations to calculate the tax in two different ways and pay only the lower amount of tax.
The two methods are known as the authorized shares method and the assumed par value capital method. Almost always, the assumed par value capital method results in a much lower tax than the authorized shares method.
Using the authorized shares method, a corporation would pay $35 up to the first three thousand shares, then $62.50 for the next two thousand shares, then $112.50 for the next five thousand shares, then $62.50 for each additional ten thousand shares, up to a maximum of $165,000.
To use the assumed par value capital method, you begin by determining your corporation’s total gross assets (basically the corporation’s total assets as reported on its Form 1120 federal income tax return) for the fiscal year. The calculation is fairly involved and is easier to illustrate that it is to explain in words.
So here’s an example: Let’s say a Delaware corporation with one million shares of stock with a par value of $1, and two hundred fifty thousand shares of stock with a par value of $5, has gross assets of $1 million and issued shares totaling four hundred eighty-five thousand. Here’s how you would calculate the corporation’s Delaware franchise tax:
1. Divide the corporation’s total gross assets by its total issued shares carried to six decimal places. The result is the corporation’s assumed par. So: $1,000,000 assets ÷ 485,000 issued shares = $2.061856 assumed par.
2. Multiply the assumed par by the number of authorized shares having a par value of less than the assumed par. So: $2.061856 assumed par x 1,000,000 shares = $2,061,856.
3. Multiply the number of authorized shares with a par value greater than the assumed par by their respective par value. So: 250,000 shares x $5 par value = $1,250,000.
4. Add the results of 2 and 3 above. The result is the corporation’s assumed par value capital. Example: $2,061,856 + $1,250,000 = $3,311,956 assumed par value capital.
5. Figure the franchise tax due by dividing the assumed par value capital, rounded up to the next million if it is over $1,000,000, by 1,000,000 and then multiply by $250. So: 4 x $250 = $1,000.
Corporations that plan to engage in Title III crowdfunded offerings will need to have lots of authorized shares: at least one million and possibly as many as ten million.
Choosing the state with the lowest franchise tax for a large number of authorized shares will be critical to many start-up companies, especially those on extremely limited budgets.
One way to avoid the whole franchise tax issue, believe it or not, is to form a corporate mimic LLC and authorize it to issue voting and nonvoting units of membership interest. An interesting loophole in the law is that in virtually all states, franchise taxes are limited only to shares of stock in corporations.
The idea that LLCs could be set up to mimic the capital structure of corporations using units of membership interest did not occur to state legislatures when they drafted their LLC statutes in the 1990s.
They probably assumed that LLCs would be used only by small businesses managed by their owners and accordingly, would operate as partnerships in which owners have percentage interests in the LLC’s profits and losses rather than shares.
If that was the case, they certainly underestimated the creativity and shrewdness of your average corporate attorney.
As a result of this discrepancy between the two statutes, in virtually every state I’m aware of:
A corporation with one million authorized shares of common stock would have to pay a hefty franchise tax upon incorporation.
An LLC with one million authorized units of membership interest would not.
That loophole may well be closed in future years.
Until that happens, however, many companies seeking to avail themselves of Title III crowdfunding that does not want to (or cannot afford to) reincorporates in another state with a lower franchise tax may want to consider forming an LLC, at least temporarily, to eliminate their franchise tax exposure.
If the crowdfunded offering is successful, the LLC will then have plenty of money to convert into a C corporation and pay the franchise tax at that time.
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Next, look at the rights granted to shareholders in your state corporation statute. Generally, you want to be able to limit your crowdfunded investors’ rights as much as possible without jeopardizing the success of the offering.
You want (and need) their money, but you do not want their unsolicited advice, and you certainly do not want them to have the right to tell you how to run your company. Yet if these rights are granted by your state corporation law, you must honor them in your dealings with investors.
LLC statutes in virtually all states are much more flexible—the rights of LLC owners (called members) are generally not set out in the statute but rather in an operating agreement (similar to a partnership agreement) that you would prepare as one of your crowdfunded offering documents.
You or your legal counsel would set out the rights your investors would have when becoming members of your LLC and any limits on those rights. As part of the offering terms, investors would be required to agree to be bound by the terms and conditions of the LLC operating agreement.
Here are some basic rights state corporation laws grant to shareholders of corporations (both C and S).
Voting Rights. Virtually all state corporation laws grant shareholders the right to vote at meetings of shareholders and participate in the management of the corporation’s business unless these rights are denied in the articles of incorporation.
Most corporations have two classes of common stock, one of which (sometimes called Class A) carries with it the right to vote, while the other one (sometimes called Class B) does not.
The rights of each class of shares would be spelled out in the corporation’s articles of incorporation. The company founders and key executives would own the voting shares, while investors would own the nonvoting shares.
Inspection Rights. Virtually all state corporation laws grant shareholders the right to inspect and review the blogs and records of the corporation at reasonable times and on advance notice to the corporation.
Antidilution Rights. There are two types of antidilution rights shareholders can have:
1. Price based antidilution protection: the right to acquire additional shares (without paying for them) in the event the company makes a subsequent offering of securities at a lower valuation than the offering the shareholder subscribed to;
the number of shares would be enough so the shareholder would maintain its original percentage ownership of the corporation’s shares.
2. Structural antidilution protection: the right to acquire additional shares (again without paying for them) in the event of a stock split, stock dividend, or another event that increases the number of the corporation’s issued and outstanding shares other than a public or private offering of those shares.
Virtually all state corporation laws deny these rights to holders of a corporation’s common stock. These rights are almost certain to be included, however, in offerings of preferred stock, by agreement between the corporation and the investors.
As will be seen later in this blog, it wouldn’t make much sense to launch a crowdfunded offering of preferred stock, although an accredited-investor-only offering under Title II of the JOBS Act could easily be structured that way.
A shareholder with a preemptive right has the right to acquire additional shares (and pay for them, at the same price per share offered to subsequent investors) in the event the company makes a subsequent offering of securities at a higher valuation than the offering the shareholder subscribed to;
The number of shares would be enough so the shareholder would maintain its original percentage ownership of the corporation’s shares.
The right of Nonvoting Shareholders to Receive Notice of Shareholder Meetings. Even if shareholders in a corporation are denied the right to vote, they still may have rights under the state corporation statute.
For example, do they have the right to receive notice of meetings of the voting shareholders, even though they have no legal ability to influence the decisions made at those meetings?
In many states, the answer is yes, especially if the matter being voted on is a major change, such as a merger or acquisition, the sale of all or substantially all of the corporation’s assets, the amendment of the corporation’s articles of incorporation, or the corporation’s dissolution or liquidation (including a filing in bankruptcy).
The failure to give notice to your nonvoting shareholders within the time frame required by the statute (usually ten days before the meeting is held) could void any decision made at that meeting.
Shareholder Rights to Compel Dissolution of the Company. A handful of states allow owners of a significant minority percentage of a corporation’s shares (usually 10 or 20 percent) to petition a court to dissolve the corporation or force the majority shareholders to buy out their interest at fair market value.
If they can demonstrate they were “oppressed” by the majority shareholders. The definition of “oppressed” in these states is left up to the courts to decide.
Setting a Minimum Offering Amount
Regulation Crowdfunding allows you to set a single target amount for your crowdfunded offering, but most issuers will opt for the so-called min/max offering, with a minimum offering amount they will accept and (sometimes) a maximum offering amount.
Even without a maximum offering amount, it is recommended that you set a minimum offering amount to hedge your bets in case your target amount proves unrealistic.
So, for example, you can stipulate in your Form C disclosures that you are seeking to raise $500,000, but with a minimum offering amount of $200,000. If at least $200,000 is raised by the scheduled closing date, the offering is successful and will close even though you didn’t raise the full $500,000.
Keep in mind, though, that crowdfunded offerings are all or nothing: if the minimum offering amount you set has not been raised by the scheduled closing date, the offering has failed and your funding portal will be required to return any investments that have been made to the investors.
Setting a Maximum Offering Amount
You also have the option under Regulation Crowdfunding to set a maximum offering amount for your crowdfunded offering, such that the offering automatically closes if the maximum is reached prior to the scheduled closing date.
If your crowdfunded offering is wildly successful, and you raise the full amount of capital you need in twenty-one days or less, why would you want to shut off the spigots?
The only requirement in Regulation Crowdfunding is that you state in your Form C disclosures what you will do with any excess proceeds of your offering.
Also, by setting a maximum offering amount, if your offering is oversubscribed, you will be forced to decide which investors you will accept and which you will reject (or accept only a percentage of each investor’s subscription to keep everyone happy), and describe in your Form C disclosures how you will handle the oversubscription.
Managing and Marketing Your Crowdfunded Offering
You have prepared the offering documents for your Title III crowdfunded offering and found the perfect funding portal to handle the offering.
You have posted your offering documents to the portal, and either you or the portal has filed the Form C disclosures with the SEC. The portal has listed your offering on its website.
Congratulations! You have now reached the starting gate.
To get to the finish line, you now have to raise the money within your scheduled offering period.
While your funding portal has helped you get to the starting gate (indeed, you could not have gotten there without it), there are only a limited number of things the portal can legally do to help you get to the finish line.
At the end of the day, a successful crowdfunded offering depends entirely on you—the strength and sex appeal of your business plan, the extent, and depth of your social networks, and your ability to persuade prospective investors that you and your co-founders have a winner on your hands.
Your Offering Announcement: Where It Should Go, Where It Can’t Go
The success of any crowdfunded offering depends on your company’s ability (and its founders’ ability) to leverage its networks—on social media and otherwise—to find investors willing to shell out their hard-earned money in exchange for a piece of your company.
But you cannot—cannot—send these materials to your website, your social media pages, or anyone else. They exist only on the funding portal, and that is the only place online where people should be able to find them.
What you can send to your social networks—once and once only—is a notice, in the form prescribed by Regulation Crowdfunding, directing investors to the funding portal that is handling your offering.
Under Regulation Crowdfunding, the notice may contain no more than the following:
A statement that the issuer is conducting an offering, the name of the funding portal conducting the offering, and a link to the portal’s website.
The terms of the offering, including the number of securities being offered, the nature of the securities, the price of the securities, and the closing date of the offering period.
Factual information about the legal identity and the business location of the issuer limited to the name of the issuer, the address, the phone number, the website URL of the issuer, an email address for a representative of the issuer, and a brief description of the issuer’s business.
The notice would be similar in appearance to tombstone ads for initial public offerings permitted by the SEC’s Rule 134, except that the Regulation Crowdfunding notice must direct potential investors to the funding portal.
One of the guiding rules of Regulation Crowdfunding is that all communications between an issuer and investors during the offering period must take place not directly but only through the funding portal to ensure that all investors receive the same information at the same time and that all communications are available for public scrutiny in one place only.
Regulation Crowdfunding does not place restrictions on how the issuer distributes these notices. An issuer could place these notices on its own website, on various social media websites, or in newspaper and magazine ads (theoretically, the notice could be given over radio and television as well.
But the cost is likely prohibitive to most issuers), and the notice would direct those interested to the funding portal page, where they could access the Form C disclosures and supplemental materials necessary to make informed investment decisions.
Posts on Facebook, tweets on Twitter, LinkedIn updates, and the like that do not follow these limitations would violate Regulation Crowdfunding and legally disqualify your crowdfunded offering.
The prohibition on advertising the terms of the offering and related requirements apply to people acting on behalf of the issuer. For example, those acting on behalf of the issuer are required to identify their affiliation with the issuer in all communications on the funding portal’s platform.
Note also that if an issuer is offering securities under another SEC exemption at the same time as it is offering securities under Regulation Crowdfunding, the other offering might have to limit its advertising activities in order to avoid being integrated with the crowdfunded offering.
Advertising and Promoting Your Offering on the Funding Portal
Regulation Crowdfunding requires funding portals to maintain communications channels enabling issuers and investors to communicate directly with each other; such channels include chat rooms, discussion threads, frequently-asked-questions pages, webcasts, podcasts, and webinars.
Issuers are not only allowed but encouraged to communicate about the terms of the offering through these channels, as such communications will be publicly available for view by all potential investors.
Regulation Crowdfunding requires that any communication from the issuing company, its founders, or other management team members be clearly identified as such.
Also, any communications made on the portal by someone who has received compensation or a gift from the issuing company, its founders, or other management team members must state clearly the compensation or gift received by the person making the communication (for example, in paid reviews or testimonials by celebrities who receive gifts in exchange for their endorsement).
The downside, of course, is that funding portal channels may be used by people—such as competitors—who masquerade as investors in an effort to solicit confidential information about your company or post negative comments designed to frighten investors away from your offering.
Regulation Crowdfunding allows communications on funding portals only by investors who have opened accounts with the portal, and presumably, the portal will conduct the necessary due diligence to ensure that those claiming to be investors are indeed who they say they are. Still, despite a portal’s best efforts, a few bogus email accounts are likely to find their way over the threshold.
The only remedy offered for such activities is to do the same thing you would do if the posting appeared elsewhere on the Internet: find out who the posting is from and then out them publicly on the funding portal. Issuers should also notify the funding portal of any such activities in the hopes it may take action to ban offenders from the portal.
Advertising and Promoting Your Offering Elsewhere
In two words, you can’t. Other than posting or sending the Regulation Crowdfunding notice to folks, you cannot advertise or promote your offering other than through the funding portal.
Each member of your management team will need to be made aware of this requirement, as each no doubt will send emails, post on his social media pages, and generally do everything he can to get the word out about your offering to the maximum number of potential investors.
What you and your management team need to understand is that even a single communication in violation or Regulation Crowdfunding may disqualify the entire offering and force you to withdraw it from the funding portal, at great cost and potential embarrassment in the marketplace.
Can the Funding Portal Help You Advertise Your Offering?
In a word, no. A cryptic statement in Regulation Crowdfunding says that a funding portal is permitted to “highlight issuers or offerings based on objective criteria that would identify a large selection of issuers.”
The criteria used, however, cannot implicitly endorse one issuer or offering over others, and the criteria must be consistently applied to all issuers and offerings.
Some of the objective criteria noted by the SEC are the type of securities being offered, the geographic location of the issuer, and the number or amount of investment commitments made.
Similarly, a funding portal is permitted to provide search functions or other tools that allow investors and potential investors to search and categorize the offerings on the portal based on objective criteria.
In addition, Regulation Crowdfunding allows a funding portal to (1) categorize its offerings into general subject areas so a potential investor can find an offering, and (2) give potential investors the ability to create automated email notifications about offerings on the portal.
A funding portal is prohibited from endorsing specific offerings or receiving special or additional compensation for identifying or highlighting an issuer or offering on the platform. So, for example, promotions such as Kickstarter’s “Deals We Love!” highlights on its homepage would violate Regulation Crowdfunding.
Updating or Changing Your Offering Documents Midoffering
Time does not stand still once an issuer’s offering documents are filed with the funding portal and the SEC. Change happens, and an issuer will want to keep its offering materials as up to date as possible to reflect changes such as:
The addition of new members to the management team The withdrawal of any member of the management team
News articles and media coverage about the company that appear during the offering period
Changes in the company’s product and service offerings
News that may negatively impact the company’s success, such as a competitor’s introduction of a similar or identical product, or a regulatory change making the company’s service less desirable
Issuers are not only allowed but encouraged to update their offering documents. The supplemental materials may be updated at any time by posting them to the funding portal (and, perhaps, paying an additional fee—this will be up to each individual portal).
What If You Made a Mistake in Your Offering Documents?
Despite your best efforts to get everything right when filing your initial offering documents, you may find out later that something in the offering documents is wrong when you or a member of your management team discovers the error or when someone responding to your offering on the funding portal points it out to you.
When it comes to offering document mistakes, there are three levels of concern.
Under Regulation Crowdfunding, “insignificant deviations” do not affect a crowdfunded offering’s exemption under Title III. In order for a mistake to qualify as an insignificant deviation, an issuer must show that:
The failure to comply with a term, condition, or requirement of Regulation Crowdfunding was “insignificant with respect to the offering as a whole”
The issuer made a reasonable and good faith effort to comply with all terms, conditions, and requirements of Regulation Crowdfunding
The issuer did not know of the failure to comply, where the failure to comply with a term, condition, or requirement was the result of the failure of the funding portal to comply with the requirements of Regulation Crowdfunding, or such failure by the funding portal occurred solely in offerings other than the issuer’s offering
The SEC acknowledges that whether a deviation from the requirements would be “significant to the offering as a whole” will depend on the facts and circumstances of the offering and the deviation.
Given the serious penalties that could attach to a mistake in crowdfunded offering documents (including loss of the Title III exemption, liability to investors in a class-action lawsuit, action by state and federal regulators, and possibly personal liability for the offending company’s founders and management team members).
An issuer should never assume that a mistake is an insignificant deviation from the Regulation Crowdfunding rules. If the issuer can correct the mistake in time, it should.
A material mistake—any error that could potentially mislead an investor into making the wrong investment decision—should be corrected as soon as possible on the funding portal, and an announcement should be made on the portal’s communications channels.
If the mistake affected the issuer’s Form C disclosures, a formal Amendment to Offering Statement, using Form C-U, should also be filed on EDGAR.
When a material change to an issuer’s offering documents is announced, the following actions must take place:
The funding portal must send notice to committed investors that their investments will be canceled unless reconfirmed within five business days.
Investments that are not reconfirmed by their investors must be canceled.
Upon canceling an investor’s investment, the portal must send notice of cancellation to the investor, together with the reason for cancellation and a statement of the investor’s refund amount.
If the material change occurs within five business days of the offering’s scheduled closing date, the offering period must be extended for five business days to give investors sufficient time to reconfirm their investments.
If the mistake is so serious as to render the offering documents meaningless, seriously misleading, or in material violation of Regulation Crowdfunding, the issuer will need to consult with the funding portal and decide if the offering should be withdrawn.
Regulation Crowdfunding permits the issuer to withdraw an offering at any time and for any reason prior to the scheduled offering date. The issuer cannot, however, accept any money from investors (even if the offering has reached the minimum offering amount), and the portal must return all investor funds to investors.
Either the issuer or the portal would file Form C-TR on EDGAR announcing the withdrawal of the offering. It is also advised that the issuer and portal agree on a statement to be made to investors explaining the reason for the offering’s withdrawal so the issue is not precluded from making a subsequent crowdfunded offering with improved and compliant offering documents.
Closing Your Offering Early, or Quitting While You’re Ahead
Regulation Crowdfunding allows issuers to terminate their offerings before the scheduled closing date and take whatever money has been invested up to that point, as long as:
At least twenty-one days have elapsed since the offering commenced
Investors are given five business days’ notice of the new closing date
Investors are allowed to cancel their investments up to forty-eight hours prior to the new closing date
The issuer notifies investors whether or not it will continue to accept investments during the final forty-eight hours
At the time of the new deadline, the issuer has exceeded its target offering amount or minimum offering amount
Filing Progress Reports with the SEC: Form C-U
While an offering is pending, issuers (or the portals acting on their behalf) must file the following documents on EDGAR:
Any changes to the Form C Disclosures on Form C-A
A progress update on Form C-U within five business days after reaching 50 percent of the target offering amount
Another progress update within five business days after reaching 100 percent of the target offering amount
A final Form C-U to disclose the total amount of securities sold in the offering and the total amount of investment, among other things
Issuers may rely on a funding portal to make publicly available on the offering platform frequent updates about the issuer’s progress toward meeting the target offering amount, but an issuer relying on the portal’s progress reports must still file a Form C-U at the end of the offering to disclose the total amount of securities sold in the offering.
After Your Successful Crowdfunded Offering Is Completed
If your offering fails to reach its target amount (or the minimum offering amount you specified in your offering documents) by the scheduled closing date, the ball game’s over. The funding portal takes down your listing, those who invested in your offering get their money back, and you and your management team go back to square one.
If your offering reaches its target amount within the specified offering period, congratulations! I predict you and your co-founders will be enjoying a very wild (and well deserved) celebration indeed. Just make sure you don’t use any of your investors’ money to fund the party (they really, really don’t like that).
And don’t celebrate for too long. You and your management team have lots more work to do.
Does the Portal Handle My Type of Company?
Most funding portals will be focused on technology-related companies, for three reasons:
1. That’s what the funding portal’s founders know and understand (keep in mind always that funding portal executives are entrepreneurs just like yourself. Most will be coming from venture capital backgrounds and accordingly will be more familiar with tech companies than other issuers).
2. Tech companies generally have higher valuations and therefore higher offering amounts (leading to greater commissions for the funding portal) than other issuers.
3. Most serious investors (angels and venture capitalists) will be focused on tech companies and other scalable businesses to the exclusion of everyone else.
However, one of the great selling points of Title III crowdfunding is that it opens up the securities markets to retail, service, distribution, franchise, and other companies that have not historically had an easy time attracting investors. It is not inconceivable that specialized funding portals may emerge to focus on these nontraditional issuers.
Is the Portal Handling Other Issuers in the Same Industry (Is It Vertical)?
Generally, you want to work with a funding portal that understands your industry and is handling offerings for other companies in your industry, for two reasons:
1. They are in a better position to vet your offering and point out areas where your offering documents may need improvement.
2. They are more likely to attract investors who are interested in your specific industry.
The downside, of course, is that you may find your offering being listed shoulder to shoulder with an offering by one of your competitors. That is great for investors, of course, as it permits side-by-side comparison of different offerings by similar companies, but is highly stressful for the participating issuers, who may find themselves in a beauty contest to attract the best investors.
In such a situation, competing issuers will be under pressure to outdo the others in their offering terms and conditions (because your offerings are publicly available for view online, they can see yours and you can see theirs), with a greater risk of fraud or misstatement if one or the other competitors promote its offering too aggressively.
It can be a difficult decision to make: is your company better off being the only one in its industry listed with a particular portal (and therefore more likely to stand out) or being one of many similar companies handled by a portal known for its expertise in that industry (and therefore more likely to attract the best and most knowledgeable investors in that industry)?
Does the Funding Portal Have Lots of Investors On Board?
Not only issuers but investors are required to list with funding portals. The difference is that while investors may register with more than one portal, issuers are limited to one portal for their crowdfunded offering.
While funding portals will be prohibited from providing you with personally identifiable information about their investors—for fear you will try to contact them directly and circumvent the portal’s role as intermediary.
They probably will offer aggregate information about the number of investors that have registered with them, the percentage of accredited investors, and other statistical information that may help you make a more informed portal selection decision.
Is Portal Marketing Itself Aggressively?
Remember that funding portals are start-up companies just like yours, competing with other portals for business and that just like your company, they have to market themselves to attract issuers and investors to the portal.
Maybe—just maybe—some funding portals themselves use Title III crowdfunding to raise capital for their business operations (which raises the question of who would be acting as their funding portal?)
Regulation Crowdfunding specifically allows portals to advertise themselves and to seek brand recognition from broker-dealers, investment banks, and other players who may recommend investors to the portal. Your company should be looking for funding portals that are marketing themselves aggressively and securing the capital they need to grow their operations.
As in all industries, aggressive competition among funding portals will lead eventually to a handful of companies dominating the industry. Your company should be listed with a winner in that competition, not an also-ran.
Will the Portal Coach My Company Through the Process?
Regulation Crowdfunding allows funding portals to advise an issuer about the structure or content of the offering, to a limited extent. For example, a portal can:
Provide pre-drafted templates or form documents to the issuer
Provide advice on the types of securities the issuer can offer and the terms of those securities
Provide advice on compliance with crowdfunding regulations (including advice on correcting mistakes in the Form C disclosures)
Obviously, the line between telling an issuer what it did wrong in its offering documents and coaching an issuer on the right way to do its offering documents can be a very thin one, and funding portals will have to train their employees dealing with issuers carefully to make sure no one crosses a line that might invalidate an offering or (worse) put the funding portal’s SEC or FINRA registration in jeopardy.
Just as obviously, your company will probably have to pay a bit extra for any hand-holding services a funding portal believes it is safe to provide. What a funding portal cannot do, under any circumstances, is play favorites or discriminate between your company and other issuers. This would include giving you advice that would give you a leg up over any issuers competing for the same investors.
Should I Use a Matchmaker?
Because under Regulation Crowdfunding issuers are required to work with only one portal when launching a Title III crowdfunded offering, the selection of that portal will become mission critical to the offering’s success.
To avoid mistakes in the portal selection, it may be worth getting professional help in making that decision. It is almost certain that some individuals and companies will set themselves up as matchmakers who will help link issuers and funding portals online.
Regulation Crowdfunding allows you to use a matchmaker to find the right portal, as long as you disclose the amount of its compensation in the Form C disclosures.
Unless the matchmaker is a registered broker-dealer, it cannot accept a percentage of your successful offering as compensation: it must charge a flat fee, hourly rate, or other compensation that is not tied to the amount or success of your offering.
Setting the Offering Schedule and the Minimum/Maximum Amounts
The last question you need to ask before launching a Title III crowdfunded offering is: when do we really need the money?
Setting the Offering Closing Date
You must first set a closing date for your crowdfunded offering. Crowdfunded offerings are not open-ended; they must close at a specific date and time set forth in the Form C disclosures.
Regulation Crowdfunding requires that crowdfunded offerings last a minimum of 21 days. Even if it takes only two or three days to raise your minimum offering amount, you cannot grab the cash until 21 days have passed.
This is a cooling-off period required by the SEC to give investors more time to study your company and possibly withdraw their investments if they get cold feet or a better opportunity comes along, and give you time to fine-tune and update your offering documents to reflect the latest changes,.
You can set as long a period as you like for your crowdfunded offerings, although periods of 90 to 180 days will be commonplace, and periods of more than a year probably will be discouraged.
You may be able to extend the closing date of your offering if you find yourself close to achieving your minimum offering amount, but you will have to give the portal at least five business days before the scheduled closing date to process and post the extended closing date.
And the portal will be required to give existing investors five days in which to reconfirm their investments. If an investor fails to reconfirm an investment within the five-day period, the investment is canceled and the investor gets the money back.
An extended closing date may give your investors additional time to get cold feet and pull the plug on their investments, as they will be able (as they always were) to withdraw their investments up to forty-eight hours before the extended closing date.
Also, the funding portal is almost certain to charge your company an additional fee for keeping the offering documents posted for an extended period of time. All in all, if your offering has generated lots of investments within the scheduled offering period, it may be advisable to take the money and run.