by Noel R. Bagwell, III
for Executive Legal Professionals, PLLC

November 3, 2015

Wanna “Kickstart” A Whole Company?

After nearly four years of waiting, after the 2012 “JOBS Act” (a tragic misnomer, if ever there was one) was passed, the Securities and Exchange Commission (“SEC”) has finally gotten around to releasing their rules and regulations for Title III of the Act–the equity crowdfunding law. But the waiting isn’t over, because it will be another 18 months, at least, before people can actually start using crowdfunding to sell equity in their companies.

Go make yourself a fresh pot of coffee. The SEC isn’t known for churning out can’t-put-down, exciting page-turners. These new rules should come with a warning lawyers can pass on to their clients when discussing the regs. Personally, I’d pattern the warnings after Lunesta’s prescriptions. It would probably go something like, “Tell readers to immediately report any suicidal thoughts. Tell readers that the regs can cause next-day impairment even when legal consultation has been provided, and that this risk is increased if reading time is not carefully managed. Caution readers reading more than 5 pages within a one-hour period against driving and other activities requiring complete mental alertness the day after reading. Inform readers that impairment can be present despite feeling fully awake…” and so on.

Despite the fact that reading these regulations is boring as hell, pretty much anyone with a hot new start-up, and tons of existing companies too, will need to know some basics about the new equity crowdfunding laws. Despite the federal government’s meddling, this is a revolutionary opportunity for raising capital that is truly new and innovative, and has never existed until recently. This kind of opportunity is just too good to utterly ignore.

Silly Little Caps

No, this section isn’t about hats, as much as I love hats. It’s about limitations on the amount of money a company can raise through equity crowdfunding under the Title III regulations. The magic number: a cool $1 million. If that sounds like a lot, think again; a million bucks doesn’t stretch as far as it used to. Hell, it cost the federal government $43 million just to build an utterly useless gas station.

Break Out the Handcuffs

Limiting the amount of cash a company can raise wasn’t enough for the SEC. No, they had to “protect” investors by shackling each investor down to very small investments. Title III limits investors to “(a) the greater of $2,000 or 5 percent of the lesser of their annual income or net worth, if either the annual income or the net worth of the investor is less than $100,000 and (b) 10 percent of the lesser of their annual income or net worth, if both the annual income and net worth of the investor is equal to or more than $100,000.” (Almerico)

Oh, and because the SEC still doesn’t trust you not to risk too much of your own money, no investor may invest more than $100,000.00 in one year. My interpretation of this restriction is that no investor may invest more than $100,000.00 in any one equity crowdfunding investment in one year. Arguably, an investor could invest in any number of equity crowdfunding investments, but only to the tune of $100k, each, per year.

Miss Your Mark, Refund the Cash, and You’re Stuck With the Bill

That’s basically the risk equation for companies who want to use equity crowdfunding. If they can’t raise their goal, they have to refund every dime of the money they raised, and they cannot recover the costs of their campaign. With apologies to Norman Vincent Peale, my advise is: Don’t shoot for the moon. If you miss, you’ll be seeing stars.

The News Isn’t All Bad–And WE Have an Exciting Announcement!

“The biggest news from the new SEC rules is that the proposed requirement of a full financial audit has been dropped by the SEC for companies using the equity crowdfunding law for the first time. Requiring a startup to spend tens of thousands of dollars on an audit made no sense. The SEC removed that burden, and now a company using the law for the first time must only have reviewed financials to raise more than $100,000, and lesser financial disclosures when raising less than $100,000.” (Almerico)

While Executive Legal Professionals can offer very affordably priced legal services related to companies’ equity crowdfunding campaigns. Still, brokers, funding portals, and marketing expenses–not to mention all the other compliance costs–are going to be substantial. In our upcoming 2016 Menu of Services, Executive Legal Professionals will be releasing flat-fee and subscription-based pricing for a full array of legal services to support companies’ equity crowdfunding campaigns.

What Would An Over-the-Top, Ridiculous Regulatory Scheme from the SEC Be Without Everyone’s Favorite Requirement: Disclosure?

Of all the things the SEC does, most of them incredibly stupid, expensive, damaging to the economy, and barely-if-at-all-constitutional, the one thing it does pretty well is require disclosure. The disclosure requirements under Title III include the requirement for companies to disclose to equity crowdfunding investors (and file with the SEC) the:

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but-wait-theres-more

  • Price of the securities;
  • Method for determining the price of the securities;
  • Target offering amount (i.e., the campaign’s target fundraising goal);
  • Deadline to reach the target; and
  • Whether or not the company will accept investments in excess of the target.

But wait, there’s more! “Companies also must provide a discussion of the company’s financial condition, a description of the business and the use of proceeds from the offering, information about officers and directors and owners of 20 percent or more of the company and annual financial statements.” (Almerico)

Honesty: The Best Policy for Staying Out of Prison

Just don’t lie. If you do, you could go to jail. Your Corporation or Limited Liability Company or other business organization type will not protect you from personal criminal and civil liability for making negligently or intentionally misleading statements or otherwise misbehaving and / or defrauding investors. The SEC is serious business.

“Choose your love, Love your Choice” — Thomas S. Monson

As Mr. Monson said, you better love your choice, because, under Title III, you’re stuck with it, at least for a year! “Much like most shares sold through private placements, the shares of stock sold in equity crowdfunding cannot be sold (in most circumstances) for at least one year. There is no marketplace or exchange for these shares, and in all likelihood, never will be unless a company registers with the SEC and becomes a public company.” (Almerico)

Equity-Crowdfunding

Image Credit: JEFFRY BYRD | SACRAMENTO BUSINESS JOURNAL

But Can It Work?

There are some deep, serious flaws in this law. As Nobel Laureate Gary Becker said, “government failure is far more pervasive, damaging, and less self-correcting, than is market failure.” Congress can’t be bothered to do its job (a government failure); so, it created the SEC to do its job for it. Because equity crowdfunding, as a concept, did not exist before the advent of the information era–that is, before the Internet–by the time crowdfunding was invented and someone had the brilliant idea of applying a crowdfunding model to the sale of securities, it was too late for us to have the opportunity to test whether or not there would be significant market failures in the market for crowdfunded securities.

The whole premise of permitting the SEC to regulate equity crowdfunding is that investors can’t be trusted with their own money, and companies and their officers can’t be trusted to treat equity crowdfunding investors fairly. Along comes the SEC, saying, “I’m from the government, and I’m here to help.” But who needs that kind of help?! Who needs enemies when you have such “friends” in the government? But this is the government we have, unless and until we can replace it with one that will permit people and markets to be free again.

President Franklin D. Roosevelt (FDR) supposedly remarked, in 1939, that Nicaraguan “

[President Anastasio] Somoza [García] may be a son of a bitch, but he’s our son of a bitch.” I think that’s the way a lot of people feel about the federal government. They’re sons of bitches, but they’re our sons of bitches. For whatever reason, the American people just shrug off the unbelievably massive weight of the federal government, and tap into their greatest trait, their optimism, to find innovative ways of living on the ever-narrowing spit of land that arises out of the always-rising ocean of federal regulation over every area of life.

Will it work? Title III of the JOBS Act is designed not to work well, but I have every confidence that the innovative, hard-working American people will find a way to create new opportunities even within the confines of this poorly-written piece of crap law. And you know what? If you’re a company or start-up looking to use equity crowdfunding to give your business a jolt, Executive Legal Professionals is eager to assist you in navigating the labyrinth of Title III regulations. So, at least you will not be alone.

Citations

  1. Almerico, K. (2015, November 2). What the New Equity Crowdfunding Rules Mean for Entrepreneurs. Retrieved November 3, 2015, from http://www.entrepreneur.com/article/252315

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