By Arina Shulga
Although Regulation Crowdfunding (or Reg CF in short) is a great way to get funding for companies that otherwise would have been overlooked by angel or VC investors, running a successful and compliant Reg CF campaign is not an easy undertaking. Based on experience working with Reg CF issuers, in this blog I describe and discuss three key legal challenges that all Reg CF issuers should know about: restriction on advertising, hiring promoters, and putting together a complete and accurate Form C.
First, the issuer cannot generally solicit and advertise its Reg CF offering. All communications must be done through the portal. According to Rule 204 of Reg CF, the issuer can make factual statements and then direct potential investors to its page on the portal. Such factual statements are limited to the following information: the fact that the issuer is conducting a Reg CF offering; the terms of the offering (amount, nature of securities, price, and closing date), and factual business information about the issuer. While the first two categories are straight forward, issues can arise when talking about the factual business information. Such information cannot include predictions or opinions and must be limited only to facts, such as name, address, website of the issuer and a brief factual description of its business.
Second, Rule 205 of Reg CF allows issuers to hire promoters for their offerings as long as the promoters work within the portal page and the issuer takes reasonable steps to ensure that the promoter discloses the fact that they are compensated. Outside of the portal, the promoters are restricted to providing the same factual statements that are described above. Again, the issuer must take reasonable steps to ensure that the promoters disclose that they are being paid by the company. As a separate issue, companies should not pay promoters a commission or a success-based fee. Such transaction-based compensation is a red flag to the SEC that the promoters are acting as unregistered broker-dealers, which may invalidate the entire offering. Compensation should be in the form of a flat fixed fee, rather than be tied to the success of the sales efforts.
Third, prior to launching a Reg CF offering, the issuer must file a disclosure document called Form C with the SEC. Even though its disclosure requirements are less extensive than for other offerings (such as Regulation A or an IPO), Form C must still be taken seriously. Form C requires the company to provide a description of its business and the anticipated business plan, the team bios, use of proceeds, and the risk factors that describe in depth the risks of investing in the company as well as the risks related to the company’s operations. Further, Form C asks for disclosures related to the ownership and capital structure of the company and rights of all securities that have been issued by the company prior to the offering. The company must list all of its other securities offerings for the past three years. This has often proven to be a challenge for some younger companies that may not realize that they were conducting securities offerings when, for example, they sold a SAFE to a neighbor or a couple of convertible notes to unaccredited friends, fail to file Form Ds for prior offerings, or comply with the offering exemption requirements. When preparing Form C, issuers should remember that under Rule 10b-5 of the Securities Act they have liability for any material misstatements or omissions in their Form Cs.
Additionally, even the younger companies must include US GAAP financial statements. For offerings of $107,000 or less, the financial statements must be certified by the principal executive officer of the issuer; for offerings between $107,000 and $535,000, they must be reviewed by a public accountant independent of the issuer; and for the offerings over $535,000, the financial statements must be audited (although the first-time issuers could provide reviewed financials instead).
Consequences for violating these rules can be severe. Regulation CF is a safe harbor exemption from the general requirement that a company must register its securities with the SEC. If violated, the offering may be deemed to be void, and all investors in the offering could receive recession rights (i.e., the right to get their money back). Additionally, the SEC may impose sanctions and shareholders may file civil lawsuits against the company. Further, the company itself may be deemed to be a “bad actor” and be prevented from conducting private placements of its securities in the future.
In conclusion, running a successful and compliant crowdfunding campaign is not a simple task. The key to success often lies in finding the right advisers: a funding portal that would be willing and able to support its issuers throughout the entire crowdfunding campaign, and an expert legal adviser that can prepare Form C, ensure that the company’s legal records and corporate governance documents are in order, and guide the company through the maze of legal rules and forms of Regulation Crowdfunding.
This blog contains general information about legal matters. The information is not advice, and should not be treated as such. Communication of information by, in, to or through this blog and your receipt or use of it: (1) is not provided in the course of and does not create or constitute an attorney-client relationship; (2) is not intended to convey or constitute legal advice; and (3 is not a substitute for obtaining legal advice from a qualified attorney. Pursuant to Rule 1-400(D)(4), you are notified that this blog may constitute a communication or solicitation concerning the availability for professional employment of a member or a law firm in which a significant motive is pecuniary gain. For more information on this topic, please contact the author, Arina Shulga.