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We are still waiting for the SEC to issue final rules with respect to the Title III crowdfunding that will allow the U.S. companies to issue up to $1 million in securities to non-accredited investors through the online funding portals. So, while we are all waiting, crowdfunding in the U.S. is alive and happening. And I am not talking here about rewards-based crowdfunding like campaigns on Kickstarter. I am referring to the equity / debt crowdfunding. In the U.S., it is currently being done in several different ways. Here is a short summary of each. Crowdfunding through the accredited investor portals: the fund model This crowdfunding model came out of the two no-action letters: the AngelList LLC and the FundersClub Inc., both issued in March 2013. I previously wrote about them here. Essentially, both are online platforms that aim to invest accredited investors’ money in the startup companies. However, they do so indirectly. Each aims to pool investors’ money into a separate investment fund that in turn invests into the startup. A new fund is formed for each investment. Accredited investors become members (or limited partners) of the fund in a Rule 506(b) offering. Only accredited investors can participate in these types of offerings. Both FundersClub and AnglelList operate as investment advisers, which means that they either have to register with the SEC as such or comply with an available exemption. They receive carried interest (a share of profits distributed at the termination of an investment) from their funds. However, since they are not broker-dealers, they cannot accept any transaction-based fees. Crowdfunding through the accredited investor portals: the broker-dealer model Alternatively, funding portals can partner with registered broker-dealers in order to be able to receive transaction-based compensation (a percentage of the total offering proceeds). A good example is CircleUp Network, Inc. CircleUp itself is an online portal, but all securities-related activities are conducted through Fundme Securities LLC, a wholly owned subsidiary of CircleUp Network, Inc., which is a registered broker-dealer and a member of FINRA/SIPC. In this model, securities of the startup itself, not the fund, are sold to accredited investors in a Rule 506 offering. This crowdfunding model can be used for any type of startup, irrespective of its industry. However, this model has its challenges, beginning with the need to find an interested broker-dealer and having to compete with the more established platforms and broker-dealers. Lending platforms LendingClub Corporation and Prosper Marketplace, Inc. have adopted a different crowdfunding model, that of the peer-to-peer lending. Each company is an online platform that enables individuals to borrow up to $35,000 from a large number of lenders each of whom commits only a very small amount. These platforms have been tremendously successful. However, these offerings are not exempt from registration with the SEC. Each platform has filed a registration statement on Form S-1 that allows them to engage in a continuous offering to the general public . The LendingClub investors do not invest directly in loans (the minimum investment is only $25) but instead purchase Member Dependent Notes from LendingClub. Loans are issued by WebBank, an FDIC insured Utah-chartered bank, that then assigns the loans to the LendingClub in exchange for money received from the investors. The platforms earn a transaction-based fee on each loan as well as servicing fees while payment are made on the loans. Crowdfunding within a single state (intrastate offerings) It is permissible under Section 3(a)(11) and Rule 147 of the Securities Act to conduct an offering of securities to the general public that is not registered with the SEC so long as the securities are only offered to the residents of a single state by an issuer that is registered and doing business in that state. These exemptions were available even before the JOBS Act. However, now these exemptions are being actively used by intrastate crowdfunding portals. All intrastate offerings must comply with the applicable state registration and offering requirements (which vary from state to state). On April 11, 2014, the SEC issued new Compliance and Disclosure Interpretations ("CDIs") relating to intrastate securities offerings made pursuant to Rule Section 3(a)(11) and Rule 147 of the Securities Act. The new CDIs provided guidance and clarification with respect to the recent numerous state crowdfunding exemptions that are rapidly increasing in number. One aspect in particular was previously unclear: how and whether the use of general solicitation and advertising, including social media and online crowdfunding portals, in intrastate offerings could be reconciled with the requirement that offers only be made to persons resident in the issuer's home state. You can find a good analysis of the new CDIs here. According to this blog, as of June 2014, 12 states (Alabama, Colorado, Georgia, Idaho, Indiana, Kansas, Maine, Maryland, Michigan, Minnesota, Tennessee, Washington and Wisconsin) have intrastate crowdfunding exemptions in place and 14 states (Alaska, Arkansas, California, Connecticut, Florida, Illinois, Missouri, North Carolina, New Jersey, Pennsylvania, South Carolina, Texas, Utah and Virginia) are in various stages of enacting/considering sponsored legislation regarding such intrastate crowdfunding. It may, in fact, be easier for the companies to comply with such intrastate requirements than to comply with the much expected crowdfunding rules. The disadvantages of such offerings include (i) the fact that the offers can only be made to made to residents of a single state; (ii) resales to out-of-state residents are restricted; (iii) if the offerings are subject to that state’s regulatory approval, if such approval is not obtained, the offering will never take place.
In conclusion, I find that the crowdfunding industry is not waiting in one place for the enactment of the SEC rules relating to Title III of the JOBS Act. The crowdfunding is already taking place now, whether it is done through a broker-dealer portal, as a lending platform or in instrastate offerings.
This article is not a legal advice, and was written for general informational purposes only. If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga. Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of business, corporate, securities, and intellectual property law.
Read more commentary from Arina Shulga on the legal aspects of operating new and growing businesses at Business Law Post.
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