Crowdfunding Equity Crowdfunding Update January 21 and 22, 2014 David Menard 860.240.6047 (Hartford) | 617.457.4105 (Boston) [email protected] Rajesh.

CrowdfundingEquity Crowdfunding Update

January 21 and 22, 2014

David Menard860.240.6047 (Hartford) | 617.457.4105 (Boston) [email protected]

Rajesh Patel, [email protected]

Crowdfunding Explained

Aggregating funds from a broad donor/investor base toward a common goal

Breaks down two key barriers:

• Communication

– investors finding companies and vice versa

• Money

– allowing pool of money to come from all types of investors, not just sophisticated wealthy investors

Crowdfunding (cont’d.)

Four Types

• Microfinance / Microloans

– ex. Kiva.Org – minimum loan is $25; Have handled approx. $322M in loans since 2005, with numbers increasing rapidly in the last few years

– Generally no investor returns or very small returns expected.

Crowdfunding (cont’d)

• Peer-to-Peer (P2P) Loans / Social Lending

– Loans from group of lenders without traditional intermediaries (banks) - reduces overhead costs

– Strong financial regulations involved – depends on jurisdiction; non-bank commercial lenders.

– Ex.

» Prosper.Com (US) ($692M in loans since 2006 ($248 since last year); 2M members (400K increase over 2012)

» See SoMoLend.Com

» Lending circles (ex. FundingCircle.Com (UK) – Approx. € €201,758,400 (approx €100M over 2012) in loans since 2010; average net return: 5.7; bad debt – less than 1.3%

Crowdfunding (cont’d)

• Donor/Reward-Based Funding

– Generally creative and culture-based (technology, movies, television, art and music) as well as philanthropic endeavors

– No financial return on investment, but may get physical reward (final copy of movie, t-shirt, stage prop, etc.) or offered a unique experience (walk-on part in movie).

– Ex. Kickstarter.com (over $943M funded); IndieGoGo.com; RocketHub.com

A Few Light Statistics

Gartner – Non-equity Crowdfunding expected to reach $3.3B in 2013

2013CF Crowdfunding Industry Report – expects actual non-equity total will have been $5.1B in 2013 (81% increase over 2012)

As of 2012: US non-equity CF platforms -191; UK – 44; EU over 100 more; total worldwide – est. 536

Average time frame for current equity CF campaigns (worldwide): 8.2 weeks

• versus donor/reward campaigns: 10-10.2 weeks

Equity Crowdfunding

• Equity Crowdfunding

– Securities (equity, debt or revenue share) for funding.

– Prior to JOBS Act, this type of funding generally violated securities rules for private placements.

– What is the downside? Fraud.

» Kickstarter has had less than 4 cases of possible reported fraud, less than 0.01% of their total offerings. Expect more fraud in equity CF, but how much more is the question?

– World Bank predicts worldwide Equity CF market to exceed $93B by 2025..

Why is Equity Crowd Funding Important

• Restrictions on sales of securities – all sales must be registered or exempted from registration on both federal and state levels;

• 4(2) private sale exemption; Reg. D safe harbors;

• The more sophisticated the investor, the less protection/information needed.

• The barriers broken down by CF (communication, money) are anathema to the purpose of the SEC.

Status in United States

• WHERE WE ARE NOW

Reg D. General Solicitation Changes effective Sep. 23.

New equity CF proposed rules came out Oct. 23. Still subject to comments and revisions (90 day comment period, and then 90-120 day SEC review period)

FINRA releases proposed CF Portal registration form – Jan 8. 2013.

Many companies were lining up to become crowd funding portals – including IndieGoGo, Crowdfunder, Circle UP, SoMoLend. Some companies are in a holding pattern until the regulations are finalized, some are focusing on debt-based crowd-funding in the meantime. BoostFunder, intended to be a portal, now a traditional start-up incubator. Another portal, ProFounder, ceased doing business, while Earlyshares has already acquired a potential competitor portal.

SoMoLend founder suggests debt-based crowd funding may have more impact on banking industry than equity-based crowd funding will have on securities markets.

Reg D. 506 Rule Change

• Breaks down the communication barrier

(money barrier still in place)

• Can now use general solicitation (advertising)

to reach audience of accredited investors.

Reg D. (cont’d.)

• New Additional Requirements for General Solicitation Offering:

Submit Form D 15 days prior to first sale (used to be 15 days

after first sale)

Disclose:

• # and type of accredited investors, and how verification was

made (enhanced verification requirements)

• Copies of offering/solicitation materials (and whether such

materials were disclosed to FINRA)

• Website address; use of proceeds; legends

Proposed U.S. Equity CF Rules

• Basics of U.S. CF Rules:

Crowd Funding must take place through SEC (or SEC designee) regulated online portals or brokers – portals must participate in registration regime.

Unlimited # of investors, including foreign investors, may invest, in the aggregate, up to $1M in a company’s securities in a 12-month period (limitation only applies to securities sold in CF offering – but also applies to affiliate companies)

Investors with net worth of $100K or less may invest no more than the greater of $2,000 or 5% of net worth / annual income;

Proposed CF Rules (cont’d.)

Investors with net worth of more than $100K may invest no more than the lesser of $100,000 or 10% of net worth / annual income;

How to determine when an investor has hit limit? SEC leaves this up to the Portal to determine.

Certain resale restrictions on securities for no less than one year after purchase (unless sold to accredited investor, death/divorce, in public offering).

Companies will having varying requirements with respect to disclosures and financial statements depending on amount of investment being sought (e.g., audited returns for companies seeking $500,000 or more in crowdfunded investments).

Proposed Equity CF Rules

• Sample disclosures:

20% or greater stockholders;

Business and business plan;

Use of proceeds;

Target offering amount and deadline;

How investors can cancel an investment commitment;

How offering price was determined;

Other offerings by issues in past 3 years;

Related party transactions

Proposed Rules (cont’d.)

• Reporting continues until company goes public,

liquidates or all securities purchased in the offering are

sold to a third party.

• Limits on advertising, which must direct the reader to the

appropriate Portal.

• CF offering not allowed if any “bad actors” are involved,

which includes directors, officers and 20% stockholders.

CF Portals

• Register with SEC as a broker or Portal

• Portal, directors, officers and partners cannot have direct financial

interest in any issuer that uses Portal’s services

• Must provide investors with educational materials

• Must take steps to reduce fraud risk: have reasonable basis to

believe an issue is in compliance with regs and keeps accurate

records; and must deny access to any offering that presents a

potential risk of fraud.

• Must perform background and regulatory checks on issues and

related parties.

CF Portal (cont’d.)

• Portal must ensure no investor exceeds limits (allowed to

rely on investor representation), and allow investors to

cancel investment commitment.

• Portal must provide for communication between

investors and between investors and issuer.

• If Portal provides for secondary market, it must register

as a securities exchange or alternative trading system.

• Must protect investor privacy.

US Equity CF Thoughts

• Liability has started to land where expected: on the Portals.

• Communication among investors – now regulated.

• Possible concerns:

Company disclosure requirements:

• Ongoing audited financials (compare to Reg. A $5M Offering

• Ongoing nonfinancial disclosure

Portals getting short shrift: liability, unable to participate, cannot

prohibit issuer from participating based on qualitative or

subjective factors (advantage to broker; curation)

Foreign Crowd Funding

• Currently permissible in:

Australia (ex. Pozible, ASSOB),

UK (See Next Slide); and

Sweden (ex. FundedByMe).

• Canada: intra-state exemption first adopted by Saskatchewan in

December 2013. Ontario looking for general exemption first quarter

of 2014. More legislative effort remains for general equity CF.

• In each case, governed by government regulations and monitored

by government agencies.

Foreign Crowd Funding (cont’d)

• 4 UK Crowd Funding portals: CrowdCube (equity focused); Abundance Generation (energy-focused); Seedrs (equity focused); and BankToTheFuture.com (supported by Richard Branson).

In one widely-cited example, in 2012 CrowdCube helped a web-based company Escape the City obtain £600,000 in funding; £100K over goal – in 13 days! ETC had turned down an offer from a top London VC firm citing a desire to remain independent.

In first year and a half of operation CrowdCube has funded 85 businesses to the tune of £16,488,270.

In interesting meta-CF example; Seedrs is raising £500,000 for its own expansion in to mainland Europe

UK expected to raise £1.6B in Crowdfunding in 2014 (Nesta Study)

Equity Crowdfunding forEntrepreneurs/Startups

• Should you do it?

• Cons:

Ongoing reporting requirements (audited financials and other

disclosures)

VCs and Angels may not want to invest in a crowdfunded company

Too many shareholders make corporate governance and logistics very

difficult

Funding Limits – $1M in any given 12 month period

Skill assessment – are you ready to manage this type of company

without outside assistance?

Equity Crowdfunding forEntrepreneurs/Startups

• Pros: It does work – much more capital available for companies

It can possibly be cheaper and quicker than traditional equity

fundraising

Better deal terms for founders – on average: give up smaller

percentage of Company; non-voting shares; no additional

information, registration or management rights given to investors

Equity Crowdfunding forEntrepreneurs/Startups

• How to Prepare for Equity Crowdfunding/Considerations

Build your audience – your customers may be your investors

Have good internal recordkeeping – be ready for financial and other

reporting requirements

Know your market, and how to communicate with them. Consider

whether a PR/Advertising specialist is needed. Crowdfunding of any type

is a sales campaign.

Learn how to be a CEO – use growth advisors, accelerators and

incubators to learn the skills necessary to deal with many shareholders

and a rapidly growing company.

• It’s ok not to know how, but it’s not ok to not educate yourself.

What makes a successfulcrowdfunding campaign?

• From GoGetFunding.Com (Dec. 13, 2013):

Successful campaigns receive an average 193 likes and 57 tweets

Best tools for converting a finder to a funder: email (53%); facebook (12%); twitter (3%)

Once you’ve raised 40% of funds – visitors stay on page 31% longer and are 22% more

likely to donate

If a campaign reached its goal, 78% received more than goal

Campaign with personal video raises 105% more than one without

Projects with word count between 300 and 500 words raise the most money

Most successful campaigns generally last between 20 and 40 days

Campaigns with teams raise 38% more;

Campaigns with day-to-day marketing plans raise 180% more

Mr. Menard is a Partner in the firm's corporate law practice, where he represents both private and public companies. He practices in the areas of general corporate law, private equity and venture capital investments, mergers and acquisitions, and securities law. In the private equity and venture capital area, Mr. Menard has represented both companies and investors in debt and equity offerings, and has provided both pre and post-investment general corporate law guidance to companies in the high tech, bio-science, manufacturing, audio and video, steel and retail industries. [email protected] | 860.240.6047

Rajesh Patel. Ph.D., is the Managing Director of RedAcre Investments. Prior to Red Acre, Rajesh was a Member of Technical Staff with the Massachusetts Institute of Technology, (MIT) Lincoln Laboratory where he analyzed the strategic value of emerging technologies to enhance the capabilities of the U.S. Military. Rajesh holds a Ph.D. in Applied Physics from the University of California, Davis, a Master's in Environmental Science from Rice University and bachelors degrees in both Physics and English from the University of Connecticut.

Disclaimer

This information is educational material that provides an overview of the issues described. It does not deal with every issue, and does not deal with every exception to this information.

This information does not constitute legal advice.

Please contact your attorney or a Murtha Cullina attorney if you would like legal advice which would be best for your particular circumstance.

© 2013 Murtha Cullina LLP