Fundraising is essential for many startups, but the types of fundraising methods are limited. The traditional methods are bootstrapping, convertible notes, simple agreements for future-equity (SAFEs), and priced equity rounds. We have guided many founders through fundraising.
Equity crowdfunding is a newer option. Crowdfunding is meant to allow founders to accept small investments from a broad base of investors. True crowdfunding was not previously feasible: securities laws – intended to protect investors (discussed below) – made it difficult for companies to accept investments from investors not meeting certain financial requirements, a.k.a. “non-accredited investors” (discussed below).
In 2013, the Securities and Exchange Commission (SEC) proposed its first set of rules governing equity crowdfunding. However, equity crowdfunding has not been as popular as proponents had hoped. The cost of complying with the SEC’s restrictions often outweighed the capital a founder could raise through crowdfunding. (See our original posts about the proposed rules in 2014 and their efficacy.)
This blog post aims to help you understand equity crowdfunding in general and how the new amendments to Regulation Crowdfunding may make equity crowdfunding more attractive to founders.
First, some basics…
Why does the SEC regulate securities offerings?
The SEC’s mission is to protect investors. It does so by imposing significant disclosure requirements on companies that wish to offer securities through public markets (i.e., stock exchanges), and by restricting access to private offerings to investors able to bear the risks of those investments.
The SEC can enforce its rules through fines and penalties, which can pierce through the corporate shield and reach a founder’s personal assets. (We recommend that you ask an attorney for assistance with fundraising efforts to ensure that your fundraising efforts comply with securities laws.)
What is crowdfunding?
There are two types of crowdfunding for businesses: rewards-based crowdfunding and equity crowdfunding.
With rewards-based crowdfunding, a business creates a campaign (e.g., Kickstarter, Indiegogo) seeking contributions in exchange for rewards (often including preferential access to the final product). If the business’ announced funding goal is met, the business receives the funds and is then responsible for delivering on its campaign promises.
Equity crowdfunding focuses on investors instead of contributors. Regular people invest small amounts of money in exchange for a small stake in a company. These investors usually interact with the company through a representative.
Can non-accredited investors participate in equity crowdfunding?
The SEC classifies investors as accredited or non-accredited. Accredited investors are presumed sophisticated enough to understand and bear the risks of investing in private markets. The SEC recently broadened the criteria for who can qualify as an accredited investor. Non-accredited investors, by contrast, do not benefit from this presumption, and are essentially excluded from participating in the traditional forms of private-company fundraising.
Now, to the recent changes…
What recent amendments did the SEC make to Regulation CF?
The SEC has scaled back the compliance burdens associated with equity crowdfunding. Investors now have greater freedom to invest, and private companies (startups in particular) have greater latitude with fundraising. The amendments took effect on March 15, 2021. Here are the key points:
Increase in offering limit The offering limit for non-accredited investors has been increased from $1.07 million over any 12-month period to $5 million, which may shift the cost-benefit analysis when companies are considering equity crowdfunding.
Regulation CF no longer limits how much an accredited investor can invest. (This makes equity crowdfunding more closely resemble traditional private investments under Regulation D.)
Broadening the class of permitted investors Non-accredited investors may now use the greater of their annual income or net worth when calculating their limits on investment amount – this should result in non-accredited investors investing more.
Extending the exemption from financial statement review requirements A business offering securities under Regulation CF is required to file annual financial disclosures with the SEC. The disclosures must be made on Form C-AR and the first is due within 6 months of the completion of the offering.
The SEC has created an exemption to the filing requirement for companies that raise less than $250,000 within a 12-month period under Regulation CF. The exemption has been in place since the Regulation was first published and is periodically extended. The recent amendments have extended the exemption by an additional 18 months. This provides some additional temporary relief but is unclear if this exemption will be made permanent.
Classifying Regulation CF securities as Covered Securities Securities issued under an equity crowdfunding campaign that complies with Regulation CF will also be exempt from state registration. As we discuss here this is already the case with securities issuances that comply with other federal safe harbors.
What does all this mean for startup founders?
Time will tell if these changes make equity crowdfunding more attractive to founders. If you are interested in raising capital (via equity crowdfunding or otherwise) goodcounsel is here to help.
One of my legal newsletters today included the following blurb, crediting TechRadar:
TikTok enabled its Android app version to collect millions of users’ unique identifiers for at least 15 months that could be used for ad tracking, which violates Google’s privacy rules, according to a Wall Street Journal investigation. A TikTok spokesperson said, “The current version of TikTok does not collect [media access control] addresses,” and a Google spokesperson said the firm is investigating the Wall Street Journal’s report.
As we’ve written about before, Android is an example of the high cost of “free” (or cheap) services. Google basically subsidizes these phones because their more important business is to monetize people’s personal information. This is different than Apple, whose main business is selling you hardware and associated services.
I was browsing — okay, I admit it, I was on Twitter — and came across an ad for a new, privacy-respecting web browser called Brave. Intrigued, I went to look at it.
It’s based on Chromium (Google’s open-source code behind the Chrome browser) but has a whole different (better) approach to privacy.
Interestingly, it also has an innovative approach to helping content creators get paid. It seems that users tip websites using “Basic Attention Tokens” (a form of cryptocurrency) that they earn by voluntarily looking at browsing privacy-compliant ads.
This seems like a promising model; I am going to try it out.
There’s so much great content being created today. It’s virtually impossible to keep up with the high quality “television” shows being broadcast and streamed. (Still, do yourself a favor and watch Orange is the New Black and Chernobyl at minimum.)
It’s pretty much the same with podcasts. Fortunately, I have a reasonable amount of commuting, dog-walking, and dish-washing time to pop the earbuds in and listen. Ezra Klein of Vox is so sharp and interesting and I have developed a genuine soft spot for the NY Times journalists on The Argument. However, the podcast that I feel is fantastic and indispensable, certainly for anyone with professional or personal interests in tech, is Recode | Decode with Kara Swisher.
I have been interested in computers and technology since junior high school, when my school acquired its first computer – a lonely RadioShack TRS-80, housed up in the library. Because I was a strong math student, I was selected as one of two kids from each class to visit with the computer a couple of times a week to learn how to program in BASIC. From that point forward, I was enchanted.
In those days (we are talking about the early 1980s now) and for the two decades that followed, the power and sophistication of technology grew exponentially, accompanied by optimism about the promise of offering amazing services and solving big problems. Sure, there were people of great foresight, who saw the darker implications just over the horizon of this rise in processing power and the increasing ubiquity of computer hardware. But these were lone voices in the wilderness, for the most part; I consider myself a critical person yet I certainly did not pay a whole lot of attention to these concerns.
Most companies are aware of issues concerning how they use
and handle “personally identifiable information” (PII) of their customers. In
general, web-based businesses (which is to say, nearly all businesses) disclose
their uses of PII with some specificity in their privacy policies and terms of
use (goodcounsel is often called up to draft these for its clients). PII in the
healthcare context is tightly regulated under the Health Insurance Portability
and Accountability Act, and the
use of PII more generally by the Internet giants has come under increased
scrutiny in the last two years.
Many startup founders don’t really have to sweat board of directors meetings all that much; typically, at the earliest stages, the founders are the only people on the company’s board. If the board meets at all, it’s a “family affair” or otherwise, official actions are handled by written consents outside of meetings. However, once you have outsiders on the board – and especially, outside institutional investors like VCs – there is more pressure to perform.
Clients frequently ask goodcounsel to draft online Terms of Use and Privacy Policies. What they often fail to consider is whether the Americans with Disabilities Act applies to their websites and mobile apps. Yes, you read that correctly: the Americans with Disabilities Act. Whether the ADA applies depends on the state(s) the company operates in, the kind of goods or services the company offers, and how and to whom the company provides such goods or services.
It’s striking to me how the media hypes certain companies to
ridiculous heights with fawning, uncritical coverage, only to join in the feeding
frenzy of negativity when the same companies inevitably encounter problems. In
that respect, I suppose, the media plays a central role in the tech-era bubbles
that we’ve lived through over the past two decades.
What else could be prompting this observation right now than
the story of WeWork? This story hits home for us at goodcounsel, literally,
since we work at WeWork.
In my last post, I enthusiastically recommended Tim O’Reilly’s piece in Quartz, critiquing the prevailing winner-take-all ethos of Silicon Valley investing.
In this post, I want to recommend a piece animated by a similar spirit: an interview with Bryce Roberts, founder of Indie.vc (and one of O’Reilly’s partners in the O’Reilly AlphaTech Ventures fund) on the Recode Media podcast.
