New rules allow sophisticates to do crowdfunding
The crew at Holy Falafel, which is raising money via crowdfunding to begin franchising.
Making a donation to a crowdfunding campaign for a preordered gizmo or special perk is nothing new. But the Kickstarters and IndieGoGos of the world have a sophisticated new relative: equity crowdfunding.
Under new rules finalized at last by the Securities and Exchange Commission in October 2015, small investors can truly buy in to a company for a financial stake and reap the profits—or suffer the losses.
These new rules were laid out in the JOBS Act, which President Obama called a “potential game changer” for startups and small businesses when it first passed back in 2012.
The act went through multiple changes and several phases; the most novel piece of the investment crowdfunding rules were outlined in Title III and go into effect in May 2016. Title III rules allow businesses to raise up to $1 million from small investors across state lines.
At the same time Title III was passed, the SEC made changes to crowdfunding rules for investments within state borders. At press time, nearly 30 states had attractive crowdfunding options for local investors with several more poised for new legislation. Previously, businesses were allowed to crowdfund from only wealthy, accredited investors.
“Those changes, once approved, are going to make these intrastate laws more competitive. When you compare them to Title III, these intrastate laws are going to make more sense for companies raising capital for the first time from outsiders,” said Zachary Robins, a Minnesota-based securities attorney who advises companies on equity crowdfunding projects.
Along with Title IV of the JOBS Act, which allows larger companies to raise up to $50 million (along with some arduous SEC regulations), and Title II that allowed companies to raise money via the Internet, there will soon be a slew of crowdfunding options.
“More than likely, there’s going to be a counterpart law that will make sense for any company depending on their size,” said Robins, of Winthrop & Weinstine.
The first step on any of the bevy of current or upcoming investment crowdfunding options is putting together a solid business plan and figuring out what owners want to get out of the chosen option.
“Start by doing the internal investigation about how much money do they need, what do they need it for, how much equity can they sell or are they willing to sell and at what price,” said Charles Switzer, a lawyer with Faegre Baker Daniels in Indianapolis who advises companies on corporate governance.
He said there will be a sea change in some industries, but companies must be conscious about the nuances of raising equity capital, like the cost of capital and the corporate structure required to do a crowdfunding campaign. Then there’s the legal exposure and proper disclosures.
“An attorney can help you craft the language in a way that doesn’t put you in hot water with the SEC for having provided fraudulent or misleading information,” said Switzer.
Proper disclosures will also protect against investors suing if the business fails. “The fear here is that you raise money, and the company goes bad, you go bankrupt and the investors turn around and say, ‘You never told us about that risk or that pending lawsuit,’ and then they sue for fraud,” said Switzer.
Simply knowing which documents to file is a major part of the new crowdfunding landscape. “You’re going to have a filing that needs to be made with a regulatory authority, be it either the state or the federal government,” Robins said.
Once the financial picture is clear and the disclosures have passed legal muster, a business must go to a registered intermediary—although this could change soon. Laws written decades ago to prohibit companies from advertising across state lines never took outlets like Facebook or Twitter into consideration. Currently, no company can advertise the sale of securities across state lines, but an intermediary can.
There are some portals out there like ApplePie Capital, SeedInvest, Crowdfunder, EquityEats and others that offer group equity investments from accredited investors. While none has specific plans for expanding with smaller investors, there will be a surge of state and national intermediaries and likely changes among the leaders to include small-investor options.
Greg Ewasiuk at Holy Falafel just started franchising and is raising funds on another group equity platform called CircleUp to build a home office for an upcoming franchising push. The single-location restaurant in British Columbia, Canada, is in the sweet spot for equity group funding with strong sales, novel differentiators and a seasoned management team, but little by way of operating history. “Traditional lending partners and financial institutions are not so willing to lend money to small restaurants,” said Ewasiuk.
But with one of the state or Title III crowdfunding routes, restaurants and other brick-and mortar companies will make attractive options for small investors. “Those businesses may be very profitable enterprises and return two, three, four times investment, but aren’t going to attract venture capitalists who are looking for investments that are going to reap 10 times profits,” said Robins.
The capital is an obvious goal, but there is a bigger benefit, according to Johann Moonesinghe, CEO at EquityEats, which sells securities to accredited investors and allows small investors to buy in for restaurant credits. “It’s the awesome, loyal customer base that you create through the process.”
Specifically for franchisees, raising equity capital via a crowdfunding round might become an attractive way to build brand loyalty while building a new location or embarking in a new territory with the help of an intrastate option.
Larger companies can get growth capital via the Title IV route (also known as Regulation A+) for a much larger raise if they can manage the slew of SEC regulations. And franchisors of all sizes can benefit from Title II and Title III rules to get small accredited and small investors nationwide via a crowdfunding portal.
Lastly, none of the SEC guidelines has rules barring other forms of financing. That means companies can do crowdfunding and still get a bank loan to fill out the capital table.