The Securities and Exchange Commission is proposing to expand the definition of “accredited investor” to include additional entities that could bear the economic risks of investment and certain financially sophisticated persons irrespective of income or wealth. The Commission’s main objective is to identify more effectively institutional and individual investors that have the knowledge and expertise to participate in private capital markets and thus do not need the protections of registration.  If adopted, the proposed expansion would significantly benefit issuers and investors alike.

Regulation D and Current Accredited Investor Definition

Private offerings conducted under Rule 506 of Regulation D play a significant role in capital formation in the United States. In 2018, an estimated $1.7 trillion was raised in Rule 506 offerings, as compared with $1.4 trillion raised in registered offerings. Of the $1.7 trillion raised in private offerings, $1.5 trillion went to investment funds and $228 billion to operating issuers.

Rule 506 allows an issuer to sell shares to an unlimited number of “accredited investors” and up to 35 non-accredited investors. As a practical matter, however, the vast majority of issuers in Rule 506 offerings offer and sell the offered securities only to accredited investors. The reason for this is a built-in disclosure bias in favor of accredited investor-only offerings: if you sell only to accredited investors, you do not have to satisfy the specific, mandated and rather onerous disclosure requirements set forth in Regulation D. Instead, an issuer selling only to accredited investors may determine for itself what is material and what is not, and satisfy its disclosure obligation through the concept of “access”, whereby the investors are given access to information offered to or requested by the investors and an opportunity to ask questions directly. The theory here is that an accredited investor is able to fend for himself and has the leverage to extract information.

Currently, the term “accredited investor” means anyone who fits any of the following categories:

  • banks, registered broker-dealers, certain insurance companies and certain employee benefit plans with more than $5 million in assets;
  • private business development companies;
  • 501(c)(3) companies, corporations, business trusts and partnerships, in each case exceeding $5 million in assets and not formed to acquire the offered securities;
  • directors, executive officers and general partners of the issuer of the securities, or any director, executive officer or general partner of a general partner of that issuer;
  • individuals with net worth, or joint net worth with spouse, exceeding $1 million;
  • individuals with income of over $200,000 (or $300,000 with spouse) in each of two most recent years, with reasonable expectation of earning at least same in current year;
  • trusts with assets exceeding $5 million not formed to acquire the offered securities, whose purchase is directed by a sophisticated person; or
  • entities in which all of the equity owners are accredited investors.

In June 2019, the Commission issued a concept release that solicited public comment on ways to simplify and improve the exempt offering framework to promote capital formation and expand investment opportunities while still maintaining appropriate investor protections. In the concept release, the Commission requested comments on possible approaches to amending the definition of “accredited investor” in Rule 501(a) of Regulation D.

Historically, the accredited investor definition used income level and wealth as a proxy for both capacity to sustain investment loss and for financial sophistication. The problem with the old approach is that it excluded investors who are financially sophisticated but do not meet the income and wealth criteria. In this regard, the concept release requested comment on the use of sophistication measures other than income and net worth to expand the universe of accredited investors.

Proposal to Expand Accredited Investor Definition

The Commission’s current proposal to expand the accredited investor definition was presented in its release dated December 18, 2019 entitled Amending the “Accredited Investor” Definition (the “Release”). The Release is premised on the Commission’s stated belief that wealth and income should not be the sole means of establishing financial sophistication for purposes of the accredited investor definition. Accordingly, it seeks to create new categories of individuals who would qualify as accredited investors irrespective of wealth and income on the basis that such investors have the requisite financial sophistication to assess an investment opportunity. It also seeks to add new categories and add to existing categories of entities that can fend for themselves as a result of asset ownership or investment in securities.

The proposed revised definition would add the following categories of individuals and entities as “accredited investors”:

  • individuals with a license as a general securities representative (Series 7), investment adviser representative (Series 65) or private securities offerings representative (Series 82);
  • “knowledgeable employees” of a private fund, as to investments in that fund;
  • registered investment advisers (but not “exempt reporting advisers” relying on the venture capital adviser exemption or private funds adviser exemption);
  • “family offices” with at least $5 million in assets under management, directed by a sophisticated person and not formed to invest in the offered securities, as well as their “family clients”;
  • entities owning “investments” of more than $5 million, so long as the “investments” fall within Rule 2a51-1(b) of the Investment Company Act and so long as the entity was not formed for the specific purpose of investing in the offered securities;
  • limited liability companies exceeding $5 million in assets not formed to acquire the offered securities; and
  • rural business investment companies.

Benefit to Issuers and Investors

The proposed amendment to the accredited investor definition could prove enormously advantageous to issuers and investors beyond the obvious expansion of the universe of accredited investors who supply the vast majority of private capital in the U.S.  The benefit of an expanded accredited investor definition to Regulation A issuers is that accredited investors are not subject to the Tier 2 investment cap.  In Regulation Crowdfunding offerings, the expanded definition would mean enhanced resale opportunities inasmuch as securities purchased in a Regulation CF offering may not be resold for a one year period other than to accredited investors, the issuer or family members (or in a registered sale).  The reasonable verification requirement has been identified as an impediment to Rule 506(c) offerings, and the expansion of the definition to include those with professional certifications would provide issuers with more palatable methods to verify status. For holders of restricted securities, an expanded accredited investor pool would make it easier to conduct a private resale under Rule 4(a)(7) which requires that the purchaser be an accredited investor.  If the proposed rules indeed make it easier to conduct private resales of restricted securities, this could lead to lower liquidity discounts and thus higher prices.

Finally, the Release also proposes to amend the definition of “qualified institutional buyer” for purposes of the resale exemption under Rule 144A to include additional entity types that meet the $100 million threshold to avoid inconsistencies between the types of entities that are eligible for accredited investor status and those that are eligible for qualified institutional buyer status under Rule 144A.

The Commission is seeking input on its proposed amendments to the accredited investor definition, and comments may be communicated using the Commission’s internet comment form, by email to or by mail to Vanessa A. Countryman, Secretary, Securities and Exchange Commission, 100 F Street, NE, Washington, DC 20549-1090. Published comment letters, including your humble blogger’s January 13, 2020 comment letter regarding inclusion as accredited investors limited liability companies with more than $5 million in assets not formed to invest in the offering, as well as managers of manager-managed LLCs, could be found here. Comments need to be received by the Commission not later than March 15, 2020 (60 days after the Release’s January 15, 2020 publication in the Federal Register).

On September 30, 2019, the Securities and Exchange Commission announced that blockchain developer had agreed to pay a $24 million fine to settle charges that it had engaged in an unregistered offering of securities in violation of Section 5 of the Securities Act.  The announcement set off a mini-firestorm of criticism in the crypto community because the $24 million penalty seemed disproportionately small relative to the $4 billion it raised in its ICO and relative to the penalties imposed on other ICO issuers targeted by the Commission in similar cases not involving fraud.  Moreover, was not hit with any of the non-monetary sanctions imposed in the other cases, namely rescission, registration and bad actor disqualification. The apparent enforcement disconnect has resulted in confusion among ICO issuers, exchanges, lawyers and other players in the space, along with demands for an explanation from the Commission and predictions that the case signals a relaxation of enforcement policy. A closer look at the circumstances of’s ICO, however, suggests another possibility.

Rescission, Registration and Bad-Actor Disqualification

Before, Commission sanctions in unregistered offering cases not involving fraud allegations such as Airfox and ParagonCoin included rescission, registration and bad-actor disqualification.

Rescission refers to the process of remedying a securities violation by offering investors the right to rescind their purchase of securities and receive a repayment of their investment. Purchasers who reject the offer lose the right to bring a private action under state securities law, but it is unclear whether federal claims are barred as well. The Commission has taken the position through no-action letters that rescission offers don’t eliminate Federal securities liability to those rejecting the offer, but Federal courts have held the opposite.

The mechanics of the rescission obligation under previous settlement orders begin with the requirement to issue a press release within a certain number of days following the settlement order.  The press release notifies the public of the order and links to the rescission claim form, which also must be posted on the issuer’s website.  The claim form along with a notice is then delivered to all potential claimants informing them of their rescission rights and the deadline for filing the claim form. The issuer then is required to make payments to all claimants properly delivering claim forms, and to provide updates to the Commission to enable the Commission to monitor the rescission process.

A rescission offer is deemed a separate offer of securities which must either be registered or qualify for an offering exemption. This is to ensure that those receiving the offer have sufficient meaningful information on which to base a decision on whether or not to accept the offer. Consequently, the aforementioned settlement cases also obligate the issuer to register the ICO tokens with the Commission. Specifically, the issuers in the subject settlements were required to register the tokens on Form 10 under the Securities Exchange Act of 1934. See for example ParagonCoin’s Form 10 here. The filing of a Form 10 also triggers the periodic reporting requirements of the Exchange Act, obligating the issuer to file annual reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K.

Finally, the settlements also include bad actor disqualification from future utilization of the exemptions provided in Regulation A, Regulation CF (crowdfunding) and Regulation D.  Although the settlement orders don’t explicitly provide as much, the disqualification applies because the order requires the issuer to cease and desist from committing or causing any future violations of Section 5 of the Securities Act, and a Commission order to cease and desist from future violations of Section 5 of the Securities Act is one of the disqualifying events under the Commission’s bad actor rules.

Why the Enforcement Disparity?

So what explains the apparent enforcement disparity between, which involved only a relatively insignificant monetary penalty, and previous non-fraud unregistered offering cases which included rescission, registration, bad-actor disqualification and relatively more significant penalties relative to offering proceeds? Some have suggested that the settlement order signals a relaxation of enforcement in these cases. Others have justifiably called for the Commission to provide more detail and explain the disparate treatment.

It would certainly be helpful to ICO issuers, exchanges, lawyers and other market participants for the Commission to provide further detail explaining the apparent disparity. In the meantime, some of the details of how the ICO was conducted may suggest an explanation. The order states that implemented certain measures to prohibit U.S. persons from participating in the ICO.  First,’s offering website included certain measures intended to block U.S.-based purchasers from buying the offered digital tokens, including by blocking U.S.-based IP addresses from accessing the website token sale page. Second, required all token purchasers to sign a token purchase agreement which provided that U.S. persons were prohibited from purchasing the tokens and that any purchase by a U.S. person was unlawful and rendered the token purchase agreement null and void.

So if took steps to ensure offers and sales were not made to U.S. persons, why was the ICO of any concern to the Commission? Despite the aforementioned efforts to exclude U.S. persons from purchasing tokens in the ICO, the settlement order implies that some portion of the multi-billion dollar proceeds was raised from U.S. persons. The Commission also implies in the order that whatever U.S. sales did occur may not have been purely accidental. The order states that did not ascertain from purchasers whether they were in fact U.S.-based persons. Also, a number of U.S. based persons apparently purchased tokens directly through’s offering website, and received information through that site and various social media and forum posts. Further, the order states that undertook efforts for the purpose of, or that could reasonably be expected to have the effect of, conditioning the market in the U.S. for the tokens, including by engaging in directed selling efforts. Among other things, was said to have participated in blockchain conferences in the U.S. where it promoted its ICO.  Its offering website, white paper and other promotional statements were accessible to potential U.S. purchasers. Finally, the order states that the tokens were traded and widely available for purchase on numerous online trading platforms open to U.S.-based purchasers throughout the duration of the ICO, and that didn’t take any steps to prevent the tokens from being immediately resold to U.S.-based purchasers in secondary market trades.

So in the final analysis, the Commission may have been worried about’s selling efforts in the U.S. despite the tangible and seemingly reasonable safeguards implemented by it to ensure no sales were made to U.S. persons. But perhaps because the Commission was not ultimately able to prove how much of the offering proceeds were in fact generated in the U.S., and because of the difficulty of ever being able to make such a determination, the Commission may have tried to split the baby by settling with under terms more relaxed than in previous enforcement actions.

Key Takeaway

The key takeaway here is that ICO issuers that believe they can conduct a successful offering outside the U.S. should implement the safeguards employed by while avoiding the offering pitfalls that may have undercut its efforts to exclude U.S. persons.  That means blocking U.S.-based IP addresses from accessing the offering website, requiring that all token purchasers sign token purchase agreements prohibiting U.S. persons from purchasing tokens and providing that any purchase by a U.S. person is unlawful and renders the token purchase agreement null and void.  It also means obtaining written representations from purchasers that they are not U.S.-based persons.  It also means refraining from any efforts that could reasonably be expected to have the effect of conditioning the market in the U.S. for tokens, including by engaging in directed selling efforts such as promoting the ICO in U.S. blockchain conferences. Issuers should ensure that their offering website, white paper and other promotional statements are not accessible to potential U.S. purchasers, and that their digital tokens are not available for purchase on online trading platforms open to U.S.-based purchasers.

On October 11, 2019, the Securities and Exchange Commission (the “Commission”) announced it filed a complaint and obtained a temporary restraining order against Telegram Group Inc. and its wholly-owned subsidiary TON Issuer Inc. (collectively, “Telegram”) relating to Telegram’s offering of tokens without registration in violation of the Federal securities laws. The action sends a strong signal that the Commission is paying close attention to SAFT-based digital token offerings and is willing to go to court to stop the subsequent public launch of underlying tokens if it appears that the tokens are not yet fully developed and where the expectation of profit necessarily still derives from the efforts of the issuer.


In late 2013, Telegram launched an encrypted messaging application called “Messenger” which today may have as many as 300 million monthly users worldwide and has become a ubiquitous messaging application for the cryptocurrency community. Telegram, however, doesn’t make money from Messenger; the app is free to users and Telegram has pledged not to sell ads or introduce subscription fees and never to give third parties access to user data. Although Messenger incorporates ad hoc functionality that lets users exchange goods and services for both fiat and digital currency, Telegram envisioned integrating the ability to exchange digital assets directly into Messenger. It concluded, though, that existing networks like the Bitcoin and Ethereum blockchains don’t have the capability to replace high-volume transaction mechanisms like credit cards and fiat currency. So in late 2017, Telegram announced its intention to develop “next-generation multi-blockchain” systems designed to host a new generation of cryptocurrencies and decentralized applications at a massive scale, calling it “Telegram Open Network” or “TON”.

Telegram began funding the development of the TON blockchain network in January 2018 with the sale to investors of Purchase Agreements for Cryptocurrency, a form of simple agreement for future tokens, or SAFT. Under the Purchase Agreements, each purchaser made an investment in exchange for a promise by Telegram to issue the investor a certain number of its new cryptocurrency token “Grams” following the development and launch of the TON network. Importantly, the Purchase Agreements also provided that if the Network Launch had not occurred by October 31, 2019, Telegram would be obligated to return the investment amounts to the investors.

SAFTs Under the Howey Test

A typical SAFT based ICO consists of two stages. First, the issuer developing the blockchain network seeks to fund its network development through the sale of SAFTs to investors, in which the issuer promises to issue network tokens to the investors upon completion of the development and when the tokens are functional and offered to the public, usually at a discount to the public offering price. The prevailing securities law approach to a SAFT is that the SAFT itself and the tokens issuable thereunder are generally considered to be an investment contract and thus a security, meaning that their offering must either be registered with the Commission or qualify for an exemption from registration such as under Rule 506 of Regulation D. However, the status of the tokens issuable to the public after the network launch requires a thorough analysis under the Howey test. The key issue in the Howey analysis is the last prong of Howey, namely whether the purchaser of the token following the network launch is expecting a profit through the efforts of others. If he is, it’s a security; if he isn’t, it’s not. Whether there is an expectation of profit through the efforts of others in turn depends on whether the network is fully developed and the token fully functional. If it is, it’s a utility token and any expectation of profit derives not from the efforts of the developers (who have completed their development) but rather on the myriad of factors that cause assets to increase or decrease in value in a free market.

Complaint and TRO

Not much attention in the Commission’s complaint against Telegram was given to the securities law compliance of the early 2018 offer and sale of Telegram’s Purchase Agreements. Those were offered and sold under the exemption provided under Rule 506(c) of Regulation D, and Telegram filed with the Commission the required Notice of Exempt Offering of Securities on Form D in February 2018 with respect to $850 million in proceeds and filed another Form D in March 2018 with respect to an additional $850 million in proceeds. By filing the Forms D, Telegram was effectively conceding that the Purchase Agreements and the Gram tokens issuable to the original investors thereunder were securities. Although Rule 506(c) requires that the issuer sell only to accredited investors and use reasonable methods to verify accredited investor status, there is no direct assertion in the Commission’s complaint that Telegram violated either of these requirements or any other aspect of Rule 506(c) in connection with the Purchase Agreements. The complaint does allege, however, that the Purchase Agreements did not contain proper disclosure, as required under Regulation D. But if the Purchase Agreements were offered only to accredited investors (as is required by Rule 506(c), Regulation D would allow Telegram to avoid providing the investors the specifically mandated disclosure otherwise set forth in Regulation D. Instead, Telegram would be allowed to determine for itself what information is material and how to deliver that disclosure (including by providing its investors “access” to information).

What is at issue, however, is whether the planned issuance of the Gram tokens to the public prior to October 31, 2019 is an offering and sale of securities. The complaint states that Telegram took the position that the Gram tokens were currency and not securities. Public purchasers of Gram tokens were not restricted from reselling them. There was no restrictive legend associated with the to-be-publicly-issued tokens, and no warning was communicated that the publicly issued tokens may not be resold without registration or exemption therefrom. This contrasts with the Purchase Agreements, which contained legends stating that “this security” (presumably the Purchase Agreements and the Gram tokens issuable thereunder) is not registered with the Commission and may not be resold without registration or exemption therefrom, which restrictions on reselling were enforced through smart contract-based lockups.

The Commission rejects Telegrams position that the publicly issuable Gram tokens were not securities. In its complaint, the Commission points out that the October 31 deadline was not tied to whether the Gram tokens could be used to buy any products or services, but solely to whether Telegram was able to launch the TON blockchain network. If Telegram launched the network and sold the tokens publicly before they were fully functional, the tokens would be deemed to be securities because the public investors’ expectation of profit would necessarily depend on Telegram’s ability to complete the development of the tokens, i.e., the profit expectation would be “through the efforts of others”. Because Telegram planned to “flood the U.S. capital markets with billions of Grams by October 31”, the SEC jumped in to stop it.

The complaint further alleges the Gram tokens are not a currency because they currently have no realistic currency uses. It asserts that Telegram sold Grams in amounts that far exceed any anticipated “use” on the TON Blockchain. Telegram also didn’t restrict sales to individuals who would actually “use” Grams. The complaint further alleges that Telegram led investors to reasonably expect that Telegram’s and others’ entrepreneurial and managerial efforts would drive the success or failure of Gram tokens and the TON network. Telegram’s offering documents made clear that Telegram’s work would continue for some years after delivery of Gram tokens on the new TON Blockchain and would remain critical for the foreseeable future. The offering documents also spoke of potential future uses for the Gram tokens, specifically as a medium of exchange for goods and services (or “cryptocurrency”), to purchase not-yet-developed tools on the TON network (e.g., network storage, blockchain-based domain names, identity-hiding services) and as a token for future unspecified uses that Telegram and other third parties may eventually develop. But none of these uses of Gram tokens existed at any time. There are not now and have never been any products or services that can be purchased with Gram tokens. Finally, the principal means by which investors would reasonably expect to profit is through their resale of the tokens.


The Commission’s TRO and complaint against Telegram should serve as a stark warning to SAFT-based digital token issuers that the Commission is paying close attention to the unique characteristics of post-network launch tokens and will not hesitate to go to court to seek enforcement if the publicly launched tokens are not fully functional. The Commission in the past has at least informally acknowledged the viability of SAFT-based offerings by allowing that a class of digital tokens originally sold in a securities offering could be later sold in a manner that does not constitute an offering of a security where there is no longer any central enterprise being invested in or where the token is sold only to be used to purchase a good or service available through the network on which it was created. See the Division of Corporation Finance William Hinman’s June 14, 2018 speech on this issue here and my blog post on that speech here . Whether a post-network launch token is deemed to be an investment contract and thus a security will require a facts and circumstances inquiry, and will focus largely on whether a third party drives the expectation of a return and whether the digital token is structured through contractual or technical methods so that it functions more like consumer items and less like a security. Issuers would do well to try to structure enough flexibility into their SAFTs so that they are not forced to launch prematurely by an arbitrarily chosen deadline, and instead try to negotiate into the SAFT the right to postpone the launch for a reasonable period of time without having to return funds, perhaps conditioned on the consent of the SAFT investors, if the token is not fully functional by the deadline date. In the Telegram complaint, the Commission emphasized that the Purchase Agreement deadline is not tied to any promise or guarantee that the Gram tokens could actually be used to buy goods and services and instead depends solely on Telegram’s ability to create and launch the TON blockchain network. Clearly, Telegram’s public statements that it intended to launch the public release of the Gram tokens prior to October 31 was motivated by its determination to avoid returning investment proceeds to the original purchasers. In addition or as an alternative to a deadline postponement mechanism, issuers should focus on avoiding unrealistic network launch deadlines. Finally, it appears that Telegram had refused to accept service of an administrative subpoena, and the TRO mentions this as one of the reasons for its necessity. Lesson here is that issuers fail to cooperate with SEC investigations at their own peril.

The corporate spectacle better known as The We Company IPO officially and mercifully came to an end September 30 when The We Company (“We Co.”), the corporate parent of WeWork, requested that the Securities and Exchange Commission consent to the withdrawal of We Co.’s registration statement because it “no longer wishes to conduct a public offering of securities at this time”.  The filing of the withdrawal request was no shocker, following six weeks of intense scrutiny by prospective IPO investors and the media over WeWork’s business model, $1.6 billion in losses in 2018, related party transactions, questionable corporate governance and CEO Adam Neumann’s bizarre behavior, all of which prompted the company’s board last week to fire Neumann, put ancillary businesses up for sale and slash the company’s implied IPO valuation from $47 billion down to as low as $10 billion.

Much focus has been placed on We Co.’s largest investor, SoftBank, which directly or indirectly through its Vision Fund invested more than $10 billion in the company, with its latest investment earlier this year valuing the We Co. at $47 billion. Softbank clearly was not happy about the prospect of an IPO price based on a $10 billion valuation. But a feature in We Co.’s amended and restated certificate of incorporation will help cushion the blow when the company completes its next offering: dilution protection, or anti-dilution rights.

Without any desire whatsoever to pile on and kick We Co. when it’s down, I thought this was a good occasion to delve into the concept of dilution and the mechanics of anti-dilution.

There are two types of dilution experienced by investors: percentage dilution and economic dilution. Percentage dilution is not necessarily a problem; economic dilution always is.

Percentage Dilution

Percentage dilution is simply the mathematical result of one’s share in the whole declining as a result of the whole expanding. This automatically occurs when a company sells shares to new investors. For example, if a company with 1,000 outstanding shares completes the sale of 500 new shares to a new investor, the incumbent shareholders will experience percentage dilution in that their percentage of the outstanding shares drops as a result of the new issuance from 100% to 67% (1,000/1,500). Percentage dilution may be an issue if the dilution causes the holder to fall below a percentage threshold needed to maintain certain rights, such as board representation or veto rights. Otherwise, percentage dilution is not a cause for concern; it certainly was not for Softbank in WeWork.

Economic Dilution

Economic dilution, on the other hand, is always a problem for an incumbent investor. Economic dilution is experienced by an investor when the company issues new shares at a lower price per share than the price paid by that previous investor, a so-called down round. For example, a Series A investor purchases one million Series A shares at $1 per share. After failing to hit one or more milestones, the company burns through the Series A proceeds and must raise another round. But to attract investors in its Series B round after the economic hiccups, the company must agree to a lower valuation and sells shares at $0.50 per share. As a result, the value of the Series A investor’s shares has decreased from $1 million to $500,000. That’s economic dilution, and the Series A investor is not happy.

Anti-Dilution Protection

As a measure of protection against economic dilution, venture investors typically negotiate at the time of their investment for anti-dilution rights, which get baked into the company’s amended certificate of incorporation. In plain English, it means that if the company subsequently issues stock for consideration per share lower than what the investor paid, the company will be obligated to issue additional shares to the investor upon conversion of the preferred.

Preferred stock is almost always convertible into common, which is what allows the preferred to benefit from any upside on a sale of the company. In a disappointing exit with low proceeds, the preferred holder would just get his liquidation preference, expressed as an amount per share (usually equal to the amount per share paid by the investor). If the company sells for an amount that exceeds the aggregate liquidation preference, the preferred converts into common to share in the excess proceeds.

In a conversion, the number of shares of common that each share of preferred is convertible into is equal to the original price per share paid by the investor divided by the conversion price, which is initially equal to the price per share paid by the investor (resulting in a one-for-one conversion rate). The anti-dilution section triggers a downward adjustment in the conversion price resulting in additional shares issuable upon conversion. The magnitude of the adjustment depends on the extent to which the formula is investor friendly (full ratchet) or company friendly (weighted average), as explained below.

It’s important to understand that anti-dilution does not trigger issuance of additional (preferred) shares at the time of the down round, but rather additional (common) upon conversion which would occur on a sale of the company. That’s because anti-dilution is intended to protect the upside, not the downside. Otherwise, the issuance of additional preferred shares would result in unfairly increasing the liquidation preference amount, which would not be intended. If the pre-down round investor were to receive additional preferred shares for no additional consideration, the investor would receive an increase in his down side protection, an unintended windfall.

There are two general methods of calculating the anti-dilution adjustment: full ratchet and weighted average.

Full Ratchet Anti-Dilution

Full ratchet anti-dilution is the most investor friendly, and extremely rare. In plain English, it provides that the conversion price gets adjusted all the way down to the lower down round price, irrespective of the number of shares that were issued in the down round. Basically, a do-over in the earlier round that would result in the earlier round investor receiving for the same dollar amount of his investment, on conversion, a number of shares calculated based on a price per share equal to the lower down round price. As an absurd example for illustration, if a Series A investor invested $1 million and received one million shares constituting 20% of the outstanding, and the company then issued just one Series B share for one penny, the post-full ratchet cap table would indicate that the Series A holder would then have 100 million as-converted shares ($1,000,000/$0.01) constituting 96% of the fully-diluted, as-converted outstanding shares (100,000,000/104,000,001). The real victims? The founders. In my absurd example, the founders dropped from 80% post-Series A to just 3.99% post-Series B.

Weighted Average Anti-Dilution

Weighted average anti-dilution is far more common and considered more reasonable because it takes into account, in addition to price, the number of additional shares issued in the down round relative to the pre-money shares outstanding. The actual formula is as follows:

CP2 = CP1 x ((A + B) ÷ (A + C))

  • “CP2” is the new (post-down round) conversion price;
  • “CP1” is the conversion price in effect immediately before the down round;
  • “A” is the number of shares of common stock (including all shares issuable upon exercise of outstanding options or upon conversion of convertible securities) outstanding immediately prior to the down round;
  • “B” is the number of shares that would have been issued in the down round if price per share were equal to CP1 (determined by dividing the aggregate consideration received in the down round by CP1); and
  • “C” is the number of shares issued in the down round.

There’s an important wrinkle to weighted average anti-dilution protection. Weighted average anti-dilution could be either broad based or narrow based, depending on the extent of options and convertible securities that are included in shares outstanding. The formula that appears above is broad based because the number of shares outstanding includes all shares issuable on exercise of options and on conversion of convertible securities. The broader the formula (i.e., the more securities that are included in the outstanding), the less of an adjustment to conversion price.

Under narrow based weighted average anti-dilution, the only securities that would be included in shares outstanding (in addition to actually outstanding common shares) would be the number of shares outstanding of the particular series of preferred whose conversion price is being adjusted.

SoftBank’s Anti-Dilution Protection in We Co.

Page F-115 of We Co.’s S-1 Registration Statement  states that all preferred stock (including preferred held by SoftBank) is subject to “broad weighted-average anti-dilution protection”. For companies that have issued multiple series of preferred, each series has a separate conversion price (which typically starts out being equal to the purchase price per share). The beneficial ownership table in We Co’s S-1 indicates that SoftBank directly or indirectly is the beneficial owner of shares in 11 different series of We Co. preferred stock. SoftBank’s last investment in We Co. was $5 million at a $47 billion valuation, with a per share purchase price of $112 per share.

At this point, it remains to be seen when (if at all) We Co. will resume its efforts to go public. But what’s clear from the S-1 and many media reports, We Co. needs to raise cash. Before it withdrew its IPO, We Co. and its underwriters were rumored to be prepared to drop the valuation to as low as $10 billion. So whether the next round is a public or private offering, it almost certainly will be a down round.

Given the eleven different series invested in by SoftBank, each with its own price and conversion price, the amount of time it would take to calculate all the anti-dilution adjustments would be a multiple of what it has taken me to write this blog post. In fact, the conjecture is that the complicated calculations needed to figure out the anti-dilution adjustments to SoftBank’s various conversion prices in its multiple funding rounds weighed heavily on SoftBank’s decision to cause We Co. to pull the IPO plug for now. Ultimately, We Co. couldn’t proceed with the IPO without SoftBank’s, part of a package of vetos over major decisions usually negotiated by investors.

So how impactful will the anti-dilution adjustment be with respect to SoftBank?  Even under the more relaxed weighted average method of anti-dilution protection, because of the magnitude of the drop in valuation from SoftBank’s previous investment, coupled with the enormous number of shares that would be issued in We Co.’s IPO (if it does happen) at that lower valuation, the additional number of common shares issuable to SoftBank on conversion will be dramatic.  So much so that Renaissance Capital estimates the anti-dilution adjustments here could result in the largest IPO anti-dilution adjustment ever, as large as $200 million to $500 million worth of additional shares issuable on conversion to preferred stockholders, mostly going to SoftBank.  Moreover, it was disclosed in the S-1 that upon payment of the final $1.5 billion installment of SoftBank’s most recent Series G-1 round investment, We Co. will issue it a warrant to purchase a large but undisclosed number of additional shares at a very low but undisclosed price per share.

In the final analysis, anti-dilution softens the economic dilution blow of the down round to the preferred stockholders, resulting in massive disproportionate percentage and economic dilution to the common stockholders.

On July 10, 2019, the Securities and Exchange Commission declared Blockstack PBC’s offering statement “qualified”, thus allowing Blockstack to commence the distribution and sale of its Stacks Tokens under Regulation A. This is the first offering of digital tokens to be qualified by the Commission under Regulation A, a significant milestone for the blockchain industry which raised billions of dollars in 2016-2018 in unregistered non-exempt initial coin offerings before the Commission threw down the gauntlet in the form of lawsuits and enforcement actions alleging illegal unregistered offerings, most recently against Kik Interactive Inc.  Yet given recent Regulation A headwinds, it’s unclear to what extent other blockchain developers will follow Blockstack’s lead and look to raise capital under Regulation A.

State of Regulation A

Regulation A was reformed under the JOBS Act of 2012 to allow issuers to raise up to $50 million in any rolling 12-month period with scaled down disclosure relative to full-blown registration, freedom to test-the-waters and no qualification at the state level. Referred to as a mini-IPO, Regulation A also provides a streamlined pathway to Securities Exchange Act registration (for those issuers choosing to be SEC reporting companies) and for listing on a national securities exchange. Shares issued in a Regulation A offering are unrestricted; they can be freely resold without a holding period or other restriction.

Issuers’ and securities professionals’ hopes were high that Regulation A could be a viable alternative to registered public offerings or other existing exemptions. Initial signs were encouraging. Since Regulation A went live in 2016, over 100 transactions have been consummated averaging $10 million per deal, including ten issuers that got listed on Nasdaq or the NYSE.

Unfortunately, however, Regulation A has experienced some hiccups lately. The shares of the ten listed Regulation A issuers have fared poorly, and the Commission recently approved Nasdaq’s proposed rule to require Regulation A funded companies seeking Nasdaq listing to have a minimum two year operating history. One Regulation A issuer, Longfin Corp., terminated operations less than one year after closing its Regulation A offering and is now the subject of a fraud lawsuit by the Commission.

Blockstack Offering of Stacks Tokens

Blockstack is developing an open-source peer-to-peer network using blockchain technologies to ultimately build a new network for decentralized applications. Blockstack is offering up to $40 million of its Stacks Tokens, consisting of a combination of full-priced tokens to “qualified purchasers” as defined in Regulation A, discounted tokens to holders of certain purchase vouchers and non-cash consideration tokens under Blockstack’s “app mining” program in exchange for the development of well-reviewed applications on its decentralized application network.  Blockstack previously raised over $50 million in VC rounds and under Rule 506(c); among those investing were big-time early stage investors Union Square Ventures, Y Combinator, Lux Capital and Naval Ravikant.

The Evolving Token

In a June 2018 speech, SEC Division of Corporate Finance Director William Hinman broke new ground when he stated that a digital asset originally sold in a securities offering could later be sold in a manner that does not constitute an offering of a security when there is no longer any central enterprise being invested in or where the digital asset is sold only to be used to purchase a good or service available through the network on which it was created. I blogged about the speech here.

Consistent with the guidance from Hinman’s speech and with the Commission’s recent guidance in its “Framework for ‘Investment Contract’ Analysis of Digital Assets”, Blockstack asserts its Stacks Token is a security now but may not be so in the future. In its offering statement, Blockstack states that, for the foreseeable future, it anticipates treating the Stacks Token as a security based on its view that the token is an “investment contract” under the application of the Howey test to digital assets: an investment of money, in a common enterprise, with a reasonable expectation of earning a profit, through the efforts of others. With investment of money in a common enterprise and a reasonable expectation of earning a profit assumed, the real issue is whether that profit expectation is through the efforts of others.

Under the Framework and the Howey Test, a profit expectation is considered to be through the efforts of others if the network is still being developed and the token is not fully functional, because the success of the network is considered to be dependent on the efforts of management. Once the network is sufficiently decentralized, that success can no longer be said to be dependent on the efforts of management. Blockstack maintains that, currently, it employs all core developers of the Blockstack network. But as the network becomes increasingly decentralized, core developers other than those employed by Blockstack may become primarily responsible for the development and future success of the network. Blockstack also maintains it may transfer governance and control of the Blockstack network to other parties, such as network users and developers.

Whether Stacks Tokens lose their status as investment contracts will ultimately depend on whether purchasers of the tokens no longer expect Blockstack to carry out essential managerial or entrepreneurial efforts, and whether Blockstack no longer retains a degree of power over the governance of the network such that its material non-public information may be of special relevance to the future of the Blockstack network, as compared to other network participants.  Arguably, purchasers will no longer have that expectation and Blockstack will no longer have that power when the network becomes truly decentralized, at which point Blockstack asserts the Stacks Tokens will no longer constitute a security.

Precedent Setting?

Blockstack’s Regulation A journey has been an expensive and long one, purportedly costing it $2 million over the ten months of engaging in the process. Blockstack’s co-founder Muneeb Ali joked about what he calls Blockstack’s “$2 million donation to the crypto industry”, but he also made these interesting comments on his blog about the precedent setting potential of the offering:

“[the offering could] set a precedent for others in the industry…Recently, U.S. markets have been closed to crypto projects given regulatory uncertainty, and we believe in opening the U.S. markets to innovation in this area. We’ve been working with securities lawyers to create a legal framework that can enable blockchain protocols to comply with SEC regulations…Following a regulated path and proactively working with the regulators was a decision we made with the understanding that it’ll require a lot of work and time…This can potentially set a precedent for others in the industry, not just for public offerings, but also as a path to launch new public blockchains and establish a path to bootstrapping decentralized ecosystems.”

Whether Blockstack’s Regulation A offering will indeed set a capital raising precedent for others in the blockchain industry remains to be seen, and will depend on several factors including whether Regulation A can rehabilitate its brand and whether Blockstack’s “$2 million contribution to the crypto industry”, presumably through multiple versions of its offering circular and responses to voluminous SEC comment letters, will have created a practical, workable model from which others can follow Blockstack’s lead in a more cost-effective manner.

Non-accredited investors are estimated to constitute approximately 92% of the U.S. population. Yet restrictive rules governing exempt offerings have significantly limited their freedom to invest in private offerings and prevented or discouraged issuers from selling them privately offered securities. But in a recently issued concept release, the Securities and Exchange Commission has signaled a willingness to approach the issue in a much more creative way, suggesting the possibility of expanded opportunities for companies to include non-accredited investors in exempt offerings without unduly compromising their protection.

The SEC’s June 18, 2019 concept release seeks public comment on ways to simplify, harmonize and improve exempt offerings by removing some of the existing complexity, thereby promoting capital formation without unduly compromising investor protections and expanding opportunities for investors. In its press release issued the same day, SEC Chairman Jay Clayton noted that “input from startups, entrepreneurs and investors who have first-hand experience with [the SEC’s] exempt offering framework will be key to its efforts to analyze and improve the complex system we have today.”

Significant changes over the past few years to the rules governing exempt offerings (most notably through the Jumpstart Our Business Startups Act of 2012, the Fixing America’s Surface Transportation Act of 2015 and the Economic Growth, Regulatory Relief and Consumer Protection Act of 2018) have resulted in a complex framework of differing requirements and conditions, which may be difficult for issuers to navigate, particularly startups and emerging companies with more limited resources.

Interestingly, the amount raised in exempt offerings has been trending higher in both absolute terms and relative to registered offerings, and now is twice the amount raised in registered public offerings. The concept release estimates that in 2018, registered offerings accounted for $1.4 trillion of new capital compared to approximately $2.9 trillion raised through exempt offerings.

Given the dominance of exempt offerings, the focus of the release is to seek input on whether the current regulatory framework provides adequate access to capital for a variety of issuers, particularly smaller issuers, and adequate access to investment opportunities for non-accredited investors while maintaining investor protections. Non-accredited investors’ primary investment opportunities have historically been in registered markets because of the restrictions on their participation in private offerings. Non-accredited investors have not had the same level of access to investment opportunities in exempt markets as an accredited investor would, and the upward trend in exempt offerings only exacerbates the problem.

Consequently, the SEC is seeking comment on whether it would be consistent with capital formation and investor protection for it to consider steps to make a broader range of investment opportunities available to non-accredited investors. In particular, the SEC is seeking comment on the following specific questions (among others):

Accredited Investor Definition. To be considered an accredited investor, an entity would need to fall under one of the designated categories of financial institutions, have more than $5 million in assets or have only accredited investor owners, while an individual must pass either a net worth or income test. The SEC is seeking comment on:

  • Whether the $5 million asset test for entities should be replaced with a $5 million investments test that includes all entities rather than specifically enumerated types of entities?
  • Whether individuals should be allowed to qualify based on other measures of sophistication, such as minimum amount of investments, certain professional credentials, experience investing in exempt offerings, knowledgeable employees of private funds for investments in their employer’s funds, individuals who pass an accredited investor examination?
  • Currently, a natural person just above the income or net worth thresholds would be able to invest without limits, but a person just below the thresholds cannot invest at all as an accredited investor. Should that be changed?

Rule 506 of Regulation D. Currently, Rule 506(b) allows sales to up to 35 non-accredited investors (and an unlimited number of accredited investors), but the exemption from the specific, mandated disclosure obligations of Regulation D for offerings sold only to accredited investors serves as a significant incentive to exclude non-accredited investors.   Accordingly the SEC seeks comment on:

  • Whether it is important to continue to allow non-accredited investors to participate in Rule 506(b) offerings, and if so are the information requirements having an impact on the willingness of issuers to allow non-accredited investors to participate?
  • Whether the SEC should consider eliminating or scaling the information requirements depending on the characteristics of the non-accredited investors participating in the offering, such as if all non-accredited investors are advised by a financial professional or a purchaser representative?
  • Whether information requirements should vary if non-accredited investors can only invest a limited amount or if they invest alongside a lead accredited investor on the same terms as the lead investor?
  • Should non-accredited investors be allowed to purchase securities in an offering that involves general solicitation? If so, what types of investor protection conditions should apply? For example, only if: (i) such non-accredited investors had a pre-existing substantive relationship with the issuer or were not made aware of the offering through the general solicitation; (ii) the offering is done through a registered intermediary; or (iii) a minimum percentage of the offering is sold to institutional accredited investors that have experience in exempt offerings and the terms of the securities are the same as those sold to the non-accredited investors?

Regulation A. In a Tier 2 offering by an issuer of securities that are not going to be listed on a national securities exchange upon qualification, non-accredited individual investors are limited in how much they can invest to no more than 10% of the greater of their annual income or net worth, alone or together with a spouse and excluding the value of their primary residence and any loans secured by the residence (up to the value of the residence). The SEC seeks comment on:

  • Whether the individual investment limits for non-accredited investors in Tier 2 offerings should be changed or eliminated?
  • If the investment limits are changed, what limits would be appropriate?

Responses to the foregoing or any other requests for comment set forth in the concept release may be submitted to the SEC here prior to the deadline of September 24, 2019.

The Securities and Exchange Commission filed a complaint last week against the founder of venture-backed mobile payments startup Jumio, Inc., charging him with causing the company to prepare false and misleading financial statements that inflated the company’s earnings and gross margins and with defrauding secondary market purchasers of his shares. The founder, Daniel Mattes, agreed to pay more than $16 million in disgorgement and prejudgment interest plus a $640,000 penalty and to be barred from being an officer or director of a publicly traded company in the United States.

Jumio, Inc. was founded to make mobile phone purchases easier and more secure through its customer identity and credit card verification technology.  The company had two lines of business: a processing business which connected merchants to payment processors in exchange for a commission paid by the processors equal to 10% of their processing fee, and a product business which licensed its ID and credit card verification technology to merchants.

Mattes appears to have engaged in separate fraudulent schemes for each of the two lines of business. As to the processing business fraud, the complaint alleges that Mattes prepared Jumio’s financials for 2013 and 2014 which overstated revenue and profitability by recording as revenue the entire amount of processing fees collected by payment processors, rather than the 10% actually paid to Jumio.

The product business fraud involved a roundtrip contract with no economic substance and improper recognition of subscription revenue. The roundtrip transaction consisted of an agreement Mattes entered into on Jumio’s behalf with a software developer under which the software developer would ostensibly pay Jumio $710,000 per quarter for credit card verification scans that the developer could resell to third parties, and Jumio would ostensibly pay the developer $800,000 per quarter for software development services. The complaint alleges that Mattes caused Jumio to recognize as revenue the $710,000 from that contract in the first quarter of 2013. Mattes apparently wasn’t careful enough in concealing this deception; the complaint asserts that he wrote to an employee not to get excited over the transaction because “it’s more a deal to get our numbers straight for the upcoming round”, evidently a reference to Jumio’s Series C offering. Although both parties ceased making payments to each other after the first quarter of 2013, Mattes had Jumio continue to record the stated revenue from that contract throughout 2013 and 2014.

The second type of product business related fraud involved recognizing as revenue at the commencement of certain subscription agreements the entire amount of subscription fees due under such agreements before services were performed, and even when it became obvious a subscriber wouldn’t pay, in clear violation of revenue recognition rules. Under Generally Accepted Accounting Principles, Jumio should have only recognized the revenue over the period of the subscription as the revenue was earned, and should not have recognized revenue from deals where collectability was not reasonably assured. Mattes’ accounting also violating SEC staff policy on revenue recognition. SEC Staff Accounting Bulletin No. 101 – Revenue Recognition in Financial Statements provides that revenue generally is realized or realizable and earned only when all of the following criteria are met: (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred or services have been rendered, (iii) the seller’s price to the buyer is fixed or determinable, and (iv) collectability is reasonably assured.

The misstatements Mattes made in Jumio’s financial statements were material. The complaint states that Jumio’s 2013 financials represented that Jumio’s gross revenue was $101 million, when it was actually only $9.5 million; that its gross margin was $23 million, when it was actually only $9.2 million; and that its net profit was $1.3 million, when in fact it had a net loss of $10 million.

Mattes also deceived the board regarding his intentions, according to the complaint. In early 2014, Mattes set up a program to allow employees to sell shares through a broker in the secondary markets. Mattes himself had previously sold large blocks of shares to institutional investors and was under a contractual obligation to provide notice to the board (and presumably receive board consent) before selling any of his own shares. Mattes was evidently informed by a director that the board would not authorize further sales by him, apparently out of concern that he have sufficient skin in the game and be properly incentivized. When the board authorized the employee share selling program, Mattes represented to the board that he would be excluded. Nevertheless, Mattes in fact did sell his own shares through the program without notifying the board. The complaint further asserts that Mattes had been warned by company counsel that he needed board approval for the sales, and that he falsely represented to counsel that he received informal approval with ratification to follow.

Mattes’ profit from the alleged fraud was considerable, securing a profit of over $14 million from the sale of his own shares to secondary market investors through the employee selling program. His involvement in the fraud, according to the complaint, was direct. He prepared the false financials, caused them to be provided to the broker and personally discussed them with investors. He also misrepresented to at least one investor that he was not selling his own shares. When the investor noticed that funds were being wired to Mattes, Mattes falsely claimed that he was only acting as an intermediary for legal reasons on behalf of employee sellers. He was even quoted as saying to the investor that he didn’t want to sell a single share because of “lots of great stuff coming up” and that “[he]’d be stupid to sell at this point.”

In late 2014, Jumio hired a CFO, who quit after just a few days on the job. He told Jumio’s board that revenue numbers were inaccurate, referencing the roundtrip transaction in particular. The board then hired outside accountants to assess Jumio’s books, leading to a restatement of its 2013 and 2014 financial statements. But even after Mattes knew that the financial statements would need to be restated, he continued selling his stock in the secondary market.

Mattes resigned from Jumio in mid-2015 after an internal investigation. Jumio filed for Chapter 11 bankruptcy in 2016 and the shares that Mattes had sold to the secondary market purchasers became worthless. Ironically, Mattes founded Jumio in 2010 to decrease fraud (in mobile purchases). Certainly, primary culpability for the wrongdoing here lies with Mattes. But to minimize the risk of internal management fraud and avoid Jumio’s fate, companies should exercise good corporate governance and sound internal controls which appeared to be somewhat lacking at Jumio before it was too late. Among other safeguards, there should be some independent review of financial statements such as an audit committee composed of non-management directors and/or an independent accounting firm. Counsel also has an important gatekeeper role to play and should exercise diligence in protecting the interests of the company when uncovering evidence of possible fraud.



Lyft, Inc. last week completed its highly anticipated initial public offering, raising over $2.3 billion at a valuation of approximately $25 billion, and turning its co-founders Logan Green and John Zimmer into near billionaires on paper. But that’s not the only reason they’re smiling. Despite owning only 7% of the outstanding pre-IPO shares, Green and Zimmer will control nearly 50% of the voting power by virtue of their Class B shares having 20 votes per share and the Class A shares having just one vote per share.

Nothing that unusual so far. In three of the last four years, over one-third of the technology companies that went public featured dual-class shares, including Snap, Roku, Dropbox and Spotify. Snap went to an extreme by selling to the public shares with no voting rights at all, as did Alphabet, Under Armour and Blue Apron. I previously blogged here about Snap’s IPO of no-vote shares.

What makes Lyft’s dual class structure somewhat unusual is that it lacks a fairly typical sunset provision that would be triggered when the founders’ combined ownership falls below some threshold (often 10%) of the overall shares outstanding. In Lyft’s case, the founders’ combined ownership was already below 10% prior to the IPO.  Lyft’s dual structure also has much larger disproportionality: 20 votes for every one vote held by all other stockholders, rather than the more standard 10:1. The Lyft structure will only terminate (by Class B shares converting into Class A shares) upon (I) a two-thirds vote of the Class B, (ii) the co-founders’ Class B shares representing less than 20% of the Class B outstanding, or (iii) the death or total disability of the last to die or become disabled of the co-founders.

Lyft readily concedes that its dual class structure poses a risk to investors. The first risk factor under the caption “Risks Related to Ownership of Our Class A Common Stock” in Lyft’s final offering prospectus states: “The dual class structure of our common stock has the effect of concentrating voting power with our Co-Founders, which will limit your ability to influence the outcome of important transactions, including a change in control.” It acknowledges that founders Logan and Zimmer will be able to control the vote on matters submitted to stockholders for approval, including the election of directors, amendments to the certificate of incorporation and any merger, consolidation, sale of all or substantially all assets or other major corporate transactions.

There’s an interesting debate surrounding dual class share structures, with valid arguments both for and against. Opponents assert founders shouldn’t have it both ways — access to capital markets without relinquishing control. Also, management that’s less accountable to public stockholders may pursue strategies that produce lower returns and lower value over time. Defenders contend the structure allows founders to make decisions that are in the best long term interests of the company without undue pressure from short-termist investors. Unless founders are able to control the vote through disproportionate voting shares, they may succumb to the pressure of producing quarterly results and may forego certain actions whose benefits may only accrue over the longer term like research and development and restructurings. Another argument in favor is that it neutralizes politically motivated vote initiatives such as “say on pay” or climate-change disclosures.

The New York Stock Exchange historically denied listing of companies with dual-class voting, primarily because of a general commitment to corporate democracy and accountability. But reacting to pressure from corporate boards at the height of the takeover battles of the 1980s and competition from other exchanges, the NYSE reversed course and today permits companies to go public with dual class structures.

Some opponents have advocated an outright ban on dual class structures or lobbied exchanges to refuse to list companies that have them. But the impact on IPOs must be carefully considered. Growth startups have been shying away from going public over the last 15-20 years for a variety of reasons, including regulatory burden, availability of late stage private funding and decimalization. Another reason is activist stockholder short termism, and founders may be even more reluctant to go public without the protection afforded by dual class shares, particular since other traditional defense mechanisms have fallen out of favor, including staggered boards and shareholder rights plans.

The Wall Street Journal Editorial Board, recognizing there are merits and risks associated with a dual class structure, argues that prospective Lyft investors who oppose it should simply not invest, or invest elsewhere; Uber’s IPO is rumored to be happening later this year.

A fair question to ask is whether dual-class structures, once adopted, should last forever. Research in this area indicates that the benefits of a dual-class structure for any given company decline over time, that the costs of letting management essentially entrench itself eventually outweigh the benefits of shielding the company from short-term investors.  Last year, the SEC reviewed the stock market performance of companies with dual-class structures, comparing those that had time-based sunset provisions with those that allow them to last in perpetuity. It found that within two years of an IPO, companies with sunset provisions significantly outperformed those without them. Because of this and similar research conclusions, the Council of Institutional Investors has advocated in favor of time-based sunsets requiring multi-class structures with unequal voting rights to collapse to one-share, one-vote within a reasonable, specified period of not more than seven years after IPO.

Mandatory sunsets sound logical. After a certain number of years following an IPO, a company’s business model should have reached maturity such that it no longer needs protection from short termists in order to make long term changes. But here one size probably does not fit all. Companies often pivot differently in reaction to market trends and technological developments, and there’s no way to predict when companies will reach maturity. The better approach might be to give stockholders holding one vote/share stock the opportunity to vote after some period of time following an IPO as to whether or not to discontinue the dual class structure. Such a vote would ensure that founders aren’t insulated forever and would allow stockholders to determine when their company has matured to the point where the dual class structure is no longer needed or justified.

2018 was a historically good year for venture capital in the United States in terms of dollars invested by VC funds in U.S. companies, dollars raised by VC funds and dollar value of exits by VC-backed companies, according to the Venture Monitor for Q4 2018 published by PitchBook and the National Venture Capital Association. VC funds invested over $130 billion in over 8,000 portfolio companies in the U.S., limited partners committed $56 billion to 256 new American VC funds and 864 venture-backed exits exceeded a combined value of $120 billion. Here’s a slightly deeper dive into some of the numbers:

  • Record Year for VC Investments: The $130 billion invested by VC funds in U.S. companies marked the first time annual capital investment surpassed the $100 billion watermark set at the height of the dot-com boom in 2000.
  • Historical Year for VC Fund Capital Commitments: The $55.5 billion committed to new fund formations in 2018 was the highest amount of capital that PitchBook has ever recorded and the fifth consecutive year that at least $34 billion was raised by VC funds in the U.S.
  • Bigger but Fewer Funds: The median new venture fund raised $82 million, nearly triple what it was in 2014. The number of new funds, however, was below a 2016 peak.
  • Beginners’ Luck: Even first-time fund managers kicked butt, raising over $5 billion, the highest figure recorded in over ten years.
  • Early Stage Deals Surge: Early stage (Series A or B) value and count reached decade highs.  Early stage median deal sizes were also higher in 2018, creating a perception that Series A is the new Series B.
  • But Number of Angel & Seed Deals Tanked: Although angel and seed median deal sizes increased (as was the case with the rest of VC), the number of angel and seed deals dropped by roughly half since its 2015 high.
  • Valuations Soaring: Median pre-money valuations more than doubled since 2013 for Series A, B, C, and D+ rounds, with the median of the latter seeing a three-fold increase.
  • Latest Stage Valuations Remain Fastest Growing.  Median pre-money valuation of companies in Series D deals or higher shot up to $325 million, an increase of approximately 30% over 2017.
  • Bigger Exits, including IPOs: Total exit value surpassed $120 billion for the first time since 2012. The 85 IPOs were the most since 2014 and represented more than 50% of exit value for the second straight year.
  • Usual Suspects Continue Regional Dominance: No shocker, California, Massachusetts and New York continued to dominate VC investment activity, with companies in those states attracting 79% of total U.S. capital invested, although only 53 percent of completed U.S. deals.

With VC funds stockpiling massive amounts of dry powder as a result of five consecutive years of $34+ billion capital commitment hauls, VCs should be well positioned to invest in startups for the next few years, even if there’s a downturn in the VC market.



Real estate developers should seriously consider equity crowdfunding to fund development projects for two major reasons, one of which has little or nothing to do with money. The first reason is that new securities offering legislation enacted in 2012 creates new legal capital raising pathways which allow developers for the first time to use the internet to find investors, and also to raise money from non-accredited investors. The second reason is that a crowdfunding campaign can be a potent weapon in overcoming political and neighborhood opposition to a development project.

Pre-2012 Impediments to Capital Formation

Before 2012, real estate developers seeking to finance projects from private investors were faced with three major legal impediments. First, they could only accept investment from accredited investors[1], a legal designation for institutions with assets of at least $5 million or individuals meeting either an income test ($200,000 in each of the last two years, or $300,000 combined with one’s spouse) or a net worth test ($1 million without including one’s primary residence). This meant that real estate entrepreneurs were excluded from roughly 93% of the U.S. population that did not qualify as accredited investors and the $30 trillion that is estimated to be socked away in their savings accounts. Second, as if the first wasn’t limiting enough, the accredited investor had to be someone with whom the developer had a preexisting relationship. And not just any relationship; it had to be of the sort that would enable the developer to assess whether the investment was appropriate for the investor. And third, and perhaps most limiting, the developer was prohibited from engaging in any general solicitation or advertising: no ads, no mass mailings, no e-blasts and, most notably, no internet.

JOBS Act of 2012: Three Crowdfunding Alternatives

In 2012, Congress passed and President Obama signed into law the Jumpstart Our Business Startup Act, better known as the JOBS Act, a major piece of rare bipartisan legislation intended to make it easier for entrepreneurs to raise capital. In the U.S., any offering of securities must either be registered with the SEC (enormously expensive and time consuming, and triggers ongoing SEC reporting and other regulatory burdens as an SEC reporting company), or satisfy the requirements of an exemption from registration. Among other capital markets reforms, the JOBS Act created three crowdfunding exemptions from registration, divided into Titles II, III and IV, each with its own dollar limitations and other myriad rules.

Accredited Investor Crowdfunding

Title II of the JOBS Act and the SEC’s related Rule 506(c) provide for what many refer to as “accredited investor crowdfunding”. It allows developers to use the internet and other methods of general solicitation and advertising to raise an unlimited amount of capital, but with two strings attached. One, sales of securities may only be made to accredited investors. And two, the issuer must use reasonable methods to verify accredited investor status. The requirement to reasonably verify status means the old check-the-box on the one-page investor questionnaire doesn’t fly here; one would need to dig deeper and request such evidence as brokerage statements or tax returns (which investors are loathe to produce) or lawyer or accountant certifications (good luck getting those). Despite the advantage of being allowed to use the internet to reach accredited investors, however, only four percent of the capital raised in Regulation D offerings since Rule 506(c) went live in September 2013 was raised in offerings conducted pursuant to Rule 506(c), according to the SEC. It stands to reason that the culprit is the enhanced verification requirement, which is now the target for reform among capital markets reform advocates.

Non-Accredited Investor Crowdfunding

Under Title III of the JOBS Act and the SEC’s Regulation Crowdfunding, an issuer may offer and sell securities over the internet to anyone, not just accredited investors, without registering with the SEC. There are many limitations and restrictions, foremost of which is that an issuer may raise no more than $1,070,000 per year using this method. Investors in Title III deals are also capped based on their income and net worth. Issuers must sell through a third-party funding portal (only one), and there are disclosure and SEC filing requirements. Title III was the section of the JOBS Act that received the most buzz, largely because of the disruptive nature of allowing companies to raise capital from non-accredited investors, using the internet and without registering with the SEC and giving ordinary people the chance to invest in startups and other private investment opportunities they were previously shut out of, but also because of the controversy it created among those who believed that this new opportunity would be a recipe for massive fraud. To date, thankfully, there’s been virtually no fraud reported in Title III deals.

Mini-Public Offering

The third crowdfunding exemption allows companies to raise up to $50 million from the general public in a mini-public offering over the internet under Title IV of the JOBS Act and Regulation A+ promulgated by the SEC thereunder.  A Regulation A+ offering is similar to a traditional registered public offering except that the disclosure statement is scaled down and the whole process far less expensive and time consuming. Regulation A+ has several distinct advantages: It generally preempts the states, meaning that issuers need only go through a review process at the Federal level with the SEC (the predecessor rule required issuers to get clearance from each state in which investors were solicited). Shares sold in a Regulation A+ offering are freely tradable and may be resold right away. And issuers may “test the waters” and gauge investor interest before committing to launch an offering. For these and other reasons, real estate developers and funds have been the most active users of Regulation A+.

Real Estate Crowdfunding

Real estate crowdfunding has rapidly grown into a multi-billion-dollar industry since the passage of the JOBS Act in 2012. It is leveling the real estate investment playing field, providing access both for ordinary individuals to an asset class they were previously shut out of, and for real estate entrepreneurs to a universe of previously forbidden but low hanging investor fruit, particularly in the form of people living in the communities where projects are being proposed for development. Through equity crowdfunding, high quality real estate investment opportunities are no longer offered strictly on a “who-you-know” basis. It replaces the hand-to-hand combat of raising capital in the old school, country club network way. What used to be multiple phone calls one investor at a time, is now a tweet that potentially reaches millions of people. With equity crowdfunding, a real estate entrepreneur can post a deal on a single portal and reach thousands of potential investors at once with the portal handling the subscription process and fund transfers electronically. Another positive aspect of real estate crowdfunding is that it has the potential to attract funding to emerging neighborhoods where traditional funding sources rarely go. Furthermore, most crowdfunding portals pool investors into a single purpose entity that acts as the investor of record, so that the pooled investors are only treated as one owner on the issuer’s cap table for accounting and corporate governance purposes.

Regulation A+ has proven to be an enormously popular capital raising pathway for diversified REIT-like real property investment vehicles because of the ability to raise up to $50 million from the general public (not just accredit investors) in a streamlined mini-public offering process and then invest those proceeds in several projects. Like conventional real estate funds, these investment vehicles generally conduct their capital raises prior to identifying specific projects. Other real estate professionals using crowdfunding are using the Rule 506(c) model, allowing them to raise an unlimited amount over the internet albeit only from accredited investors. Under this model, the real estate entrepreneur typically first identifies a project and then offers the investment to prospective investors under offering materials that describe the particular project.

Some real estate institutions have taken the crowdfunding plunge and launched crowdfunding platforms of their own, with Arbor Realty Trust/AMAC claiming to be the first institution to do so with its ArborCrowd platform. ArborCrowd markets one deal at a time and writes a check upfront, which allows a property’s sponsor to close quickly on its acquisition. ArborCrowd then offers interests in the investment vehicle through its platform to accredited investors under Rule 506(c), with minimum individual investments of $25,000. I checked on SEC’s EDGAR site and saw that ArborCrowd has done seven deals thus far, aptly named ArborCrowd Investment I-VII, respectively, which average approximately $3 million each.

Real estate funding portals come in two general varieties: those that act as matchmaking sites between real estate entrepreneurs seeking funding and investors seeking real estate investment opportunities, and others operated by real estate firms offering investment opportunities in their own proprietary deals.  There are currently over 100 real estate crowdfunding platforms; some of the more established include Fundrise, RealtyMogul, CrowdStreet, Patch of Land and RealCrowd.

In My Backyard

And now we get to the more intriguing use of equity crowdfunding by real estate entrepreneurs: giving community residents skin in the game and incentivizing them to support a local development project.  Most major development projects are likely to be challenged by the not-in-my-backyard phenomenon, and such opposition can derail, delay or increase project costs dramatically. Whether the project is affordable housing, a power plant or a sewage treatment facility, the developer can expect opposition from a vocal NIMBY minority, irrespective of how much the proposed project is needed by the community at large.  An equity crowdfunding campaign could be a powerful tool to convert opponents and mobilize pro-project allies. One approach could be for sponsors to allocate some percentage, e.g., 10%, of a crowdfunding offering for investors residing within some given mile radius of the project. Another approach might be to conduct simultaneous offerings, one under Title III within the $1,070,000 cap with the hope of attracting local residents to invest, and a larger parallel offering to accredited investors under Rule 506(c).


Real estate crowdfunding is still in its nascent stages. But as awareness grows, smart reforms are implemented to improve the rules and the market matures, I believe real estate developers will embrace equity crowdfunding as both a way to fund projects that are neglected by traditional funding sources and as a strategic tool to enlist community support and overcome opposition.


[1] Technically, the most popular private offering method (Rule 506(b) of Regulation D) actually allows investment from up to 35 non-accredited investors (and an unlimited number of accredited investors). But nearly all such offerings have historically been made only to accredited investors because doing so makes the specific disclosure requirements in the Rule inapplicable.