A recent Delaware Chancery Court decision provides important guidance on what types of defective corporate acts may be ratified under Section 204 of the Delaware General Corporation Law (the “DGCL”), and what types may not.  Paul Nguyen v. View, Inc. also underscores the importance of focusing on whether to opt out of the class vote required by DGCL Section 242(b)(2) for changes in authorized capital, which effectively gives the common stock a veto over future funding rounds.

The facts of the case are as follows. View, Inc. develops smart windows that allow the light, heat, shade and glare properties of the glass to be controlled manually or electronically, thus enhancing comfort and reducing energy consumption and greenhouse gas emissions. After closing on a Series A round, View replaced its founder, Paul Nguyen, as CEO and CTO. While in mediation over the termination, View proposed a new Series B round of funding, which under Section 242(b)(2) of the DGCL required the consent of Nguyen as holder of a majority of the common. The parties then signed a settlement agreement in which Nguyen consented to the Series B, subject to a seven day revocation right. When Nguyen discovered the terms of the Series B would materially diminish his rights, he revoked his consent within the revocation period. Unbeknownst to him, View had already closed on the Series B. Nguyen then brought an arbitration proceeding against View, seeking a declaration that the revocation was valid and the Series B funding invalid. While the arbitration was pending, View closed on additional rounds C through F in an aggregate amount of over $500 million. After View filed two certificates of validation under DGCL Section 204 seeking to ratify the increase in authorized capital, Nguyen commenced the Chancery Court suit, which the parties agreed to stay pending the arbitrator’s decision on the validity of the consent revocation.

The arbitrator ruled that the revocation was valid and the Series B invalid. The ruling effectively meant that all of the related transaction documents were likewise invalid and void because Nguyen had not consented to them either. And since each of the subsequent rounds of financing rested on the Series B funding, the invalidation of the Series B effectively invalidated the Series C through Series F rounds as well, basically blowing up View’s capital structure. The Series A stockholders responded by seeking to resurrect the funding rounds through the ratification provisions of Section 204, initially by converting their preferred shares into common (thus becoming the majority holders of the class) and then by authorizing the filing of certificates of validation with the Delaware Secretary of State under Section 204.

The key issue in the case was whether an act that the holder of a majority of shares of a class entitled to vote deliberately declined to authorize, but that the corporation nevertheless determined to pursue, may be deemed a “defective corporate act” under Section 204 that is subject to later validation by ratification of the stockholders, an issue of first impression.

In 2014, the Delaware legislature created two alternative pathways for corporations to cure defective corporate acts. Section 204 provides that “no defective corporate act or putative stock shall be void or voidable solely as a result of a failure of authorization if ratified as provided [in Section 204] or validated by the Court of Chancery in a proceeding brought under Section 205.” Previously, acts deemed “voidable” could be subsequently ratified, but acts deemed “void”, such as the issuance of shares beyond what is authorized in a company’s charter, were deemed invalid. Prior to Sections 204 and 205, corporations had no way to remedy “void” corporate acts, even if the failure to properly authorize the act was inadvertent. The ability to cure defective acts is critical. Startups often need to clean up such acts prior to a funding round or acquisition, both to satisfy investor or acquirer due diligence issues and to enable counsel to issue opinion letters.

The court found that the Series B round was not a “defective corporate act” that is subject to ratification under Section 204 and ruled that View should not be allowed to invoke ratification to validate a deliberately unauthorized corporate act. As the holder of a majority of the outstanding common which was entitled to a class vote, Nguyen’s vote was required in order to authorize the Series B. The failure to obtain such authorization was not an oversight; it was the result of an affirmative rejection by Nguyen. Thus, the distinction here is between a defective corporate act that results from an oversight, which is curable under Section 204, and a defective corporate act resulting from an affirmative rejection by the stockholders, which is not curable under Section 204 (or 205).

One obvious takeaway is that companies should respect arbitrators’ rulings and should not proceed with a transaction, let alone a series of transactions, until stockholder authorization has been secured. View’s pursuit of the Series B round during the revocation period, and thereafter of the Series C through F rounds while the arbitrator’s ruling on the consent revocation was pending, was reckless to say the least. As the court put it, “[o]ne must presume that View understood that if the arbitrator found in favor of Nguyen on the consent issue, then the later rounds of financing that rested on the Series B Financing would collapse when that block was removed from the tower of blocks that comprised the Company’s preferred stock offerings”.  One can only presume further that it did so against the advice of counsel or despite counsel’s warning of the risk.

The other takeaway here is that companies should consider carefully whether to opt out of the class vote requirement under DGCL Section 224(b)(2) for changes in capital structure. Section 224(b)(2) requires any increase or decrease in authorized shares to be approved by holders of a majority of each class of stock entitled to vote, but allows corporations to opt out by providing as much in the charter. The National Venture Capital Association’s model amended and restated certificate of incorporation has an optional provision that states that the common and preferred will vote together as a single class on all proposals to increase or decrease the authorized capital, irrespective of the provisions of Section 242(b)(2). Failure to opt out effectively provides the common stockholders with a veto over future capital raises because each subsequent round requires an amendment to the charter not just to create the new series of preferred, but also to increase the number of authorized common to accommodate conversion of the preferred. Failure to eliminate the class vote requirement will force the company to have to seek the consent of holders of a majority of the common, providing them with unintended leverage in connection with a deal that’s presumably in the best interests of the company and its shareholders.

On March 22, the Subcommittee on Capital Markets, Securities, and Investment of the Financial Services Committee conducted a hearing entitled “The JOBS Act at Five: Examining Its Impact and Ensuring the Competitiveness of the U.S. Capital Markets”, focusing on the impact of JOBS Act at 5the JOBS Act on the U.S. capital markets and its effect on capital formation, job creation and economic growth. The archived webcast of the hearing can be found here. Most people won’t have the patience to sit through two hours and 44 minutes of testimony (although the running national debt scoreboard on the right side of the home page showing in real time the national debt increasing by $100,000 every three seconds, and by $1 million every 30 seconds, etc., is eyepopping). At the risk of being accused of having too much time on my hands, but as an act of community service, I watched the hearing (or at least most of it) and will offer some takeaways.

Raymond Keating, Chief Economist of the Small Business & Entrepreneurship Council, testified about some disturbing trends in angel and VC investment. The value and number of angel deals is down from pre-recession levels.  VC investment showed the most life but a decline in raymond keating2016 is troubling. So what’s going on?  Keating believes it’s about reduced levels of entrepreneurship stemming in large part from regulatory burdens that limit entrepreneurs’ access to capital and investors’ freedom to make investments in entrepreneurial ventures. He also testified on the need for further reform, particularly in Regulation Crowdfunding under Title III which allows companies for the first time to raise capital from anyone, not just accredited investors, without filing a registration statement with the SEC, and identified the following reform targets:

  • Issuer Cap. Currently, issuers are capped at $1 million during any rolling twelve-month period. There’s been a push to increase that cap, perhaps to $5 million.
  • Investor Cap. Currently, investors with annual income or net worth of less than $100,000 are limited during a 12-month period to the greater of $2,000 or 5% of the lesser of annual income or net worth, and if both annual income and net worth exceed $100,000, then the limit is 10% of the lesser of income or net worth. The proposal here would be to change the application of the cap from the lower of annual income or net worth to the higher of annual income or net worth.
  • Funding Portal Liability. Currently, funding portals can be held liable for material misstatements and omissions by issuers. That poses tremendous and arguably unfair risk to funding portals and may deter funding portals from getting in the business in the first place. The proposal here would be that a funding portal should not be held liable for material misstatements and omissions by an issuer, unless the portal itself is guilty of fraud or negligence. Such a safe harbor for online platforms would be similar to the protection that traditional broker dealers have enjoyed for decades. A funding platform is just a technology-enabled way for entrepreneurs to connect with investors, and they don’t have the domain expertise of issuers and can’t verify the accuracy of all statements made by issuers.  Part of the role of the crowd in crowdfunding is to scrutinize an issuer, a role that should remain with the investors, not with the platform.
  • Syndicated Investments. Many accredited investor crowdfunding platforms like AngeList and OurCrowd operate on an investment fund model, whereby they recruit investors to invest in a special purpose vehicle whose only purpose is to invest in the operating company. Essentially, a lead investor validates a company’s valuation, strategy and investment worthiness. Traditionally, angel investors have operated in groups and often follow a lead investor, a model which puts all investors on a level playing field.
  • $25 Million Asset Registration Trigger.  Under current rules, any Regulation CF funded company that crosses a $25 million asset threshold would be required to register under the Securities Exchange Act and become an SEC reporting company. Seems inconsistent with the spirit of Regulation Crowdfunding, which for the first time allows companies to offer securities to the public without registering with the SEC.

As to the continuing challenge for companies to go and remain public, Thomas Quaadman, Vice President of the U.S. Chamber of Commerce, testified that the public markets are in worse shape today than they were five years ago and that we have fewer than half the public companies quaadmantoday than we had in 1996, a number that has decreased in 19 of the last 20 years. Mr. Quaadman blamed this in part on an antiquated disclosure regime that is increasingly used to embarrass companies rather than provide decision useful information to investors. In order to rebalance the system and reverse the negative trend, he suggested a numbere of reform measures the SEC and Congress should undertake. The disclosure effectiveness proposal should be a top priority for the SEC to bring the disclosure regime into the 21st century. We need proxy advisory firm reform that brings transparency, accountability and oversight to proxy advisory firms. Also, there should be recognition that capital formation and corporate governance are inextricably linked and there should be reform of the shareholder proposal process under Rule 14a-8.

Snap IPOThe just completed IPO of Snap Inc. has received enormous buzz and plenty of press coverage, mostly about its eye-popping valuation and offering proceeds, the big winners among the founders and early investors and the millennials who bought shares. But not nearly as much attention has been given to Snap’s tri-class capital structure and the nature of the shares that were actually issued in the IPO: the shares of Class A Common Stock sold in the IPO are non-voting. By its own admission, Snap may have pulled off the first ever IPO of non-voting stock.

Snap’s capital now consists of the non-voting Class A shares held by public investors, Class B shares snapIPO2with one vote per share held by early round investors, employees and directors and Class C shares with ten votes per share held by the founders. As a result of the Class C common stock that they hold, co-founders Evan Spiegel and Robert Murphy will be able to exercise voting rights with respect to an aggregate of 215,887,848 shares, representing approximately 88.5% of the voting power immediately following the offering. Consequently, Spiegel and Murphy, and potentially either one of them alone (see below), have the ability to control the outcome of all matters submitted to stockholders for approval, including election, removal, and replacement of directors and any merger or sale of all or substantially all of the assets.

Multiple class structures are not unusual, and several high profile companies went public with them in recent years. What’s unusual here is that whereas the shares sold in those other multiple class structure IPOs had at least some voting rights (typically, one vote per share vs. 10 for the founder class), Snap’s public offering shares have no voting rights. Technically, Delaware law would permit holders of Snap’s Class A non-voting stock nevertheless to vote with one vote per share on any proposal to amend the certificate of incorporation in any way that would adversely affect the holders of the Class A. For example, if a proposed amendment provided for the Class A to rank junior to the Class B and Class C with respect to dividends or acquisition proceeds, a Class A vote would be required and the holders of a majority of Class A shares could defeat that amendment. Such a proposal would be extremely rare, however, and the Class A holders would have no say in the much more typical matters of board elections and any proposed sale of the company.

Multiple share classes are especially useful to public technology companies because they give them the freedom to innovate without the constraints of “short termism” and also serve as a deterrence to takeover bids because of activists’ inability to manipulate the voting machinery for election of directors.

Snap’s Class A common stock will be its only class registered under Section 12 of the Securities Exchange Act, and because the Class A is non-voting, Snap will not be required to file proxy statements except for a rare case where a vote of the Class A common stock is required (see above). Nevertheless, Snap indicated in its S-1 that it will provide Class A holders any information that it provides voluntarily to Class B and Class C holders.

What makes Snap’s structure even more unusual is survivability and portability.  According to Snap’s S-1, If Spiegel’s or Murphy’s employment is terminated (which, because of their control, could only happen if they turn on each other), they will continue to have the ability to exercise the same significant voting power and continue to control the outcome of all matters submitted to stockholders for approval. A founder’s Class C shares will automatically convert into Class B shares, on a one-for-one basis, nine months following such founder’s zuckerbergdeath or on the date on which the number of outstanding Class C shares held by such holder represents less than 30% of the Class C (or 32,383,178 shares) held by such holder at the time of the IPO. Facebook, on the other hand, amended its certificate of incorporation so that Mark Zuckerberg’s majority voting control is good only while he is an executive at the company.

Snap’s capital structure has drawn some criticism. In a New York Times piece, Cal Berkley law professor Steven Davidoff Solomon referred to Snap’s IPO as “the most stockholder-unfriendly governance in an initial public offering, ever.” In the Harvard Law School Forum on Corporate Governance and Financial Regulation, Rob Kalb and Rob Yates of Institutional Stockholder Services cited a 2016 ISS study that showed that controlled companies had weaker governance standards and tended to underperform “with respect to total stockholder returns, revenue growth, return on equity, and dividend payout ratios.” And the Council of Institutional Investors sent a letter to Snap’s co-founders objecting to the capital structure and urging them to adopt a single class structure. While acknowledging that similar emerging companies with dynamic leadership and promising products have successfully raised capital despite having dual class structures, Snap’s structure is unusual in that the investors would have no voting rights and dual class company performance has been mixed at best.

When Google, Facebook and Under Armour went public, they each did so with a dual-class share structure that at least afforded public stockholders one vote per share. Nevertheless, each company subsequently requested stockholder approval for the issuance of a third class of non-voting shares. In each case, the purpose of creating a new non-voting class was to maintain founder voting control while simultaneously providing insider liquidity.

Despite the overall positive outcomes achieved by Google and Facebook for their stockholders, going public as a controlled company with an unequal-voting-rights structure is no guaranty for financial success. Groupon, Zynga and GoPro each went public with a dual-class structure, received poor ISS corporate governance scores indicating the highest levels of governance risk, and the share price of all three dropped precipitously since their respective IPOs.

Adding salt to the corporate governance wound, Snap is taking advantage of emerging growth company status under the JOBS Act, meaning that it is not required to comply with the auditor attestation requirements under Sarbanes-Oxley and the reduced executive compensation disclosure requirements and may delay adoption of new public-company accounting principles.

In the final analysis, investors will need to decide which Mark the Snap founders better resemble, Facebook’s Zuckerberg or Zynga’s Pincus. And looking beyond Snap, it remains to be seen whether other emerging companies adopt the Snap IPO playbook by launching IPOs with multiple-class structures that preserve founder control and give public stockholders little or no governance voice.

2016 turned out to be a terrible year for IPOs, both in terms of number of deals and aggregate proceeds.

According to Renaissance Capital’s U.S. IPO Market 2016 Annual Review, only 105 companies went public on U.S. exchanges in 2016, raising only $19 billion in aggregate proceeds. The deal count of 105 IPOs was downrenaissance 38% from 2015 and the lowest level since 2009.  The $19 billion in aggregate proceeds was down 37% from 2015 and the lowest level since 2003.  In fact, if you remove the financial recession years of 2008 and 2009, the 105 IPOs in 2016 were also the lowest since 2003.  And the drop in deal activity was indiscriminate; both VC- and PE-backed IPOs were at their lowest levels by deal count and proceeds raised since 2009.

The temptation would be to blame the weak IPO market on political election 2016uncertainty, with Brexit and the U.S. election being the biggest culprits. But then how to explain the broader U.S. capital markets, which were hot in 2016. The Dow Jones Industrial Average hovered around 20,000 at year end, and the S&P 500 Index was up 9.5% for the year.  One would expect that the market for IPOs would be pretty strong, as bullish markets normally encourage companies to go public.  To be fair, much of the market gains took place in the latter half of the fourth quarter.  But market weakness doesn’t explain the two-year drought in IPOs for technology companies, considered the mainstay of the IPO market.

Another common theory is that over-regulation, particularly Sarbanes Oxley, has made it much more expensive to go and remain public, thus discouraging many growth companies from doing so. The 2012 JOBS Act tried to remedy this by creating an IPO on-ramp for emerging growth companies, allowing for confidential registration statement filings with the SEC, “testing-the-waters” and scaled disclosure.  The immediate results were encouraging: a dramatic increase in IPO deals and aggregate proceeds in 2014.  Yet IPOs plummeted in 2015 and even further in 2016.

Renaissance Capital’s report points the finger squarely at the public-private valuation disconnect. The tech startup space in 2015 was a mystifying series of mega rounds, sky-high valuations, unicorns and unicornbubble fears. But another trend has been IPOs being priced below the company’s most recent private funding round.  In its pre-IPO round, Square Inc. was valued at approximately $6 billion, but IPO’d at just over half that valuation and then plunged further post-IPO.  Etsy Inc. and Box Inc. both reported $5 billion plus private valuations, only to plunge in the days leading up to their IPOs.  Many, including Benchmark Capital’s Bill Gurley, have blamed the late-stage bidding frenzy on institutional public investors such as mutual funds rushing into late-stage private investing.  Another major contributing factor in the escalation of late stage valuations is the trend toward generous downside protections being given to investors in exchange for lofty valuations, such as IPO ratchets and M&A senior participating liquidation preferences.  The former is simply antidilution protection that entitles the investor to receive extra shares on conversion in the IPO if the IPO price is below either the price paid by the late-stage investor or some premium above that price.  The latter means that, in an acquisition, the investor gets first dollars out ahead of earlier series of preferred and then participates with the common pro rata on an as converted basis.

Renaissance maintains that VC-backed tech companies with lofty late round private valuations chose in 2016 to avoid inevitably lower public-market valuations and had the luxury of remaining private due to ample available cash in the private markets. Mergers and acquisitions offered alternate pathways for other tech companies, such as TransFirst, BlueCoat and Optiv, all of which had previously filed S-1s for IPOs.

Although the private-public valuation disconnect was a major impediment to IPOs in 2015 and 2016, Renaissance believes this phenomenon is close to correcting itself and is optimistic about 2017. Many growth companies have seen their valuations flat or down in new funding rounds to levels that will be more palatable to public investors.  Also, the election results will likely bring a dramatic change in fiscal, regulatory, energy and healthcare policies, all of which should be stimulative to equity markets, new company formation and, ultimately, IPOs.

Another reason for tech IPO optimism for 2017 is Snap, Inc.’s highly anticipated IPO in the first half of 2017. It filed confidentially under the snapJOBS Act, and has begun testing the waters with investors.  The Snap IPO is rumored to raise $4 billion at a valuation of over $25 billion. Another one is Spotify, which raised $1 billion in convertible debt in March 2016 which signals a likely imminent IPO. These two IPOs might raise more capital than all VC-backed tech IPOs in the last two years combined.

On October 26, 2016, the Securities and Exchange Commission adopted final rules intended to make intrastate and regional offerings more viable pathways for smaller raises. The new rules (i) amend Rule 147 to simplify the “doing business” SEC logostandard, (ii) create a new intrastate exemption, Rule 147A, which allows use of the internet and other forms of general solicitation as well as out-of-state incorporation and (iii) increase the 12-month offering cap under Rule 504 from $1 million to $5 million.  This post will address all three of these significant reforms.

Amendments to Rule 147

The statutory exemption for intrastate offerings appears in Section 3(a)(11) of the Securities Act of 1933, which exempts from registration “any security … offered and sold only to persons resident within a single State … where the issuer … [is incorporated] and doing business within … such State …”.  Rule 147 is the safe harbor for Section 3(a)(11), and has not been amended in any significant way since its adoption in 1974.

One of the primary impediments to the use of Rule 147 has been the difficult test that issuers have been required to meet in order to establish sufficient nexus with the state in which the offering is made. To satisfy the doing business test, issuers were required to derive at least 80% of their consolidated gross revenues in-state, have at least 80% of their consolidated assets in-state and use at least 80% of net proceeds from the offering in connection with the operation of an in-state business.  Requiring an issuer to derive most of its revenue, maintain a majority of its assets and invest most of the capital it raises all in one state could create inefficient constraints for many emerging companies to operate and grow.

The final rules modify the current “doing business” in-state requirements in Rule 147 by requiring issuers to satisfy only one of four specified tests. Under amended Rule 147 (and new Rule 147A), in order to be deemed to be “doing business” in a state, an issuer will have to satisfy only one of the following requirements:

  • 80% of consolidated assets located in-state;
  • 80% of consolidated gross revenues derived from operation of a business or of real property located in or from the rendering of services within such state;
  • 80% of net offering proceeds intended to be used, and are in fact used, in connection with the operation of a business or of real property, the purchase of real property located in, or the rendering of services within such state; or
  • Majority of employees are in such state.

The final rules take a side-by-side approach, adopting amendments to modernize Rule 147 and also establishing a brand new intrastate offering exemption under the Securities Act, designated Rule 147A, which will be similar to amended Rule 147 but with no prohibition on offers to non-residents and allowing issuers to be incorporated out of state. Under the final rules, issuers will be able to choose between utilizing Rule 147 and Rule 147A for intrastate offerings based on their preferences for communicating with investors. The SEC elected to keep and modify Rule 147 as a safe harbor under Section 3(a)(11) to allow issuers to continue to rely on state law exemptions that are conditioned upon compliance with Section 3(a)(11) and Rule 147.

New Rule 147A

In addition to the overly restrictive doing business requirements, two other features have served to dissuade issuers from taking advantage of the intrastate exemption. The first is the requirement that issuers be incorporated in-state, which disqualifies many emerging companies all over the country that choose to incorporate in management friendly confines like Delaware (or are forced to do so by their investors).  Second is the prohibition on making offers to out-of-state residents, even if sales are made only to in-state residents, which effectively eliminates the use of the internet, social media and other methods of general solicitation in conducting the offering.

New Rule 147A corrects these shortcomings. First, there is no requirement that the issuer be incorporated in-state.  So, for example, a company incorporated in Delaware that has its principal place of business in New York may sell to New York Delawareinvestors.  Second, it permits offers to out-of-state residents so long as all sales are limited to in-state residents, and more broadly allows general solicitation and general advertising (including use of unrestricted websites).  When using space-constrained social media like Twitter to solicit, the issuer may use an active hyperlink to the offering disclosure.   Rule 147A does require, however, prominent disclosure in all offering materials that sales will be made only to residents of the same state as the issuer.

Features Common to Amended Rule 147 and New Rule 147A

Both amended Rule 147 and new Rule 147A contain the following common features:

  • Issuer “principal place of business” must be in-state, and issuer must satisfy at least one “doing business” requirement that would demonstrate in-state nature of issuer’s business;
  • New “reasonable belief” standard in determining purchaser’s residence;
  • Issuers must obtain written residency representation from each purchaser;
  • Resales limited to state residents for a six month period;
  • Integration safe harbor that would include prior offers or sales of securities by the issuer, as well as certain post-offering offers or sales; and
  • Legend requirements to offerees and purchasers about resale limits.

Amendment to Rule 504

Rule 504 of Regulation D exempts from registration offers and sales of up to $1,000,000 of securities in any rolling 12-month period. Two of Rule 504’s general requirements, the prohibition on general solicitation and securities sold being deemed “restricted” securities, do not apply if the offer and sale are made:

  • exclusively in one or more states that provide for the registration of the securities, and require the public filing and delivery to investors of a disclosure document before sale;
  • in one or more states that require no registration, filing or delivery of a disclosure document before sale, if the securities have been registered in at least one state that provides for such registration, filing and delivery; or
  • exclusively according to state law exemptions that permit general solicitation so long as sales are made only to “accredited investors”.

Several states have instituted coordinated review programs to streamline the state registration process for issuers seeking to undertake multi-state registrations in reliance upon Rule 504. Because these offerings are typically limited to a few states, review of these offerings is undertaken on a regional basis. These programs establish uniform review standards and are designed to expedite the registration process, thereby potentially saving issuers time and money.

The new rules amend Rule 504 to increase the aggregate amount of securities that may be offered and sold from $1 million to $5 million. The SEC is hoping that the higher offering cap will promote capital formation by increasing the flexibility of state securities regulators to implement coordinated review programs to facilitate regional offerings.

The final rules repeal Rule 505 of Regulation D, which exempts offers and sales of up to $5 million and is now rendered obsolete by amended Rule 504. The rules also apply bad actor disqualifications to Rule 504 offerings, consistent with other rules in Regulation D.

Effective Dates

The foregoing reforms have the following effective dates:

  • Amended Rule  147: 150 days after publication in the Federal Register
  • New Rule 147A:  150 days after publication in the Federal Register
  • Amended Rule 504:  60 days after publication in the Federal Register
  • Repeal of Rule 505:  180 days after publication in the Federal Register

The cost of launching an Internet-based startup has fallen dramatically over the last 15 years. This democratization of internet-based entrepreneurship resulted primarily from two innovations: open source software and cloud computing. During the dot-com era, Internet-based startups had to build serversinfrastructure by acquiring expensive servers and software licenses and hiring IT support staff. So the first outside round of investment in an Internet-based startup was typically a Series A round of $3 million or more from one or more VCs. With the emergence of open-source software, however, startups for the most part were no longer forced to acquire software packages bundled with hardware. Another issue, though, was that startups had to acquire and maintain bandwidth to accommodate peak loads, resulting in expensive underutilization. But this all changed with the advent of cloud computing, which enabled entrepreneurs to launch an Internet startup with minimal upfront IT costs and to pay only for used bandwidth. In real dollars, the cost of starting up has declined from a few million dollars to a few hundred thousand dollars.

With the precipitous drop in the cost of launching an Internet-based startup came a significant rise in interest in seed investing by angels and early stage VCs. But the typical Series A document package (amended and restated certificate of incorporation, stock purchase agreement, voting agreement, cloudinvestor rights agreement, right of first refusal and co-sale agreement) is complex, time consuming and expensive to negotiate, and contains several economic, management and exit provisions that don’t become relevant until much later (e.g., if and when the company goes public). This level of complexity can be justified when a company is raising several million dollars, but not so for a seed round of a few hundred thousand.

The resulting pressure for deal document simplification has resulted over the last several years in innovative seed investment deal documents. Seed rounds are either structured as a simplified version of a priced Series A preferred stock or as debt that converts into the security issued in a next round of equity, typically at a discount. This Part I of a two part blog series on seed round investing will focus on priced equity structures; Part II will address convertible debt.

There are currently two alternative open sourced sets of equity seed round deal documents to choose from, each with the common goals of term simplification, cost reduction, transaction time compression and document standardization. Both feature terms similar to those found in a typical Series A deal, but stripped down from the robust set of economic, voting and exit rights usually contained in a Series A. The two deal document products are:

Series AA: Created by Cooley cooleyfor accelerator Techstarstechstarsfenwick
Series Seed: Created by Fenwick & West

The main terms of Series AA and Series Seed are as follows:

1X Non-Participating Preferred: Both Series Seed and Series AA feature 1X non-participating preferred stock, meaning on a sale of the company the investor must choose between his liquidation preference of 1X (i.e., one times his investment amount) or the proceeds he would receive on an as converted basis, but not both. In other words, the investor calculates which would yield the bigger payout and choose that one. On the other hand, participating preferred would give the investor two bites of the apple: first his liquidation preference, and then his share of remaining proceeds as a common shareholder on an as converted basis.

Antidilution Protection: Series Seed provides no antidilution protection. Series AA, however, has broad based weighted average antidilution protection. Most notably, antidilution protects the investor from the economic dilution resulting from down rounds. Weighted average is the type of protection that is more fair in that it factors in the dilutive effect of the actual down round (i.e., the conversion price doesn’t adjust all the way down to the lower down round price but rather takes into consideration the number of additional shares issued at the lower price relative to the number of shares outstanding), and broad based requires inclusion in the number of shares outstanding all outstanding options and options reserved for issuance (as opposed to narrow based which would not include options).

Board Composition: Both Series AA and Series Seed provide for boards consisting of 2 common and one preferred, except that Series AA conditions the preferred board member on the Series AA shares constituting at least 5% of the outstanding equity on a fully diluted basis.

Protective Provisions: These are veto rights in favor of the preferred. Series AA gives vetos over only changes to the Series AA. Series Seed includes vetos over changes in the Series AA, but also includes vetos over mergers, increasing or decreasing authorized shares of any class or series, authorizing any new class or series senior to or on a parity with any series of preferred, stock redemption, dividends, number of directors and liquidation/dissolution.

Right of First Offer on New Financings: Both Series Seed and Series AA give investors the right to purchase their pro rata share of new issuances.

Right of First Refusal: Series Seed gives investors a right of first refusal on shares held by key holders. Series AA does not.

Drag Along Rights: Series Seed gives Series Seed holders and founders the right to require common holders to include their shares or vote for any transaction approved by the board, by a majority of the common and by a majority of the Series Seed. No drag along in the Series AA.

So what standard Series A terms are missing from Series Seed and Series AA? Missing are dividend preference (not a big deal here inasmuch as the overwhelming majority of startups will not pay out dividends), registration rights and tag-along rights (also not a big deal inasmuch as founders rarely have an opportunity to sell their shares).

Overall, Series Seed and Series AA are worthy efforts to simplify terms and reduce transaction costs. There will certainly be situations, however, where investors will resist the weaker investor protections such as the absence of participating preferred and anti-dilution protection and stripped down protective provisions. Any effort to negotiate some terms back in will undercut the objective of diversification and simplicity.

On July 5, the House of Representatives passed a watered down version of the Fix Crowdfunding Act (the “FCA”) that was initially introduced in March.  The bill seeks to amend Title III of the JOBS Act by expressly permitting “crowdfunding vehicles” and broadening the SEC registration exclusion, but leaves out three important reforms that were part of the original version of the FCA introduced in March and about which I blogged about here. The House bill is part of the innovation initiativeInnovation Initiative which was jointly launched by Majority Leader Kevin McCarthy and Chief Deputy Whip Patrick McHenry.  The bill was passed by the House with overwhelming bipartisan support, so it’s likely to be passed quickly by the Senate.  This post summarizes what was left in the bill from the original and what was dropped from it.

What’s In: Special Purpose Vehicles and the Section 12(g) Registration Exclusion

Special Purpose Vehicles

Title III of the JOBS Act excludes from crowdfunding eligibility any issuer that is an “investment company”, as defined in the Investment Company Act, or is exempt from investment company regulation by virtue of being owned by not more than 100 persons. Several accredited investor-only matchmaking portals such as AngelList and OurCroud utilize a fund business model (rather than a broker-dealer model) for Rule 506 offerings in which investors invest into a special purpose vehicle (“SPV”), which in turn makes the investment into the issuer as one shareholder. Because Title III did not permit issuers to sell shares through SPVs, many growth-oriented startups may be dissuaded from engaging in Title III crowdfunding offerings if they expect to raise venture capital in the future, as VC funds don’t like congested cap tables.

The FCA would create a new class of permitted crowdfunding issuer called a “crowdfunding vehicle”, which is an entity that satisfies all of the following requirements:

  • purpose (as set forth in its organizational documents) limited to acquiring, holding and disposing crowdfunded securities;
  • issues only one class of securities;
  • no transaction-based compensation received by the entity or any associated person;
  • it and company whose securities it holds are co-issuers;
  • both it and company whose securities it holds are current in ongoing Regulation Crowdfunding disclosure obligations; and
  • advised by investment adviser registered under Investment Advisers Act of 1940

Section 12(g) Registration Exclusion

The JOBS Act raised from 500 shareholders to 2000 (or 500 non-accredited investors) the threshold under Section 12(g) of the Securities Exchange Act that triggers registration with the SEC, which subjects the company to periodic reporting obligations (e.g., 10-Ks, 10-Qs, etc.). It also instructed the SEC to exempt, conditionally or unconditionally, shares issued in Title III crowdfunding transactions.  In its final rules, the SEC provided that shareholders that purchased crowdfunded shares would be excluded from the shareholder calculation under Section 12(g), but conditioned the exclusion on, among other things, the issuer having total assets of no more than $25 million.

The $25 million limit on total assets may have the perverse effect of deterring growth companies from utilizing crowdfunding and/or prompting such companies to issue redeemable shares to avoid the obligation to register with the SEC if they cross the shareholder threshold because of a crowdfunded offering.

The original version of the FCA would have removed from the 12(g) exclusion the condition that an issuer not have $25 million or more in assets.

The version of the FCA passed by the House removes the $25 million asset condition but replaces it with two other conditions: that the issuer have a public float of less than $75 million and annual revenues of less than $50 million as of the most recently completed fiscal year.

What’s Out: Issuer Cap, Intermediary Liability and Testing the Waters

The House version of the FCA unfortunately dropped a few of the reforms that were contained in the original version introduced in March, apparently the price paid for securing votes of opponents of the FCA.

Issuer Cap                                                                                    

Title III limits issuers to raising not more than $1 million in crowdfunding offerings in any rolling 12 month period. By comparison, Regulation A+ allows up to $50 million and Rule 506 of Regulation D has no cap whatsoever.

The original version of the FCA would have increased the issuer cap from $1 million to $5 million in any rolling 12 month period. This was scrapped from the House version.

Portal Liability

Title III imposes liability for misstatements or omissions on an “issuer” (as defined) that is unable to sustain the burden of showing that it could not have known of the untruth or omission even if it had exercised reasonable care. Title III also exposes an intermediary (i.e., funding portal or broker-dealer) to possible liability if an issuer made material inaccuracies or omissions in its disclosures on the crowdfunding site. It is over this very concern over liability that some of the largest non-equity crowdfunding sites that have otherwise signaled interest in equity crowdfunding, including Indiegogo and EarlyShares, have expressed reluctance to get into the Title III intermediary business.

The original version of the FCA would have clarified that an intermediary will not be considered an issuer for liability purposes unless it knowingly made a material misstatement or omission or knowingly engaged in any fraudulent act. Presumably then, as proposed, a plaintiff would have had the burden of proving not just the fraud, misstatement or omission but that the intermediary knew at the time. The House version dropped this relief for intermediaries.

Testing the Waters

Securities offerings are expensive and risky with no guaranty that they will generate enough investor interest. Congress and the SEC chose not to allow Title III issuers to “test-the-waters”, i.e., solicit indications of interest from potential investors prior to filing the mandated disclosure document with the SEC, out of concern that unscrupulous companies could prime the market before any disclosure became publicly available.

The original version of the FCA would have allowed Title III issuers to test the waters by permitting them to solicit non-binding indications of interest from potential investors so long as no investor funds are accepted by the issuer during the initial solicitation period and any material change in the information provided in the actual offering from the information provided in the solicitation of interest is highlighted to potential investors in the information filed with the SEC. This too was left out of the version approved by the House.

Although it was disappointing to see the foregoing three reforms dropped from the eventual House bill, half a loaf is better than no loaf. Perhaps the dollar cap, intermediary liability and testing the waters could be revisited at some point down the road.

Ever since the Federal securities laws were enacted in 1933, all offers and sales of securities in the United States had to either be registered with the SEC or satisfy an exemption from registration. The commonly used private offering exemption, however, prohibited any act of general solicitation. The JOBS Act of 2012 JOBS Act signingcreated a new variation to the private offering exemption under Rule 506 of Regulation D that permits online offers and other acts of general solicitation, but issuers selling under this new Rule 506(c) may sell only to accredited investors and must use reasonable methods to verify investor status.

Starting today, companies will be permitted to offer and sell securities online to anyone, not just accredited investors, without SEC registration. This is pursuant to Title III of the JOBS Act and the final crowdfunding rules promulgated by the SEC called Regulation Crowdfunding.  The potential for Title III Crowdfundingequity crowdfunding is enormous and potentially disruptive.  It is believed that approximately 93% of the U.S. population consists of non-accredited investors who have an estimated $30 trillion stashed away in investment accounts.  If only one percent of that amount got redirected to equity crowdfunding, the resulting $300 billion dollars invested would be ten times larger than the VC industry.  Hence the potential.

The reality, however, is not as encouraging. In the interest of investor protection, Congress in JOBS Act Title III and the SEC in Regulation Crowdfunding created a heavily regulated and expensive regime that many fear will severely limit the prospects of equity crowdfunding.  The rules include a $1 million issuer cap, strict dollar limits on investors, disclosure requirements and funding portal liability, registration and gatekeeper obligations.

wefunderSEC registration for funding portals began on January 29. But as of last week, only five portals had completed the registration process: Wefunder Portal LLC, SI Portal LLC dba Seedinvest.com, CFS LLC dba seedinvestCrowdFundingSTAR.com, NextSeed US LLC and StartEngine Capital LLC.  Over 30 others are apparently awaiting approval.  Of the two best known and most successful non-equity crowdfunding portals, only Indiegogo has declared an intention to get in the Title III funding portal business; Kickstarter has so far declined.

The likely reason for the apparent lackluster funding portal activity so far is the restrictive regulatory regime referred to above, the burden of which falls disproportionately on funding portals. None of this should be a surprise.  Several key aspects of the crowdfunding rules were contentiously debated at the Congressional level and later during SEC rulemaking.  Opponents asserted that retail equity crowdfunding is an invitation for massive fraud against those who can least afford it and so believe Title III is a mistake.  Proponents advocated against several of the more restrictive rules but conceded on these points in order to get Title III passed.  And because the legislation itself was so prescriptive and granular, there was only room for marginal improvement in the final SEC rules relative to those proposed in the initial release.

Regrettably, there’s painful precedent for securities exemptions so restrictive that no one used them.  Regulation A allowed for a mini-public offering through a streamlined filing with the SEC.  But issuers were capped at $5 million and were forced to go through merit review in each state where they offered the securities.  The result:  hardly anyone used Reg A.  In recognition of this, Title IV of the JOBS Act reformed Reg A by increasing the cap to $50 million and, more importantly, preempting state blue sky review for so-called Tier II offerings which must satisfy investor protection requirements.

In an effort to prevent Title III from a fate similar to pre-reform Reg A, legislation has been introduced in Congress to increase the issuer cap, allow for special purpose vehicles, remove the $25 million asset cap on the exemption from the 500 shareholder SEC registration trigger and allow issuers to test the waters. See my previous blog post here on the proposed Fix Crowdfunding Act.

It may seem somewhat premature to advocate for reform when the rules have barely gone live. But given the time necessary for the legislative process to run its course, and inasmuch as the indications are already fairly clear that both issuers and funding portals remain skeptical about Title III crowdfunding, it makes sense to begin the process now of introducing necessary common sense reform of Title III.

One of the key investor protections of Regulation Crowdfunding under JOBS Act Title III is theyou've got funding requirement that offerings must be conducted exclusively through a single platform operated by a registered broker-dealer or a new type of SEC registrant, a funding portal. Although SEC registration for funding portals began January 29, 2016, intermediaries (funding portals and broker-dealers) may not engage in crowdfunding activities until May 16, 2016, the date that Regulation Crowdfunding goes live. It remains to be seen how popular Title III crowdfunding will prove to be given its burdensome rules relative to other available exemptions, but the potential is enormous both for issuers and for the brand new type of financial intermediary it created, the funding portal.

SEC logoThe SEC spent three years trying to reconcile the enormous capital markets potential of the “crowd” with the investor protection concerns voiced by equity crowdfunding’s critics. The SEC believes that requiring an issuer to use only one intermediary to conduct an offering helps foster the creation of a crowd, by facilitating information sharing and avoiding dilution or dispersement of the crowd, and helps minimize the risk that issuers and intermediaries would circumvent the requirements of Regulation Crowdfunding. For example, allowing an issuer to conduct an offering usingcrowd 2 more than one intermediary would make it more difficult for intermediaries to determine whether an issuer is exceeding the $1 million aggregate offering limit. But to mitigate fraud risk concerns, the SEC has also imposed a heavy gatekeeping burden on intermediaries, particularly funding portals.

This blog post will focus on the rules governing funding portals, and will summarize the permitted “safe harbor” activities and compliance rules unique to funding portals, as well as certain requirements common to both types of Regulation Crowdfunding intermediaries (broker-dealers and funding portals).

Unique Funding Portal Requirements

Registration. Funding portals are required to register with the SEC on Form Funding Portal, a stripped-down version of Form BD, the registration form for broker-dealers.  For example, unlike broker-dealer registration, funding portals will not be required to post a fidelity bond to register as a funding portal.  As required under the JOBS Act, SEC registered funding portals are exempt from broker-dealer registration.  The text of the Form currently appears only in the final rules release on pages 623-664 (inclusive of Schedules A-D and general instructions).[i]

All registered funding portals are also required to become members of the Financial Industry Regulatory Authority, or FINRA.  FINRA funding portal registration information can be found here.

A funding portal’s SEC registration becomes effective on the later of: (1) 30 calendar days after the date that the registration is filed with the SEC; or (2) the date the funding portal is approved for FINRA membership.

Form Funding Portal must be filed electronically on EDGAR, although as of this writing the Form has not startenginebeen assigned a submission type or even been listed on the EDGAR forms index. To gain access to EDGAR for the electronic filing of Form Funding Portal, a funding portal will first need to obtain an EDGAR access code and a central index key, or CIK, by submitting a Form ID with the SEC. When a funding portal’s registration becomes effective, the information on Form Funding Portal becomes publicly available except for certain personally identifiable information.  As of this writing, there are no Form Funding Portals shown to have been filed on EDGAR, although at least one portal, StartEngine Capital LLC, put out a press release that it did so on January 29.

Permitted Activities – Safe Harbor. Unlike registered broker-dealers, funding portals are prohibited from giving investment advice, soliciting offers, paying success fees to persons for solicitations or handling investor funds or securities.  To help funding portals navigate these prohibitions while trying to function as effective intermediaries, the rules provide a safe harbor for the following activities:

  • Curating Offerings. A funding portal may use broad discretion to determine whether and under what circumstances to allow an issuer to offer and sell securities through its platform, subject to the prohibition on providing investment advice or recommendations and provided it complies with all other provisions of Regulation Crowdfunding. The SEC believes this kind of discretion is important for the protection of investors, as well as to the viability of the funding portal industry and the crowdfunding market.
  • Highlighting Issuers and Offerings. A funding portal is permitted to highlight particular issuers or offerings on its platform based on objective criteria where the criteria are reasonably designed to highlight a broad selection of issuers offering securities through the platform, are applied consistently to all issuers and offerings and are clearly displayed on the platform. The permissible criteria include type of securities offered (e.g., common stock, preferred stock or debt securities), geographic location of the issuer, industry or business segment of the issuer, number or amount of investment commitments made, progress in meeting the target offering amount and minimum or maximum investment amount.
  • Providing Search Functions. A funding portal may provide search functions on its platform that investors could use to search, sort or categorize available offerings according to objective criteria, and that would allow investors to sort through offerings based on a combination of different criteria, such as by the percentage of the target offering amount that has been met, geographic proximity to the investor and number of days remaining before the closing date of an offering. However, search criteria may not include the advisability of investing in the issuer or its offering, or an assessment of any characteristic of the issuer, its business plan, its management or risks associated with an investment.
  • Providing Communication Channels. A funding portal may provide communication channels by which investors can communicate with one another and with representatives of the issuer through the funding portal’s platform about offerings conducted through the platform, but neither the funding portal nor its associated persons or employees may participate in these communications, other than to establish guidelines about communications and to remove abusive or potentially fraudulent communications. The communication channels must be made available to the general public and must restrict the posting of comments to those who have accounts on the funding portal’s platform. The funding portal must require each person posting comments to disclose clearly with each posting whether he is a founder or an employee of an issuer engaging in promotional activities on behalf of the issuer, or will receive any compensation for promoting an issuer.
  • Advising Issuers. A funding portal may advise an issuer about the structure or content of the issuer’s offering, including preparing offering documentation. For example, a funding portal may provide pre-drafted templates or forms for an issuer to use in its offering, and advice about the types of securities the issuer can offer, the terms of those securities and the procedures and regulations associated with crowdfunding.  Without these services, the SEC believes that crowdfunding as a method to raise capital might not be viable.
  • Paying for Referrals. A funding portal may compensate a third party for referring a person to the funding portal if the third party does not provide the funding portal with personally identifiable information about any investor, and the compensation, other than that paid to a registered broker-dealer, is not a transaction based success fee. The SEC believes the prohibition on success fees will help to minimize the incentive for high-pressure sales tactics and other abusive practices in this area.
  • Compensation Arrangements with Registered Broker-Dealers. A funding portal may pay compensation to a registered broker-dealer for services, including for referring a person to the funding portal, in connection with the offer or sale of securities, provided that the services are provided pursuant to a written agreement between the funding portal and the registered broker-dealer, the compensation is permitted under Regulation Crowdfunding and the compensation complies with FINRA rules.
  • Advertising. A funding portal may advertise its existence and identify one or more issuers or offerings available on its portal on the basis of objective criteria, so long as the criteria are reasonably designed to identify a broad selection of issuers offering securities through the platform and are applied consistently to all potential issuers and offerings, and the funding portal does not receive special or additional compensation for identifying the issuer or offering in this manner. However, a funding portal may not base its decision as to which issuers to include in its advertisements on whether it has a financial interest in the issuer, and any advertising may not directly or indirectly favor issuers in which the funding portal has invested or will invest.
  • Denying Access to Platform. A funding portal may deny access to its platform to an issuer if the funding portal has a reasonable basis for believing that the issuer or the offering presents the potential for fraud or otherwise raises concerns about investor protection.
  • Accepting Investor Commitments.  A funding portal may, on behalf of an issuer, accept investment commitments from investors but may not actually handle the funds.
  • Directing Transmission of Funds. A funding portal may direct investors where to transmit funds and may direct a qualified third party to release proceeds of an offering to the issuer upon completion of the offering or to return investor proceeds when an investment commitment or offering is cancelled. Interestingly, the SEC chose not to impose requirements that would prohibit variations of a contingency offering, such as minimum-maximum offerings, that would establish a fixed deadline for transmission of funds as compared to the proposed requirement to transmit funds “promptly” or that would require funding portals to maintain a certain amount of net capital.

            Compliance.  A funding portal must have written policies and procedures reasonably designed to achieve compliance with the federal securities laws and regulations relating to its business as a funding portal.  In addition, funding portals must follow the same privacy rules as those applicable to brokers.  Finally, funding portals are required to preserve certain records for five years, with the records retained in a readily accessible place for at least the first two years.

Rules Governing Crowdfunding Intermediaries Generally

The following rules apply to all Regulation Crowdfunding intermediaries, i.e., funding portals and broker-dealers:

  • Receiving Financial Interests in Issuers. The intermediary entity (but not its directors, officers or partners) is permitted to receive a financial interest in an issuer using its services, provided that the financial interest is compensation for the services provided to the issuer in connection with the offering and the financial interest consists of the same security as being offered to investors in the offering. This was as an accommodation in the final rules that will better enable issuers to pay intermediary upfront fees (through stock) and also have the added benefit of aligning the interests of issuer, intermediary and investors.
  • Measures to Reduce Risk of Fraud. There are several measures that intermediaries are required to take that are designed to reduce the risk of fraud in crowdfunding transactions. An intermediary is required to have a reasonable basis for believing that the issuers on its platform comply with Regulation Crowdfunding and have established means to keep accurate records of the holders of the securities, and may reasonably rely on representations of the issuer unless the intermediary has reason to question the reliability of those representations.   An intermediary must deny access if it has a reasonable basis for believing that an issuer, or any of its officers, directors or any 20% owner is subject to a disqualification under Regulation Crowdfunding.
  • Accounts and Electronic Delivery. Intermediaries may not accept an investment commitment unless the investor has opened an account with the intermediary and the intermediary has obtained from the investor consent to electronic delivery of materials.
  • Educational Materials. Intermediaries must deliver certain educational materials to investors, including information on process for purchase of securities, types of securities that may be offered on the intermediary’s platform, risks associated with each type of security, restrictions on resale, types of information that an issuer is required to provide in annual reports, frequency of the delivery of that information, limits on amounts investors may invest and limitations on an investor’s right to cancel an investment commitment.
  • Promoters. Intermediaries must inform investors, at the time of account opening, that promoters must clearly disclose in all communications on the platform the receipt of promotion compensation and the fact that he is engaging in promotional activities on behalf of the issuer.
  • Compensation Disclosure. At the time of opening an account, intermediaries must clearly disclose the manner in which they will be compensated in connection with Regulation Crowdfunding offerings.
  • Issuer Information. Intermediaries must make available to the SEC and investors, not later than 21 days prior to the first day on which securities are sold to any investor, any information provided by the issuer pursuant to Regulation Crowdfunding, and that such information be publicly available on the platform for a minimum of 21 days before any securities are sold in the offering, during which time the intermediary may accept investment commitments, and remain publicly available on the platform until the offering is completed or cancelled.
  • Investor Qualification. Before accepting an investment commitment, an intermediary must have a reasonable basis for believing that the investor satisfies the investment limits under Regulation Crowdfunding. An intermediary may rely on an investor’s representations concerning annual income, net worth and the amount of the investor’s other investments in Regulation Crowdfunding offerings through other intermediaries unless the intermediary has a reasonable basis to question the reliability of the representation. Intermediaries must also confirm that an investor has reviewed the intermediary’s educational materials, understands that the entire amount of his investment may be lost and is in a financial condition to bear the loss of the investment and has completed a questionnaire demonstrating an understanding of the risks of any potential investment.
  • Communication Channels. Intermediaries must provide on their platforms channels through which investors can communicate with one another and with representatives of the issuer about offerings, to make the channels publicly available, permit only those persons who have opened accounts to post comments and require any person posting a comment in the channels to disclose whether he is a founder or employee of an issuer engaging in promotional activities on behalf of the issuer or otherwise compensated to promote the issuer’s offering. Funding portals are prohibited from participating in communications in these channels.
  • Transaction Confirmations. At or before the completion of a transaction, an intermediary must send to each investor a notification disclosing date of transaction, type of security, identity, price and number of securities purchased by the investor, certain specified terms of the security and source, form and amount of any remuneration to be received by the intermediary in connection with the transaction.
  • Completion of Offerings, Cancellations and Reconfirmations. Intermediaries must give investors the right to cancel an investment commitment for any reason until 48 hours prior to the deadline identified in the issuer’s offering materials. If an issuer reaches the target prior to deadline, it could close the offering provided the offering has been open for a minimum of 21 days, the intermediary provided notice about the new offering deadline at least five business days prior to the new offering deadline and investors are given the opportunity to reconsider and cancel their investment commitment until 48 hours prior to the new offering deadline. Finally, if there was a material change to the offering terms or to the information provided by the issuer, the intermediary would be required to give or send to any investors who have made investment commitments notice of the material change, stating that the investor’s investment commitment will be cancelled unless the investor reconfirms his or her commitment within five business days of receipt of the notice.

[i] Although funding portal registration went live on January 29, 2016, Form Funding Portal does not yet appear on the SEC’s website and a Google search came up empty.

It’s official: the new Regulation Crowdfunding rules will become effective on May 16, 2016.  The SEC’s crowdfunding-keyboardfinal rules release of October 31, 2015 provided that, with certain exceptions, the new rules will go into effect 180 days after they are published in the Federal Register.  We just learned that the rules were published in the Federal Register on November 16, and that, accordingly, they will become effective on May 16, 2016.

So mark your calendars.  May 16, 2016 will be the first day that companies will be able to file Form C, the offering statement mandated by the SEC for Regulation Crowdfunding offerings.  But because of the requirement that disclosure be made publicly available on the intermediary’s platform for a minimum of 21 days before any securities are sold in an offering, however, the first Regulation Crowdfunding closings will not take place until at least June 6, 2016.

An important exception to the May 16, 2016 effective date relates to registration of funding portals, the relevant effective date for which remains January 29, 2016.  That means that funding portals, one of the two types of intermediaries (the other being registered broker-dealers) that will be permitted to operate funding portalsonline platforms for securities transactions under Regulation Crowdfunding, could begin filing their registration form, called Form Funding Portal, on January 29, 2016.  The reason for the staggered effective dates is to provide a level playing field between broker-dealers, who would already be registered and possess built-in infrastructure, and “funding portals”, the newly designated category of intermediary that will need to register with the SEC as funding portals and develop infrastructure.  I’ll be blogging about what the new Regulation Crowdfunding means for funding portals in my next post.

You can find my initial reaction to the new Regulation Crowdfunding rules here.