Tuesday, May 5, 2020

Temporary Rules Make Crowdfunding Easier

Yesterday, on May 4th, the Securities and Exchange Commission (the "SEC") adopted temporary rules (through the end of August) making it easier for smaller companies affected by COVID-19 to raise capital through a Regulation Crowdfunding offering.  To rely on these temporary rules, the issuers will need to disclose to the investors that they are specifically relying on them as well as meet certain enhanced eligibility requirements, one of which is that the company has been in existence for over 6 months.  The SEC press release provides a good overview of the temporary rules.

In particular, the rules allow companies to initially omit financial statements, which is an important amendment.  In our experience, preparing financial statements often delays the campaigns.  The companies can now accept investment commitments without having to wait until the closing, so long as their offering statement includes the financials.  For smaller campaigns (not exceeding $250,000), the financial statements do not have to be reviewed by a CPA but can be certified by the principal executive officer.  Sales are permitted as soon as the issuer has received binding investment commitments covering the targeted amount (no need to wait 21 days, which is the minimum offering length).  Investment commitments become binding 48 hours after they are given, and cannot be canceled after that unless there is a material change in the offering.  Early closing is permitted as soon as binding commitments reaching the target amount are received.

These measures will simplify and, what is most important, will expedite the crowdfunding campaigns, allowing the smaller companies to raise much-needed funds.

This blog contains general information about legal matters. The information is not advice, and should not be treated as such. Communication of information by, in, to or through this blog and your receipt or use of it: (1) is not provided in the course of and does not create or constitute an attorney-client relationship; (2) is not intended to convey or constitute legal advice; and (3 is not a substitute for obtaining legal advice from a qualified attorney. Pursuant to Rule 1-400(D)(4), you are notified that this blog may constitute a communication or solicitation concerning the availability for professional employment of a member or a law firm in which a significant motive is pecuniary gain. For more information on this topic, please contact the author, Arina Shulga.

Monday, May 4, 2020

Открытие Бизнеса в США: Практические Советы

Мы организуем бесплатный вебинар на тему открытия бизнеса в США. Вебинар покроет не только юридические вопросы но и налоговые. Присоединяйтесь 14 мая в 17:00 по МСК!

https://www.eventbrite.com/e/104361225234



Wednesday, January 29, 2020

LEGAL PERSPECTIVE ON RUNNING A SUCCESSFUL CROWDFUNDING CAMPAIGN

Although Regulation Crowdfunding (or Reg CF in short) is a great way to get funding for companies that otherwise would have been overlooked by angel or VC investors, running a successful and compliant Reg CF campaign is not an easy undertaking. Based on experience working with Reg CF issuers, in this blog I describe and discuss three key legal challenges that all Reg CF issuers should know about: restriction on advertising, hiring promoters, and putting together a complete and accurate Form C.

First, the issuer cannot generally solicit and advertise its Reg CF offering. All communications must be done through the portal. According to Rule 204 of Reg CF, the issuer can make factual statements and then direct potential investors to its page on the portal. Such factual statements are limited to the following information: the fact that the issuer is conducting a Reg CF offering; the terms of the offering (amount, nature of securities, price, and closing date), and factual business information about the issuer. While the first two categories are straight forward, issues can arise when talking about the factual business information. Such information cannot include predictions or opinions and must be limited only to facts, such as name, address, website of the issuer and a brief factual description of its business.

Second, Rule 205 of Reg CF allows issuers to hire promoters for their offerings as long as the promoters work within the portal page and the issuer takes reasonable steps to ensure that the promoter discloses the fact that they are compensated. Outside of the portal, the promoters are restricted to providing the same factual statements that are described above. Again, the issuer must take reasonable steps to ensure that the promoters disclose that they are being paid by the company. As a separate issue, companies should not pay promoters a commission or a success-based fee. Such transaction-based compensation is a red flag to the SEC that the promoters are acting as unregistered broker-dealers, which may invalidate the entire offering. Compensation should be in the form of a flat fixed fee, rather than be tied to the success of the sales efforts.

Third, prior to launching a Reg CF offering, the issuer must file a disclosure document called Form C with the SEC. Even though its disclosure requirements are less extensive than for other offerings (such as Regulation A or an IPO), Form C must still be taken seriously. Form C requires the company to provide a description of its business and the anticipated business plan, the team bios, use of proceeds, and the risk factors that describe in depth the risks of investing in the company as well as the risks related to the company’s operations. Further, Form C asks for disclosures related to the ownership and capital structure of the company and rights of all securities that have been issued by the company prior to the offering. The company must list all of its other securities offerings for the past three years. This has often proven to be a challenge for some younger companies that may not realize that they were conducting securities offerings when, for example, they sold a SAFE to a neighbor or a couple of convertible notes to unaccredited friends, fail to file Form Ds for prior offerings, or comply with the offering exemption requirements. When preparing Form C, issuers should remember that under Rule 10b-5 of the Securities Act they have liability for any material misstatements or omissions in their Form Cs.

Additionally, even the younger companies must include US GAAP financial statements. For offerings of $107,000 or less, the financial statements must be certified by the principal executive officer of the issuer; for offerings between $107,000 and $535,000, they must be reviewed by a public accountant independent of the issuer; and for the offerings over $535,000, the financial statements must be audited (although the first-time issuers could provide reviewed financials instead).

Consequences for violating these rules can be severe. Regulation CF is a safe harbor exemption from the general requirement that a company must register its securities with the SEC. If violated, the offering may be deemed to be void, and all investors in the offering could receive recession rights (i.e., the right to get their money back). Additionally, the SEC may impose sanctions and shareholders may file civil lawsuits against the company. Further, the company itself may be deemed to be a “bad actor” and be prevented from conducting private placements of its securities in the future.

In conclusion, running a successful and compliant crowdfunding campaign is not a simple task. The key to success often lies in finding the right advisers: a funding portal that would be willing and able to support its issuers throughout the entire crowdfunding campaign, and an expert legal adviser that can prepare Form C, ensure that the company’s legal records and corporate governance documents are in order, and guide the company through the maze of legal rules and forms of Regulation Crowdfunding.

This blog contains general information about legal matters. The information is not advice, and should not be treated as such. Communication of information by, in, to or through this blog and your receipt or use of it: (1) is not provided in the course of and does not create or constitute an attorney-client relationship; (2) is not intended to convey or constitute legal advice; and (3 is not a substitute for obtaining legal advice from a qualified attorney. Pursuant to Rule 1-400(D)(4), you are notified that this blog may constitute a communication or solicitation concerning the availability for professional employment of a member or a law firm in which a significant motive is pecuniary gain. For more information on this topic, please contact the author, Arina Shulga.

Saturday, January 18, 2020

Amending the Definition of "Accredited Investor"

The definition of an “accredited investor” is the cornerstone of Regulation D that provides a safe harbor exemption for private placements of securities by startups and more mature companies. Only in 2018, $1.7 trillion was invested into the startup sector by means of Regulation D offerings, out of which $228 billion was raised by companies rather than investment funds. Nearly all of the investors in such offerings were accredited. Now, the definition of an accredited investor may be changing to include new categories of people. This will open the extremely risky but yet extremely lucrative startup investment opportunities to more participants.

This blog focuses on certain proposed changes to the definition as it relates to natural persons.

The definition of “accredited investor” came about in 1982 together with the adoption of Regulation D (although the concept of an “accredited person” was first introduced by Rule 242 in 1980). The following categories of natural persons are deemed to be accredited:

  • Any natural person who had individual income in excess of $200,000 in each of the two most recent years or joint income with that person’s spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year;
  • Any natural person whose individual net worth, or joint net worth with that person’s spouse, exceeds $1 million (excluding the value of primary residence); and
  • Directors, executive officers, and general partners of the issuer or of the general partner of the issuer.
Other than expanding the income test to include a joint income component in 1988 and excluding the value of one’s primary residence from the net worth calculation as part of the Dodd-Frank Act in 2011, the SEC has not revised the definition since 1982.

On December 18, 2019, the SEC issued proposed rules to amend the accredited investor definition. The rules are currently in the 60-day comment process, so anyone who cares deeply about the outcome is encouraged to submit a comment to the SEC.

The main premise of the proposed rules is the fact that the SEC no longer believes wealth to be a proxy for financial sophistication, and I fully support this conclusion. There should be other criteria for establishing financial sophistication. Hence, the SEC is proposing to add the following new categories of natural persons to the category of accredited investors: (i) those who hold certain professional “certifications, designations or other credentials recognized by the Commission” and (ii) “knowledgeable employees” of a private fund who are investing in that fund. Since I fully agree with adding “knowledgeable employees” to the accredited investor definition list, I will focus my discussion on the persons with professional certifications.

With respect to the professional degrees, the SEC has proposed an initial list of accepted certifications, to be revised and amended from time to time. The initial list includes:
  • A Licensed General Securities Representative (Series 7);
  • A Licensed Investment Adviser Representative (Series 65); and
  • A Licensed Private Securities Offerings Representative (Series 82).
As currently proposed, the list of acceptable professional certifications is narrow and substantially limits eligible persons to those professionals working for broker-dealers (most of whom may already be accredited by other means). These individuals must be sponsored by a FINRA member firm to be allowed to take the Series 7 or 82 exam and first pass an introductory-level Securities Industry Essentials examination. There are no similar requirements for the Series 65 exam. As previously mentioned, taking a Series 7 or 82 exam assumes that such an individual is employed by a FINRA member firm. My view is that those individuals who are not working for a FINRA member firm should also be allowed to take the examinations, and if they pass, become “accredited investors.” In a sense, these exams, if stripped of the sponsorship requirement, should become tests for the minimum expertise necessary to be deemed to be an accredited investor. There should also be annual re-certification to ensure that these individuals keep abreast of all relevant developments in the financial and legal markets. Allowing everyone to take these exams, whether or not affiliated with a FINRA member firm, would render it unnecessary to consider other professional degrees such as a Ph.D. in finance or a Master’s degree in a similar field. All persons, regardless of the professional or educational background, should be able to take the tests and qualify to be an accredited investor. It could make sense, however, to impose investment limitations on those investors who qualify to be accredited solely based on the professional certifications criteria.

Additionally, harmonization of the various definitions that are currently used in different securities laws would go a long way towards simplifying and streamlining the compliance process. Currently, in addition to the definition of an “accredited investor” found in Rule 501(a) of Regulation D under the Securities Act, we have the definition of a “qualified purchaser” under the Investment Company Act of 1940, a “qualified client” under the Investment Advisers Act of 1940, and a “qualified institutional buyer” in Rule 144A under the Securities Act. All of these definitions generally refer to wealthy entities and individuals but vary somewhat with respect to the thresholds and scope.

In conclusion, the proposed rules are a big step forward towards democratizing the definition of “accredited investor.” Having more accredited investors willing and interested to invest in startups will fuel the growth of the startup economy and should result in producing more jobs.

This blog contains general information about legal matters. The information is not advice, and should not be treated as such. Communication of information by, in, to or through this blog and your receipt or use of it: (1) is not provided in the course of and does not create or constitute an attorney-client relationship; (2) is not intended to convey or constitute legal advice; and (3 is not a substitute for obtaining legal advice from a qualified attorney. Pursuant to Rule 1-400(D)(4), you are notified that this blog may constitute a communication or solicitation concerning the availability for professional employment of a member or a law firm in which a significant motive is pecuniary gain. For more information on this topic, please contact the author, Arina Shulga.