BLOG 16: CROWD FUNDING 102
How is CROWD FUNDING REGULATED?
My last Blog (15) spoke about the many CROWD FUNDING OPTIONS from which to choose the right one for you. Naturally, your own project will have a lot to determine your choice.
If you have an EXCHANGE project that may include annual and monthly memberships entitling the member to specific privileges, then launching an EXCHANGE campaign whereby for certain levels of monetary contributions the contributor receives one month, 3 months or a year of free membership as their reward; then this choice is relevant; or if your project involves a product then receiving the product(s) in exchange for a contribution would be the consideration.
There is a good case for using the EXCHANGE model for most projects but the final decision rest with the amount of money you wish to raise and/or whether you wish to give-up some EQUITY, which is one kind of platform or whether you wish to stay in total control and not give-up any EQUITY but need considerable amounts of money, then you may choose a DEBT platform whereby you owe the money back to the lender, period without giving up any stock or control.
There is even a combination whereby the initial thrust would be raising money as DEBT from a DEBT structured campaign but the DEBT has an optional incentive for the lender(s) to convert their note to EQUITY at a given agreed upon time, probably after the COMPANY proves itself to be a good investment for the lender (this option is my choice as it offers the best of both worlds).
And yes, at that point if a lender does decide to convert his debt to equity, the company will be issuing stock and the founder of the company will have some dilution of stock but will or should still be in-control.
I have essentially described the above attributes in my previous Blog 101 but thought it best to briefly discuss the options again; so let us proceed to what this article is all about and that is REGULATIONS involving this new form of FUND RAISING.
However, I would be remiss if I did not add that as the INTERNET has changed the way we shop, read and receive news so has the INTERNET changed the way entrepreneurs raise money.
In the so-called old-days the typical STAGE ONE fund raising campaign consisted of raising SEED money from family and friends and that has not basically changed much, even in the world of INTERNET technology and the emergence of Crowd Funding, the company will need money to fund the requirements necessary to launch a successful crowd funding campaign; such as, hiring a business consultant to prepare a business plan and financial projections, which is one of four essential requirements, the others being a videographer to prepare a video, a computer savvy helper to prepare a Power Point presentation, although the business consultant (we do here at M & A) is probably well-equipped to do this plus hiring a PORTAL OPERATOR to structure the whole project for launching the campaign and performing due-diligence and compliance application assistance.
BUT WAIT! You still need money to hire an attorney and not just any attorney but an attorney who is well versed in Federal and State Securities Laws and applicable compliance issues, without which your project is doomed before you start.
So let’s begin with Industry regulations, which were established by the FCA covering two types of crowd funding, one is EQUITY/INVESTMENT based funding (non-realized securities), which includes mini-bonds, debentures, and straight stock equity all of which cannot be easily sold-off and the other is DEBT based using the market place as a lender, who will receive interest for the amount loaned.
Ultimately, the FCA had to decide between the EQUITY and DEBT based platforms, which platform they were going to regulate based on the type of product being offered or the risk profile of the business being considered as an investment by a would-be investor, which makes the criteria clearer and more definitive and the FCA chose to focus on the RISK FACTOR as opposed the PRODUCT itself to REGULATE.
This approach then defines the platform selected for fund raising as it becomes clearer that if an equity (stock) based startup wants to raise money from crowd funding they will most likely chose and EQUITY or DEBT platform and if the startup should be more of a “cause celebre,” like a charity or community cause then the entity would choose the DONATION platform, yet the other remaining option would be an entity that would want to EXCHANGE something for something, which is the REWARD based platform.
Note: DONATION or REWARD based platforms are not included under the current regulations, only the STOCK/EQUITY/DEBT platforms ARE UNDER the rules and mandates of the FCA. And that includes complete disclosures referencing risk/reward language and no misleading marketing information; in addition to assurance that there are adequate capital reserves to sustain the company until it meets its financial (P & L) projections.
There is also a 14-day cooling-off period on behalf of the INVESTOR/LENDER plus full access to all financial data in addition to new rules regarding the investors themselves, among which are:
1. Full disclosure for EQUITY based INVESTOR
2. Identification of corporate finance and/or venture capital contacts
3. Certifying investors qualifications to make the investment as a HIGH NET WORTH individual or receive a written confirmation that the investor will not invest more than 10% of their net investible assets.
Thus the onus is actually on the INVESTOR to establish their qualifications to meet the investment requirements set-forth by the FCA rather than the focus on the platform itself. Investors must tick a box to confirm they fall into one of the above categories. They must also pass an online appropriateness test to prove they are aware of the risks.
Remember, just because the platform is FCA regulated, does not mean the investor’s money is safe, just like any high-risk investment and the company doing the money search cannot guarantee the prudence or returned funds of the investment; however, the FCA does provide strict guidelines to vet platforms before giving their seal of approval, including making sure your money is not inter-mingled from the main finances of the company in case it goes bust, and allowing you a 'cooling off' period in case you change your mind after making a donation/investment.
Though I am not sure who is reading this article, a COMPANY/CANDIDATE for applying to a PORTAL OPERATOR to raise money from their PLATFORM or a potential EQUITY INVESTOR or LENDER, the information recited above can be summarized by noting that the emergence of CROWD FUNDING as a source for raising money is something to take very seriously and consider and equally, as well, it is a source for a potential EQUITY INVESTOR to take advantage of an investment opportunity being offered.
Note: My next article/Blog (17) will continue from CROWD FUNDING 102 with CROWD FUNDING 103.
RONALD MITCHELLETTE & ASSOCIATES, LLC
2730 West Lake St., Ste.905
Minneapolis, MN. 55416
Direct: 612 715 9217
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