Regulation A+ passes unanimously

Great news! The SEC commissioners have unanimously passed final rules for Regulation A+.

While we are reading the final rules, below is a great chart from CrowdCheck that explains the differences between Reg D and the new Reg A. In short, this is going to potentially be a game changer in the crowdfunding world. Although this won’t work for small offerings of a few hundred thousand dollars, it will change the face of financing for the companies that are looking to raise a few million.

Click to access Comparison%20of%20506,%20CF,%20Reg%20A.pdf

A Little Note About Intrastate Crowdfunding …

arizona-sealLiving out here in Arizona, we are well known for interesting politics. In the aftermath of Super Bowl 49 we woke up to the introduction of an intrastate crowdfunding bill in the state house and senate. Based on the support of the business community, it is likely that the bill will pass, and Arizona will join the more than 25% of the individual states that already have intrastate crowdfunding.

I found a couple of things particularly interesting about the proposed bill:

More is less. The proposed crowdfunding bill prevents having the problems of The JOBS Act and contains very particular provisions regarding implementation of the new law. Instead of relying on the state securities officials to make any rules, the bill itself contains page after page of specific direction.

The problem is that both opponents of the bill and proponents alike will be able to find some issue with the proposed language. Does that mean that it dies on the vine because the language isn’t quite right (see SEC)?

Also, because the bill is so particular, any changes would require a legislative change. This greatly reduces flexibility in the implementation of the law. If something isn’t right, you’re counting on a legislative fix. And we all know how dysfunctional legislative bodies can be.

It just doesn’t matter. There have been a lot of states that have implemented intrastate crowdfunding laws. And there have been almost no deals completed under those laws. There are a couple reasons for the lack of activity.

First, there is a hard time educating businesses about a fundraising concept that varies from state to state. It is likewise hard to build much media momentum when the story is so hard to tell because of the variety of laws that are on the books.

Second, securities lawyers are terrified of the SEC guidance so far. There is a worry that any use of the Internet (which is available in every state) to raise money in one specific state is going to risk action by the SEC. The fear of triggering the SEC always seems to shut down lawyers …

In short, it is great news that the Arizona legislature has taken up the intrastate fight. But is intrastate crowdfunding the answer for small businesses? Nope.

Jonathan FrutkinJonathan Frutkin is CEO of Cricca Funding, LLC. He’s the author of “Equity Crowdfunding: Transforming Customers into Loyal Owners” which is available in paperback, Kindle and audio book formats.

Comments to the SEC about Crowdfunding

A few months ago, the Securities and Exchange Commission published proposed rules which govern how equity crowdfunding is going to work in the US. The proposed rules are extensive – covering nearly 600 pages. I am not alone in spending a sec seallot of time reading the rules and making comments. There have been a great number of other people who have participated in the process. You can read all the comments here:

So now the ball is back in the SEC’s court. Hopefully we will have some final rules soon. Although it won’t be everything we want it to be, a new industry will finally come to life. And we are all lucky to be part of it.

SEC Comment Letter from Jon Frutkin (pdf)


January 30, 2014

Elizabeth Murphy, Secretary
U.S. Securities and Exchange Commission
100 F Street, NE
Washington, DC 20549

Re:          File No. S7-09-13, Release Nos. 33-9470; 34-70741, Comments regarding Proposed Rules on Crowdfunding, Title III, The JOBS ACT

Dear Ms. Murphy:

First: a compliment. Although there has been a great deal of criticism relating to the specifics of the proposed rules and their extensive breadth, the Commission has done an admirable job of developing a framework for Title III of the JOBS Act which is true to the law itself. Of course this has been an enormously complicated undertaking. It is an ongoing challenge resolving the tension between unlocking capital while ensuring transparency.

However, we must remember that less than 20 years ago, a small Internet start-up named eBay successfully convinced us that people could trust each other when paying for auction items – payments made for a product sight unseen and to a stranger somewhere around the world. A person’s character is now judged by each and every transaction, and eBay proved that while fraud could never be eliminated. But fraud is disappearing in a world where trust is earned one online transaction at a time.

A great number of comment letters have already been submitted, focusing on various parts of the hundreds of pages of proposed rules. But there is one area of particular concern: what happens the “day after”?

Last year, I wrote the book Equity Crowdfunding: Transforming Customers into Loyal Owners. There is widespread opinion that equity crowdfunding will be a powerful tool to raise funding for start-up businesses. However, my belief is that crowdfunding is a great opportunity for profitable local businesses. Equity crowdfunding turns customers into super-customers, becoming marketing evangelicals that help drive revenue. In exchange, investors will receive dividends, their share of the profits which hopefully increase over time due to the new enthusiasm for their company. With that backdrop, I have thoroughly reviewed the Commission’s proposed rules.[1] And while I obviously have opinions about many aspects of the proposed rules, I focus my comments on this one relatively narrow area.

Of significant concern is the proposed requirement, found nowhere in the JOBS Act itself, that issuers raising more than $500,000 must have an audit performed each and every year moving forward.[2] Because of the transaction costs associated with raising equity crowdfunding, I posit that nearly all of the successful rounds of funding will be in this $500,000+ category. However, the ongoing cost of annual audits is such a significant deterrent that it needs to be reconsidered prior to the finalization of the rules.

So consider a successful company; one generating a return of 12% on capital. Most investors would be satisfied with a return that is considerably greater than the average return provide by public companies. Using the mid-point of $750,000 total investment, a 12% return on capital would mean $90,000 annually to those investors. But using the rough estimate of $30,000 per audit[3], this means that fully 1/3rd of the investors return would be eaten up by an audit – every single year. This audit is in addition to whatever other compliance costs come along with the annual reporting requirements.

In short, requiring an officer’s signature under the penalty of perjury, indicating that the financial statements provided to the Commission and the investors are true and correct, is sufficient to promise punishment where fraud exists. And it prevents a solid return from being greatly depleted because of the existence of a rule that is nowhere to be found in the law.[4]

Next, I have great concern about requiring publication of an issuer’s financial reports on the company’s website[5]. Certainly there is no disagreement that this information should be public. The proposed rules contain the commonsense requirement that a Form C-AR be filed and accessible online through EDGAR. It is unquestionably reasonable for the public to be able to easily access these reports, and it is paramount that prospective investors in the secondary market can receive this information.

To comply with the law’s mandate that the investors receive these reports, an issuer can be required to provide that information directly. A company could utilize one of many alternative methods. For example, the rules could require that the issuer provide the report via email, on a website that is password protected with the login information distributed to investors, or simply by mailing using first-class mail to the investor’s preferred mailing address.

The idea that financial information is going to be prominently displayed on a company website is distasteful. Whether the company is having an up or down year, this information is irrelevant to the 99% of the visitors to their website. While looking for hours of operation, key employee bios and contact information, web visitors should not be instantly privy to financial information simply because the company at some distant point in the past utilized Title III.

And the resulting impact would be unfortunate. Companies that are extremely successful may be tempted to redeem their crowdfunders ownership interest just to avoid publishing information right on their website. Or worse, companies that may be suffering from short term issues may have less customers because of the publication of the information – resulting in a deadly sales tailspin.

The Commission would be correct to require that financial reports be distributed to crowdfunders (at least to those that the issuer has current contact information).

Publication on the web through EDGAR is a must. But it is counter-productive for those financial statements to be on the issuer’s website. Just like publicly traded companies now, information should be obtainable. However, forcing financial reporting on an issuer’s main website is a mistake.

Although not required by the proposed rules, the Commission should carefully monitor the necessity of requiring crowdfunded companies to engage the services of a registered transfer agent.[6] Although for some companies it may not be problematic, one can imagine the mayhem that could be created once hundreds (and sometimes thousands) of new investors are trading stock on some secondary markets. The mechanisms for tracking capitalization tables (and investor contact information) are available for more sophisticated and organized business managers. But it is potentially a disaster where the company would be unable to pay dividends or make distribution of assets after selling or dissolving the company.[7]

I join with the incredibly energetic people who are actively involved in the equity crowdfunding community in offering our help. We all recognize that rule-making and enforcement cannot happen in a vacuum. And I remain available to provide further information and opinion to the Commission as crowdfunding becomes a commonly used tool to help grow and promote American business.


Jonathan Frutkin

[1] I am also the CEO of Cricca Funding, LLC. More information about our crowdfunding advisory services and commentary are available at
[2] See Crowdfunding; Proposed Rules, Release Nos. 33-9470; 34-70741 (“Proposed Rules”) at p. 92-3; §227.202 (referencing §227.201(t)).
[3] The proposed rules estimates the amount to be $28,700 which may be on the conservative side for a restaurant, car wash, landscaping company or other local business which has extensive operations and cash flows. See generally Proposed Rules at p. 368.
[4] Section 4A(b)(4) requires financial statements to be filed at least annually pursuant to rule of the Commission. It does not intimate that these financial statements should be audited or reviewed. To the contrary Section 4A(b)(1)(D), explicitly references audited and reviewed financial statements depending on the size of the offering.
[5] Proposed Rules at p. 94.
[6] Proposed Rules at p. 145.
[7] The Commission has expressed concern that because of the secondary market, the company may not know the identity or email address of the investors. Proposed Rules at p. 94-5. Ultimately, the issuer needs to know who owns the shares. The portal or broker could give this information to the issuer and/or its transfer agent upon closing. Any transferring shareholder could certainly be required to communicate the new contact information to the issuer.
Jonathan FrutkinJonathan Frutkin is CEO of Cricca Funding, LLC. He’s the author of “Equity Crowdfunding: Transforming Customers into Loyal Owners” which is available in paperback, Kindle and audio book formats.

SEC Proposes Crowdfunding Rules

So today was the day that the SEC finally released proposed rules on crowdfunding after more than 18 months of anticipation. I have two general observations.

My first observation is that the SEC rules are very true to The JOBS Act legislation. In sec sealmany cases that is great – it means that the SEC did not add onerous provisions that would gut the intent of the law. In other cases it is a disappointment. For example, the audit requirement for companies that are raising more than $500,000 still remains (despite the statute’s provision which permits the SEC to adjust that threshold).

My second observation is that this is an enormously complicated undertaking. The proposed rules are 585 pages and ask for comment on nearly 300 individual questions. There is a 90 day comment period, after which the SEC is going to take a look at the comments and finalize the rules. After that, there is final publication and then the rules become effective. The punch line is that we are still a solid six months away (if everything goes well) from crowdfunding becoming legal. Companies cannot raise equity using crowdfunding until then. It is very important to understand that while crowdfunding is coming, that day is not here yet.

Because of the complexity in the length of the proposed rules, I can only highlight a few things. A number of commentators will be preparing much more extensive commentaries (including one from which is sure to be excellent based on their track record). Also, remember that FINRA (the organization that regulates the broker-dealers and new funding portal websites) just published its proposed rules today also (right after the SEC release). So a lot more is coming over the next week or so. We have a long way to go, and a lot of information to digest. But, with that said, here are a few interesting points from my initial review of the extensive proposed rules.

  • Advertising. Companies that are using crowdfunding can only advertise the offering by directing potential investors to the funding portal. They are not allowed to advertise the terms of the offering, including the amount offered, the length of the offering, or even the price. All of that information can be in one place and one place only – the funding portal. This allows the company to leverage the power of social media to attract potential investors, while at the same time ensuring that all communication is centralized in one place – the funding portal. The point? Everything needs to be on the funding portal. Companies can direct people to the portal, but it isn’t open season on social media.
  • Cancellation period. The SEC believes that most of the power with crowdfunding comes from the fact that back-and-forth discussion on the campaign webpage will inform potential investors about whether or not it is a good opportunity. To that end, the rules permit an investor to cancel their commitment up to 48 hours prior to the deadline identified in the offering. In short, you could have a deal that looks like it is going to close, and then everybody backs out the last second. This has potential to be very disruptive to a company, but on the other hand, it does provide an important protection for the investors. A company can move up its closing date by providing five days advance notice, according to the proposed rules. This allows completely subscribed offerings to get closed up and funded, so long as they meet the other provisions in the law.
  • Investment limitations. The JOBS Act tries to protect investors by only permitting them to invest a maximum amount based on their income and/or net worth. The invest limits are between $2,000 and $100,000 per year, for ALL crowdfunded investments during the year. There was a lot of concern that the SEC would put forward a rule that was very difficult to be practical. Because people would be making investments on various funding portals, the information about how much investor has put into crowdfunded deals for the year may be hard to determine.

The SEC recognized that, and suggested that the investor would be able to “self-report” their income and net worth, as well as their previous crowdfunding investments for the year. The responsibility of a portal to investigate this information is limited. However, that doesn’t mean that funding portal who has already received more crowdfunding investments than is being reported by a particular investor is allowed to rely on information it knows is untrue. To the contrary, the portals still have a responsibility to pay attention. This is good news here; without allowing self-reporting of previous investments, it would be darn near impossible to figure out if someone was over the limit because of investments made on other funding portals.

  • Banks handle the money. Because a brand-new creature was created as part of the law called a “funding portal” (which doesn’t handle investor money), there was some question about how investor money would be transferred to the company. The SEC has proposed that only banks should handle the money. This is fine, provided that banks are willing to provide the service. There most certainly are broker-dealers, escrow agents, lawyers, are others who would be willing to fulfill this role if the banks don’t step up to the plate. The SEC needs to make sure that banks are “in” or else the whole system falls apart.
  • On-going reporting. This is an area where the SEC kind of whiffed. The JOBS Act requires annual reports. But, the SEC is requiring the same standard in financial reporting on an annual basis as for the offering itself. That means once a company raises $500,000+, it will always be required to produce audited financial statements. This is awfully expensive.

Additionally, the SEC wants companies to publish financial statements on their own websites. As you can imagine, the investors should have access to information, but it is kind of amazing that once a company is crowdfunded, it will be required on its very own website, to provide financial reporting. The SEC should consider giving some leeway and allowing companies to publish the information on a password protected site to investors or through the funding portal. Obviously, all this information is also available on EDGAR (the online public information tool), but it shouldn’t have to be on a company website.

  • Portals can’t give “investment advice”. Funding portals are different than broker-dealers, because they can’t promote specific opportunities. The idea is that a funding portal is a neutral marketplace which allows investors to make their own decisions. This created some real concern that funding portals would be unable to pick and choose deals which they wanted to list at all. Otherwise, they were worried about being accused of giving “investment advice” by curating only the best deals.

Fortunately, the SEC’s proposed rule permits a portal to set objective criteria that must be met in order to be displayed on the site. Moreover, the SEC rules permit search functionality which will allow an investor to look at opportunities that may work for them. Not surprisingly, the SEC prohibited enhanced fees to receive “featured listing” status (to have more prominence on the site). This is the sort of activity that could lead a funding portal to be perceived to be making recommendations. There does still remains some ambiguity regarding what criteria a funding portal can used to choose its deals without running afoul of the prohibition on investment advice. But at least there will be a limited opportunity for portals to help screen real bad deals from the public.

  • Crowdfunded companies can also raise money through other avenues. Crowdfunded offerings are limited to $1 million over any 12 month period. There was a lot of concern that would prevent companies from raising any more than that $1 million through private placement or private equity funds (like venture funds). Lawyers call these “integrated offerings”, which means that you can’t combine two different rules to skirt around certain limitations.The SEC fortunately came down on the side of common sense. Because companies could raise money through variety of other methods, having a limitation on raising any other money for a full year could potentially have prevented these companies participating in crowdfunding at all. It also would have prevented private equity funds from making larger investments and successfully crowdfunded companies for an entire year. Capping all investment at $1 million is obviously contrary to the underlying purpose of the law: to make it easier for smaller and startup companies to raise money. SEC took a reasoned approach and proposed a rule that the $1 million limitation is for the crowdfunded portion of the deal only.

There are a ton of other rules, some of which are more important than others. Ultimately, this is the opportunity for voices to be heard. While you’re welcome to comment here, I strongly urge you to also hit the website if you’ve got something to add.
Jonathan Frutkin
Jonathan Frutkin is CEO of Cricca Funding, LLC. He’s written a new book called “Equity Crowdfunding: Transforming Customers into Loyal Owners” which was published in May, 2013.

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