SEC Adopts New Crowdfunding Rules

Websites (homepages) of five leading crowdfunding platforms in the world - Kickstarter, IndieGoGo, RocketHub, Crowdfunder and GoFundMe on a computer screen.

Over the past few years, crowdfunding websites have become an increasingly significant source of consumer feedback and funding for fashion companies as fashion-specific sites such as Betabrand and general sites such as Kickstarter have allowed designers to prescreen new designs and raise funding from interested users. In some cases, supporters of a company will be asked to provide contributions for which the contributors will generally receive some form of gift or other recognition. In other cases, supporters will be asked to preorder a particular item, but only if the funding goal is met will the item go into production.

However, until recently restrictions under the federal and state securities laws have prevented fashion and other companies from raising funds in securities offerings on the internet unless the offerings were registered with the securities authorities or were limited to institutional or wealthy individual investors.

In October 2015, the Securities and Exchange Commission (“SEC”) adopted final rules that will permit ordinary investors to participate in internet-based crowdfunded securities offerings.

The final rules, which will be effective commencing in May 2016, will:

  • Permit a non-public U.S. company (other than an investment company or a shell company) to raise a maximum aggregate amount of $1 million through crowdfunding offerings – in a 12-month period;
  • Require that the offering be conducted through a registered broker dealer or funding portal;
  • Permit individual investors, over a 12-month period, to invest in the aggregate across all crowdfunding offerings up to:
    • The greater of $2,000 or 5% of the lesser of their annual income or net worth – if either their annual income or net worth is less than $100,000; or
    • 10% of the lesser of their annual income or net worth – if both their annual income and net worth are equal to or more than $100,000.
    • During the 12-month period, the aggregate amount of securities sold to a particular investor through all crowdfunding offerings may not exceed $100,000.

Companies that rely on the crowdfunding rules to conduct a crowdfunding offering will be required to file certain information with the SEC and provide this information to investors and the intermediary facilitating the offering, including among other things:

  • A description of the business and the use of proceeds from the offering;
  • The price to the public of the securities or the method for determining the price, the target offering amount, the deadline to reach the target offering amount, and whether the company will accept investments in excess of the target offering amount;
  • A discussion of the company’s financial condition;
  • Financial statements of the company that, depending on the amount offered and sold during a 12-month period, are accompanied by information from the company’s tax returns, reviewed by an independent public accountant, or audited by an independent auditor. A company offering more than $500,000 but not more than $1 million of securities relying on these rules for the first time would be permitted to provide reviewed rather than audited financial statements, unless financial statements of the company are available that have been audited by an independent auditor;
  • Information about officers and directors as well as owners of 20 percent or more of the company; and
  • Certain related-party transactions.

In addition, companies relying on the crowdfunding exemption will be required to file an annual report with the SEC and provide it to investors that contain information similar to that in the initial disclosure statement.

Each issuer will need to evaluate whether the initial and ongoing costs of a crowdfunding offering make this an attractive capital raising method in light of the amount to be raised and other available funding alternatives. For some issuers a crowdfunding offering will be a useful method to raise funds and to begin to establish a committed shareholder base with the goal of eventually becoming a full public company.

Credit:  R. Brian Brodrick

Brian is a partner in Phillips Nizer’s Corporate Law and Securities & Private Placement Practices.


Don’t Try This In Your Own Home

Fashion designers working together on an outfit in design studio

We have been meditating in these posts (here, here and here) on some of the problems that arise when two or more people start and run a new venture. Many of the issues that arise are common to all businesses, but when it comes to fashion—especially fashion good enough and fresh enough to build a brand from scratch—the question of talent moves to the forefront. Whatever else the business might do, if it is going to succeed, someone involved with it right from the start is going to have to be either very talented or very lucky. (You will soon know if it was just the latter because, as things move along, talent tends to repeat itself and luck does not.) In its simplest form, whether in design, execution or just in knowing how to buy, talent is what you see when inspiration finds a means of expression.

Luckily, like a roast lamb with a robust Bordeaux and a fish salad with a chilled Riesling Spätlese from lovely parts of the Pfalz (just beyond where I own a turnip field with a unique terroir), talent in fashion pairs well with talent in business. It is a paradox of American life that, in a country obsessed with prospering in business, managers are not considered “talent.” But that is exactly what they are. If being able to run a business were not a question of talent, and if it did not require a truly deft intelligence and plenty of self-confidence, artists, philosophers and humanities professors would be running the Fortune 500.

Whether starting up or expanding is the question, however, no one is of greater importance, at least at that moment, than the person known in show business as “the money.” Seed capital can come from the venturers’ pockets (if deep enough), friends and family, crowd funding, banks and others, but as dramatized for effect on television in programs such as Shark Tank, money comes at a price—often one that appears disproportionate to the commitment made. You may well bristle at the thought of surrendering a healthy portion of the equity in your business to someone whose contribution is little more than writing a check, but that person knows all too well that without him or her, your dream enterprise will remain just that. (And think about it for a minute: do you really want that person providing guidance for your fall/winter collection? Maybe it is better if your investor is the strong, silent type.)

So sometimes, when it comes to handing out equity, you have to give until it hurts. On the other hand, mathematics tells us that equity interests can never total more than one hundred percent, so if you shell out ownership percentages in exchange for cash, advice, goods or services, keep in mind that your control ends when more than half the equity belongs to other people.

Whatever you do, always understand this: all divisions of that magic one hundred percent must be carefully documented. You have heard the expression “Don’t try this at home.” That applies double for anything commercial or financial, such as equity participation that has a legal effect. In our experience, few things have been more painful to read than important documents with binding legal effect that were written by non-lawyers who deceived themselves into thinking that they could save the money and do it themselves.

Life is too short to prove to yourself why you decided not to practice law: when legal issues come into play—as they will from day one—it is always best, for the calm and confidence of all, to bring your lawyer into the process. If you are a designer, think of it this way: would you let your lawyer design your wardrobe for you? Turn that around, and now you know why he or she does not want to see you writing your own contracts.

Credit: Alan Behr