CROWDFUNDING 101 EPIP/PA Webinar July 30th, 2014 EPIP Host: Michael Barham Speakers: Robert Esposito and Shawn Pelsinger

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Today’s Speakers

• Robert Esposito, Jacobson Fellow in Law & Social Enterprise, NYU

• Shawn Pelsinger, Jacobson Fellow in Law & Social Enterprise, NYU

CROWDFUNDING+101

Shawn+Pelsinger,+Esq.+&+Robert+T.+Esposito,+Esq.

Overview

● What+is+Crowdfunding?++

● Types+of+Crowdfunding+

● Equity+Crowdfunding+Regulation+

● Federal+Regulations+(JOBS+Act)+

● StatePlevel+Regulations+

● Conclusion+&+The+Future+of+Crowdfunding

What+is+Crowdfunding?

● “The practice of funding a project or venture by raising many small amounts of money from a large number of people, typically via the Internet.”

!● “The use of small amounts of capital from a large number of individuals to

finance a new business venture. Crowdfunding makes use of the easy accessibility of vast networks of friends, family and colleagues through social media websites like Facebook, Twitter and LinkedIn to get the word out about a new business and attract investors. Crowdfunding has the potential to increase entrepreneurship by expanding the pool of investors from whom funds can be raised beyond the traditional circle of owners, relatives and venture capitalists.”

!● Raised via crowdfunding:

○ 2010: $89 million; ○ 2011: $1.47 billion; ○ 2012: $2.66 billion; ○ 2013 (projected): $5.1 billion.

Types+of+Crowdfunding

● Debt ○ Investors make loans to a person/company, are repaid over time at

negotiated interest rate ○ E.g. Kiva

● Equity ○ Investors receive equity security interest (shares/units) in a company. ○ E.g. SeedInvest

● Donation ○ Contributor (not investor) makes financial donation with no expectation

of repayment or consideration. ○ E.g. Razoo

● Rewards ○ Investors receive item or service as consideration for their investment/

purchase. ○ E.g. Kickstarter

Types+of+Crowdfunding:+Breakdown

!Average campaign targets:

⬜ Debt: $5,587 (22% of all crowdfunding)

⬜ Reward: $4,076 (11% of all crowdfunding)

⬜ Donation: $664 (49% of all crowdfunding)

⬜ Equity: $84,597 (18% of all crowdfunding)

Types+of+Crowdfunding:+Debt

!!● Debt crowdfunding has traditionally

been peer-to-peer. In 2005, Kiva launched with $25 minimum loanamount. Have issued $322 million inloans since 2005.

!● Kiva has been wildly successful:

○ ~870,000 users; ○ ~470,000 loans issued; ○ 98.98% repayment rate; !

● Lenders receive only their principal returned, no profit.

Types+of+Crowdfunding:+Debt

● Regulation of debt crowdfunding erupted in 2008 when the SEC issued a cease and desist letter to Prosper, a peer-to-peer lender. !

● SEC also targeted Loanio and Lending Club claiming that the notes sold “are securitiespursuant to Section2(a)(1) of the Securities Actand under the Supreme Court’s decisions in both SEC v. W. J. Howey Co., 328 U.S. 293 (1946), and Reves v. Ernst & Young, Inc., 494 U.S. 56 (1990).” !

● Exceptions: (i) note delivered in consumer financing, (ii) the note secured by a mortgage on a home, (iii) the short term note secured by a lien on a small business or some of its assets, (iv) the note evidencing a ‘character’ loan to a bank customer, (v) short-term notes securedby an assignment of accounts receivable, (vi) a note which simply formalizes an open-account debt incurred in the ordinary course of business, (vii) notes evidencing loans by commercial banks for current operations.

Types+of+Crowdfunding:+Donation

● Donation-based crowdfunding involves distributed donations made to a charitable contribution in exchange for no tangible or security interest. These are effectively donations to charitable causes.

!● Donation-based crowdfunding is the most widely visible and least novel of the

crowdfunding categories ○ Wikipedia; ○ The Red Cross; ○ Political campaigns.

!● Donation-based crowdfunding is estimated to account for 49% of all crowdfunding

dollars.

Types+of+Crowdfunding:+Donation

● Little known example: ○ Local Chicago organizer raises $137 million dollars

to fund unlikely political campaign

Types+of+Crowdfunding:+Donation

Legal Considerations !● Charitable Solicitation Regulation !

○ Currently in 44 jurisdictions !

○ Require registration and financial disclosure !

○ Triggered by requesting donations in a given state !

○ Does Donation Crowdfunding trigger charitable solicitation regulation?

!■ Charleston Principles

!○ Follow-up Communications

Types+of+Crowdfunding:+Donation

Legal Considerations Cont’d !

● Commercial Fundraisers !

○ Persons or organizations paid by a nonprofit to raise money on the nonprofit’s behalf

!○ Are crowdfunding platforms commercial fundraisers?

!■ Solicitation & Receipt/Control of charitable funds

!○ Caution: Engaging with nonregistered commercial fundraisers

Types+of+Crowdfunding:+Donation

Legal Considerations Cont’d !● Fraud & Misrepresentation !

○ Unauthorized or fraudulent crowdfunding using a nonprofit’s name

!○ Gift acceptance policies for crowdfunding donations

!○ Indiegogo’s Verified Nonprofit Campaign Badge

Types+of+Crowdfunding:+Donation

Credit: Indiegogo

Types+of+Crowdfunding:+Reward

!● Reward-based crowdfunding involves payment by an individual in exchange

for a product or service, often at the development phase, with the delivery likely to be deferred for a number of months.

Types+of+Crowdfunding:+Reward

Types+of+Crowdfunding:+Reward

Types+of+Crowdfunding:+Reward

Types+of+Crowdfunding:+Reward

!$300 investment in an Oculus Rift would’ve been worth $43,5000

Types+of+Crowdfunding:+Equity

● Equity crowdfunding typically refers to the widely distributed sale of equity securities via an online portal. Equity crowdfunding is what many people are talking about when they refer to the growth of crowdfunding.

2013 survey found the average equity crowdfunded raise was $178,790

Types+of+Crowdfunding:+Equity

SeedInvest advertises over $204 million in collective investor interest.

Equity+Crowdfunding:+Federal+Regulation

● Traditionally, the sale of securities within the United States has been regulated by the Securities Act of 1933 and the Securities Exchange Act of 1934.

!● Securities Act of 1933 restricts the sale of securities unless (a) the offering

is registered with the SEC, or (b) there is an available exemption from registration.

!● The most common exemption - known as Regulation D - provides that

only accredited investors can purchase privately sold securities.

Equity+Crowdfunding:+Federal+Regulation

!● Presently it is primarily accredited

investors that are able to participate in private offerings of securities under federal regulation.

!!!!● Private sale of equity securities

has the potential to be expanded beyond accredited investors under the Jumpstart Our American Business Act (JOBS Act).

Equity+Crowdfunding:+Federal+Regulation

The JOBS Act (Jumpstart Our Business Startups Act) was signed into law on April 5,2012

Equity Crowdfunding regulations have yet to be finalized...

Equity+Crowdfunding:+Federal+Regulation

● The JOBS Act authorized the SEC to issue rules governing equity-crowdfunding to unaccredited investors.

!● On October 23, 2013, the SEC proposed new rules to permit the offer and

sale of securities through internet crowdfunding without Securities Act registration (Regulation Crowdfunding): ○ Issuer Total Offering:$1 Million During Any 12-Month Period; ○ Individual Investor Limit:

■ greater of $2,000 or 5% of the investor’s annual income or net worth,if the annual income or net worth of the investor is less than $100,000; or

■ the greater of 10% of the investor’s annual income or net worth (not to exceed an amount sold of $100,000), if the investor’s annual income or net worth is $100,000 or more.

○ Must distribute via crowdfunding portal or broker-dealer; ○ Disclosure requirements (officers, directors, and greater than 20%

shareholders;business and business plan;use of proceeds;target offering amount, price of securities, and method of determining price; ownership and capital structure)

○ 1-year restriction on resale unless sold in registered offering, to an accredited investor, or to the company.

Equity+Crowdfunding:+State+Regulation

The Washington Jobs Act of 2014 The legislature finds that start-up companies play a critical role in

creating new jobs and revenues. Crowdfunding, or raising money through small contributions from a large number of investors, allows smaller enterprises to access the capital they need to get new businesses off the ground. The legislature further finds that the costs of state securities registration often outweigh the benefits to Washington start-ups seeking to make small securities offerings and that the use of crowdfunding for business financing in Washington is significantly restricted by state securities laws. Helping new businesses access equity crowdfunding within certain boundaries will democratize venture capital and facilitate investment by Washington residents in Washington start-ups while protecting consumers and investors.

Equity+Crowdfunding:+StatePLevel+Developments

!● States have adopted exemptions for intrastate equity crowdfunding that comply

with the federal exemption for intrastate offerings under Section 3(a)(11) of the

Securities Act of 1933, 15 U.S.C. 77c(a)(11).

● Some states have passed legislation to amend existing securities laws

○ E.g., Wisconsin, Michigan, Washington

● Some state securities regulators have adopted new rules to provide for equity

crowdfunding exemptions

○ E.g., Georgia, Kansas

● Currently, 14 states permit equity crowdfunding, and many more are considering

similar legislation

Equity+Crowdfunding:+StatePLevel+Developments

Credit: Anthony Zeoli, State of the States, http://crowdfundinglegalhub.com/2014/06/25/state-of-the-states-list-of-current-active-and-proposed-intrastate-exemptions/

Equity+Crowdfunding:+Variations+in+Intrastate+Exemptions

!○ In Wisconsin !

■ Decreased the threshold for “certified investor” to individual net worth of at least $750,000 or individual income exceeding $100,000 (or $150,000 joint income)

!■ Issuer Total Offering Cap:

● $1MM (without financial audit) ● $2MM (with financial audit)

!■ Non-accredited investor limit: $10,000

Equity+Crowdfunding:+Variations+in+Intrastate+Exemptions

○ In Michigan !

■ Uses Reg. D “accredited investor” standard !

■ Issuer Total Offering Cap: ● $1MM (without financial audit) ● $2MM (with financial audit)

!■ Non-accredited investor limit: $10,000

Equity+Crowdfunding:+Variations+in+Intrastate+Exemptions

○ In Washington !

■ Issuer Total Offering Cap: $1MM !

■ Individual Investor Limits: ● For investors with <$100,000 annual income/net worth

- the greater of $2,000 or 5% of annual income/net worth

● For investors with >$100,000 annual income/net worth - 10% annual income/net worth, up to $100,000

Conclusion+&+The+Future+of+Crowdfunding

● Crowdfunding+&+Social+Enterprise+○Both+are+currently+being+experimented+with+on+the+state+level+○Social+enterprises+are+often+small+organizations+with+local+community+focus+that+are++wellPsuited+to+intrastate+securities+offerings+!

● Crowdfunding+&+SIBs+○Also+being+experimented+with+by+state+and+local+governments+

■Essex+“Allia+Future+for+Children+Bond”+(first+opportunity+for+retail+investors)+

○SIBs+involve+state+and+local+governments,+and+thus+are+inherently+regionally+focused+

○Potential+for+increased+diligence+and+transparency+at+state+and+local+levels