Can Companies Use Both 506(c) and Title III Crowdfunding Simultaneously to Raise Capital?
Yes! Companies Can Use Both 506(c) and Title III Crowdfunding to Raise Capital! Simultaneously even.
Crowdfunding has been used in many contexts to raise money via the internet, one of which is the sale of securities. Prior to May 16, 2016 crowdfunding of securities was limited to an accredited investor base through Title II funding portals, such as 506(c) portals.[1] Since May, crowdfunding has been permitted to the general public with certain limitations on investment limits under Title III of the Jumpstart Our Business Startups (JOBS) Act.[2] The new Title III-Section 4(a)(6) crowdfunding portals allow access to the general public of investors to invest in companies without becoming an accredited investor.[3] The general public of investors is equal to about 93% of the total population of the United States.[4] Title III funding portals differ in regulations and reporting from 506(c) portals.[5] Click here for a excellent chart which breaks down some of the basic differences between the two types of portals.[6]
With the advent of the new crowdfunding rules, Title III-Section 4(a)(6) funding portals are not without their limitations. An issuers largest hurdle is the $1 million cap pursuant to Rule 100(a), which states that an issuer may only sell up to $1 million in a given 12-month period of time.[7] This is an aggregate amount, and includes any affiliates.[8] This relatively small amount of capital raising for startups can be limiting. However, an issuer may have a work around, which depends on also using a 506(c) funding portal or offering to raise additional capital.[9]
The use of a 506(c) portal is not entirely new, using both a 506(c) and a Title III funding portal may provide the quick capital generation that a strong startup company may need to remain competitive in the market place.[10] A 506(c) offering has two major benefits, they can generally solicit to accredited investors, and there is no funding cap[11]. The major benefit from a Title III offering is the access to the general public of investors. It is important to note that an issuer may be able to use both types of funding portals and offers to generate capital, but a funding portal itself may not act as both a 506(c) and a Title III-Section 4(a)(6) funding portal for the same issuer, as this brings up compliance issues.[12]
However, using both types of funding portals can pose a financial and logistical headache. Knowing what types of 506(c) portals exist, how they get paid, and the reporting and compliance issues surrounding the different types of portals is essential to saving time and money. The ultimate goal is being able to retain a larger portion of the money generated by the sale for the issuer. FundAmerica provides an excellent breakdown on the three major types of 506(c) accredited investor funding portals.[13]
The first type of 506(c) portals are Broker/Dealer portals where the portal can charge a commission based upon the amount and/or the success of the offering.[14] Typically, these types of portals charge an 8% to 11% commission rate to cover the cost of FINRA compliance.[15] An advantage to a Broker/Dealer offering is that they are relatively quick to set up.[16] For example, the marketing materials and compliance issues related to a Reg A filing would take a minimum of 4 months to put together.[17] Without the marketing and a streamlined compliance framework, 506(c) and Title III-Section 4(a)(6) offerings can be a blessing to an issuer. Additionally, there is relatively little ongoing reporting that needs to be handled.[18]
The second are Investment Advisor portals which typically operate on a 2/20 model.[19] Here, there is a 2% annual management fee on the assets resulting from funds raised in the offering.[20] Additionally, the portals receive a carried interest upside profit-share in the profits of the business investment as their interest in the success of the venture.[21] These portals have some similar benefits to the Broker/Dealer model. They still are 506(c) offerings so there is streamlined marketing and compliance frameworks that need to be followed, they are quick to set up, and still have relatively little reporting.[22] Here, though, FINRA compliance is not required, but rather must comply under the SEC due to the Investment Advisers Act.[23]
Finally, Ad/listing portals, which might charge a flat listing fee because it cannot be contingent upon the success of the deal.[24] While these portals are not subject to any regulatory oversight, the securities must still comply with the requirements of the Securities Act of 1933.[25] Again, these portals also have some of the benefits streamlined marketing (limited ad types in this type of portal), quick to set up, and have little reporting.[26]
A key point about 506(c) offerings is that the offerings do not have to be conducted by an intermediary such as a Broker/Dealer. Issuers can handle the offering themselves, if they cannot sell the offering then an issuer may go to a Broker/Dealer or other method.[27] However, a compliance issue arises when the issuer must confirm the accreditation of the investors in a 506(c) offering, and use of a portal may be easier. At the time of publication not enough information could be found to determine how much money is being raised by issuers alone or using intermediaries, but Scott Purcell suggests that issuers raise at least $1 trillion per year without intermediaries.[28]
Where 506(c) offerings do not require an intermediary, Title III offerings must have one.[29] Title III offerings have pre-investor limits based on income and net worth of the investor, you can only sell through a licensed portal, there are heavy pre-sale information requirements that must be met, and there is some ongoing reporting and possibly auditing requirements that may need to be met.[30] The downside is the $1 million cap on investments within a 12-month period.[31]
Here again, the major benefit of Title III offerings is that the general public can invest up to certain individual investor limits.[32] See FINRA’s website for an overview of the individual annual investor limits. Title III offerings relatively low costs of getting the offering running and the timeframe to begin offering is quick. This provides a direct consumer access for investors which issuers can quickly raise up to the cap limit of $1 million.
Thus, the major take away from the above discussion on the various types of 506(c) platforms used in conjunction with a Title III-Section 4(a)(6) offering is that the regulatory framework appears to allow for added capital generation beyond just the new Title III offerings. Issuers should look at their options and needs to determine how much capital they need and which path would be the better approach. The $1 million cap on Title III sales during a 12-month period may prove to be just too big a burden, and an issuer may be better just going with strictly a 506(c) offering. However, as shown above, it could be possible to take multiple avenues to generate the capital that an issuer needs with both accredited and non-accredited investors.
[1] Crowdfunding and the JOBS Act: What Investors Should Know, http://www.finra.org/investors/alerts/crowdfunding-and-jobs-act-what-investors-should-know
[2] Crowdfunding Part 1 – An Overview, https://www.dorsey.com/newsresources/publications/client-alerts/2015/11/crowdfunding-part-1-overview
[3] Title III Crowdfunding: Primer for Issuers and Funding Portals, http://www.stonybrook.edu/commcms/sbdc/Equity%20Crowdfunding%20under%20Title%20III%20.%20June%202.%202016.pdf
[4] Id.
[5] Crowdfunding Cheat Sheet, http://www.flastergreenberg.com/assets/htmldocuments/Crowdfundin%20Cheat%20Sheet%20June%202016.pdf
[6] Id.
[7] Following the Wisdom of the Crowd? A Look at the SEC’s Final Crowdfunding Rules, http://www.mofo.com/~/media/Files/ClientAlert/2015/11/151102SECCrowdfunding.pdf
[8] See Crowdfunding Cheat Sheet, Supra.
[9] Can I have both 506c and Title III offerings on my website?, Scott Percell, January 20, 2016, http://crowdfundbeat.com/mobile/2016/01/20/can-i-have-both-506c-and-title-iii-offerings-on-my-website/
[10] 506(c) Offerings and Crowdfunding: What’s the Difference?, Andrea Uptmor, http://articles.bplans.com/title-506c-offerings-and-crowdfunding-whats-difference/
[11] See Crowdfunding Cheat Sheet, Supra.
[12] What you need to know about the new SEC rules on crowdfunding, Burns and Levinson, LLP,
http://www.lexology.com/library/detail.aspx?g=7e816f61-82a5-4e6c-abc2-80a4695a1e56
[13] Portals Ask: do we need to be a broker dealer?, http://www.fundamerica.com/blog/portals-ask-need-broker-dealer/
[14] Id.
[15] Id.
[16] Early Problems in Reg A, Scott Purcell, http://www.fundamerica.com/blog/early-problems-reg/
[17] Id.
[18] See Crowdfunding Cheat Sheet, Supra.
[19] See Portals Ask, Supra.
[20] Id.
[21] Id.
[22] See citations above related to Broker/Dealers.
[23] See Portals Ask, Supra.
[24] Id.
[25] Id.
[26] Id.
[27] See Portals Ask, Supra.
[28] Id.
[29] See What you need to know about the new SEC rules on crowdfunding, Supra.
[30] See Crowdfunding Cheat Sheet, Supra.
[31] See Crowdfunding Part 1 – An Overview, Supra.
[32] See Crowdfunding and the JOBS Act: What Investors Should Know, Supra.
Yes! Companies Can Use Both 506(c) and Title III Crowdfunding Simultaneously to Raise Capital!
