Navigating Compliance in Equity Crowdfunding

Navigating Compliance in Equity Crowdfunding

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Recently, you likely saw that the SEC is charging Kim Kardashian with breaking the SEC rules around investment promotions. At first glance, this seems to have very little to do with the compliance around equity crowdfunding and raising capital via Reg CF or Reg A, but it is a surprisingly good example of ‘who’ is qualified to provide investment recommendations or testimonials and ‘what’ those individuals and/or issuers may be required to disclose.

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Licensed Broker-Dealers may recommend investments in securities in the form of a Research Report but solely upon completing due diligence on the company with the added responsibility to review such recommendation's suitability as required under Regulation Best Interest. 

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Licensed broker-dealers fulfill several important functions in the financial industry. These include providing investment advice to customers, supplying liquidity through market-making activities, facilitating trading activities, publishing investment research, and raising capital for companies. As the name implies, they perform a dual role in carrying out their responsibilities. As dealers, they act on behalf of the brokerage firm, initiating transactions for the firm’s own account. As brokers, they handle transactions, buying and selling securities on behalf of their clients.

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First: You Need a Broker Dealer

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Because of the regulatory environment and rules pertaining to offering securities to the general public and what must be disclosed when considering such an offering, it is crucial in the early discussions of your Equity Crowdfunding raise - that you speak with a Broker-Dealer to understand the steps required to successfully launch your crowdfunding raise.

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Kim Kardashian is not licensed or qualified to make any recommendations but in this particular instance, she was engaged to promote the issuer and was paid for such promotion. Unfortunately, she was not advised that under federal securities laws, she was required to disclose the details of her engagement to the investing public. 

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"The federal securities laws are clear that any celebrity or other individual who promotes a crypto asset security must disclose the nature, source, and amount of compensation they received in exchange for the promotion," said Gurbir S. Grewal, Director of the SEC’s Division of Enforcement. "Investors are entitled to know whether the publicity of a security is unbiased, and Ms. Kardashian failed to disclose this information."

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Including a Broker-Dealer (B/D) is good practice - the B/D will provide you with the steps to consider for a successful crowdfunding raise - from compliance to distribution. While not a requirement under Reg A that you engage use a Broker-Dealer, as a practical matter, most issuers do engage a B/D.  Engagement of the B/D generally occurs at the outset of the raise; you will not likely go back and engage the services of a BD Syndicate after the offering has commenced. Under the regulations, the broker-dealers involved in an offering are required to file with FINRA and this information must be disclosed in the offering circular filed with the SEC. In some cases, we’ve seen excluding a BD may result in the raise goals not being achieved. For example, an automobile company offering was a tour-de-force of consumer marketing, but the company ended their raise at $17M, even though they intended to raise $25M. Had they included a Broker syndicate, it’s assumed they would have easily raised the full amount – because there seemed to be broker-dealer interest in the offering.

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Second: Regulations are there for your protection as well

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The process of raising capital is not without some friction, but the filings and approvals are the checks and balances required to protect both your company and your potential investors. It’s critical that in the interest of moving fast and infusing capital into your business, you don’t unwittingly expose your company to additional risk. You could consider discussing additional D&O insurance or coverage if you are raising a substantial amount, and expect to add potentially hundreds or thousands of unaccredited investors to your cap table.

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Third: Plan Ahead. Raising Capital can take 2-6 months’ worth of pre-work

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If you need a cash influx in a month, doing an equity crowdfunding raise will be a risky endeavor as the filing, audits, and approvals just simply take time. You need some runway. A good rule of thumb is to plan your raise 4+ months in advance, so if you are still selecting which capital raise platform or tech you’ll leverage, just keep that in mind.

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It's also key to give serious consideration to how much you are planning to raise. Setting this goal is more science than art, so read this piece by Jonathan Stidd, President of DealMaker Reach.

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Finally, there will always be cheap options in the market for you to consider. It’s worth noting that when the price is scaled down, so are the service levels, capabilities, and functionality. Sometimes, going with the cheapest option seems like a good idea at the time - until you begin to feel under-serviced or left on your own to figure things out. And with a crowdfunding raise, if you’ve never done one before, we don’t recommend learning as you go! It will be an expensive lesson.

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