The Rise of Unregistered Securities

The SEC issued a white paper titled “Capital Raising in the USA: An Analysis of the Market for
Unregistered Securities Offerings, 2009‐2017.” This white paper presents some pretty interesting numbers. Capital formation through unregistered securities exceeds that from registered securities; 2017 saw unregistered securities raise over $3 trillion versus registered offerings’ $1.5 trillion. Also, according to the report, the JOBS Act has had a booster effect on the ecosystem. This is evident by the hundreds of crowdfunding websites launched since its passing. Regulations CF, A+, and D have unshackled entrepreneurs and democratized fundraising. But a critical part of investing in unregistered securities is the due diligence behind whether the companies seeking the funding are genuine or not. CrowdCheck, incorporated in 2012, aims to verify the credibility of companies seeking such investments.

In a chat with CEO and Founder Sara Hanks, we uncovered how CrowdCheck has become the go-to player for due-diligence, compliance, and disclosure.

The Problem With Unregistered Securities

Hanks understood the need for building the trust layer between online investor and issuer since investors will buy shares in unknown companies online. Moreover, there is a list of legal requirements that a capital raising company and an investor need to meet to ensure everything is above board and handled according to these regulations.

CrowdCheck specializes in online capital raising. It serves the entrepreneur, the crowdfunding platform, and the investor in ensuring that the transaction is handled according to current laws and all necessary approvals are in place. From handling drafting and disclosures for Reg D, A+, and CF to filing the relevant notices, CrowdCheck is a one-stop shop. The company has executed 40 Reg A+, 50 Reg D, and about 450 Reg CF offerings.

The Relevant Regulations

Regulation A+

This regulation allows companies to generate income under two tiers representing two different types of investments.

• Tier 1 – A company is permitted to offer a maximum of $20 million in any one year. The issuing company must also provide an offering circular, which must be filed with the SEC and subject to a vetting process by the commission and securities regulators relevant to the offering. Companies issuing under Tier 1 are not required to produce reports frequently. Instead, they are only required to issue a report on the final status of the offering.
• Tier 2 – A company can offer up to $50 million in any one-year period. Though an offering circular is required and is subject to review and vetting by the SEC, it doesn’t have to be qualified by any state securities regulators. Companies issuing under Tier 2 must produce continual reports on the offering as well as its final status.

The offering can be marketed to both accredited and non-accredited investors.

Regulation CF Crowdfunding

The company must be incorporated in the US.

• Allows only $1 million in fundraising.
• An investor is limited in the amount to be invested in crowdfunding securities in any one-year period. If either the annual income or net worth of the investor is less than $100,000, the investor is limited to the greater of $2,000 or 5% of the lesser of the annual income or net worth. If greater, limited to 10% of the lesser of annual income or net worth, to a maximum of $100,000.

Regulation D

Rules under 506(b)

• The company cannot use advertising to market securities.
• No maximum fundraising limit.
• Securities can be sold to an unlimited number of accredited investors and up to 35 non-accredited investors.

Rules under 506(c)

A company can generally advertise the offering and still be deemed to be in compliance with the exemption requirements if:

• All the investors are accredited investors.
• The company should review various documents like tax returns, W-2s, bank and brokerage statements, credit reports, etc. to verify that investors are accredited investors.
• Companies that comply with the above requirements do not have to register their securities offering with the SEC.

Insights from CrowdCheck

Suitability

• Reg CF is most suitable for complete startups. It is a cost effective way of raising capital due to the low threshold and regulatory requirements for fund raising. CrowdCheck offers complete services for this segment for just $5000.
• The investee company needs to decide if it is happy with hundreds of shareholders or would just like to focus on a few accredited investors. Reg A+ is thus suited for companies looking to IPO in a few years.
• Reg A+ is slightly more expensive than Reg D due to the requirement of SEC compliance. CrowdCheck offers a complete Reg A+ package for $60,000 whereas Reg D fees range from $25,000 to $40,000.

Platforms

There are multiple platforms available in the market, but the entrepreneur needs to choose carefully. Some specialize in a particular industry or particular regulation funding. Hanks believes StartEngine, Wefunder, Seed Invest, Next Seed, Micro Ventures, and Net Capital are the market leaders in the space.

Crowdfunding success is difficult to measure as startups usually have a low minimum threshold. Sites like Kickstarter are different from Wefunder as they do not provide any financial interest in the company being funded.

Numbers (as of Mid- 2018)

• Reg CF has seen 960 offerings with 390 completed. Many of them are still under process.
• The average amount raised via Reg CF is $236,000.
• Reg A+ has seen 325 filings and 232 have qualified to raise funding.
• Reg A+ has helped companies raise $1.1 billion, and 108 fundraisings are completed with the average fundraising around $10 million.

Conclusion

Hanks has 30 years in the corporate and securities field. Prior to CrowdCheck, she was general counsel of the bipartisan congressional oversight panel for TARP. The company has a core team of 19 people out of which six are full-time employees in core management, and others are paid consultants having backgrounds in securities law and finance.

As investors become more comfortable with online crowdfunding, the quality of companies looking to raise capital has improved. Many startups are skipping VC money to test crowdfunding. CrowdCheck acts as an important “check” to ensure the sanctity of the process. The entire ecosystem, from entrepreneurs to investors to platforms, depend on their validation for making online capital raising work.

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Written by Heena Dhir.