Equity Crowdfunding Risks and Liabilities – Yes, They Do Exist

Sorry startups, you actually have to be careful with equity crowdfunding disclosures. There is substantial risk of liability for securities fraud.

Based on discussions with the equity crowdfunding-curious, people seem to believe that equity crowdfunding is the wild west where anything goes.  Raise lots of money and do it cheaply! Do what you want, say what you want and the SEC does not care!  Look at the Form C’s, there were probably no lawyers anywhere near them.  Think of the savings!!!!

None of that is true.

Done correctly, an equity crowdfunding offering should be done with as much care as any private placement.  The actual information requirements are more extensive than a typical Rule 506 offering.  Most importantly, crowdfunding issuers are subject to the same liability as any other securities selling issuer.

Securities Act Section 4A(c) provides that an issuer will be liable to a purchaser of its securities in a transaction exempted by Section 4(a)(6) if the issuer, in the offer or sale of the securities, makes an untrue statement of a material fact or omits to state a material fact required to be stated or necessary in order to make the statements, in light of the circumstances under which they were made, not misleading . . .

Sound familiar?  What is the difference between this liability and private placements?  Equity crowdfunding is done publicly to more people who are potential claimants.

What does this mean for issuers?  It means the Form C and the offering page on the platform site need to be done carefully and in compliance with SEC rules.  Those rules sound a lot like watered down Regulation S-K rules for MD&A, description of securities, related party transactions, etc…  If you have never complied with them, good luck doing this without experienced help.

Well, at least the platforms are safe, right?  They are just dumb pipes for crowdfunding deals and have no responsibility for what the issuers do on their site, right?

Well, no.  While the SEC did not impose issuer liability on the platforms, it specifically declined to exempt the platforms from liability under Section 4A(c).  Why?  So investors could bring suits against the platforms to make sure that the platforms take steps to keep from becoming conduits of fraud.

The SEC believes that the platforms should take steps to protect themselves.  Congress provided them a defense if they could not have known of an untruth or omission in the exercise of reasonable care.  In other words, the “head in the sand” defense will not work.  In addition, I have seen them provide and even require standard language and provisions in their issuers Form Cs and offering pages.  I doubt the SEC will ignore this if this becomes misleading.

As the SEC stated:

These steps may include establishing policies and procedure that are reasonably designed to achieve compliance with the requirements of Regulation Crowdfunding, and conducting a review of the issuer’s offering documents, before posting them to the platform, to evaluate whether they contain materially false or misleading information.

We are coming up on the one year anniversary of equity crowdfunding.  It is still very early in the equity crowdfunding world to see where the liability issues will shake out.  However, it is clear that the SEC and the state securities regulators take these liability issues seriously, and the issuers and platforms should too.

Equity Crowdfunding. Missing Category: Liability
Equity Crowdfunding. Missing Category: Liability

Equity Crowdfunding Publicity, Or What Not To Do

Rules on marketing and advertising your equity crowdfunding campaign are more restrictive than you think.  Startups accostomed to blogging your every thoughts and feelings beware.

When the SEC adopted the crowdfunding rules under Regulation CF, it included severe restraints on a company’s ability to publicize its crowdfunding campaign.  Many people think the SEC allows general solicitation and it applies to everything.  Wrong.  It does not apply to crowdfunding.

You know those cool tombstone ads in the Wall Street Journal showing off an IPO?  That shows the type of information that your crowdfunding notices can include.

A crowdfunding advertising is limited to:

  • a statement that the issuer is conducting a crowdfunding offering in reliance on section 4(a)(6) of the Securities Act of 1933
  • the name of the platform
  • a link directing the investor to the intermediary’s platform;
  • the terms of the offering; and
  • factual information about the legal identity and business location of the issuer, limited to:
    • the name of the issuer of the security
    • the address of the issuer
    • phone number of the issuer
    • website of the issuer
    • the e-mail address of a representative of the issuer and
    • a brief description of the business of the issuer.

The description of the terms of the offering must be limited to:

  • the amount of securities offered;
  • the nature of the securities;
  • the price of the securities; and
  • the closing date of the offering period.

That’s it.  Some short bullet-pointy info dots.

There’s no “this is the Internet and I can say whatever I want.”  There’s no “This is the new world and old rules don’t apply.”

Is it limiting?  Yes.

Is there a reason?  Yes.

As with public offerings, there is a required disclosure document, in this case Form C.  The SEC wants to make sure you have access to it before you make an investment decision.  The SEC does not want a hyped-up ad to entice you to purchase before you have the ability to review 50 to 100 pages of required disclosure.

Any good news?  Well, the company does not have to file the notices with the SEC.  The company is not limited to newspapers.  The notices can go anywhere, such as social media or the company’s website.

Also, the company can communicate with investors through the crowdfunding platform.  The SEC believes that this ability will facilitate the wisdom of the “crowd” in crowdfunding.  The company must identify itself as the company and not as “Random Guy Who Believes Company Will Be the Next UBER x Google.”

Old timey Ford tombstone. Crowdfunding companies need to get used to this.
Old timey Ford tombstone. Crowdfunding companies need to get used to this.

JPMorgan Beating Startups to the AI Revolution. Artificial Intelligence to Eat White Collar Jobs – Is Going Solo in the Freelance Economy the Answer?

It is not just startups shaking up the AI world.  JPMorgan discusses its artificial intelligence program. Going Solo in the Freelance Economy starts looking better.

When I left Big Firm, it was for personal reasons.  I did not leave shaking my fist at a horrible culture and history of injustice.  I did not experience that.  I started thinking about a professional life staring at a different set of walls.  I began to question my place in the Big Firm ecosystem and whether I could succeed without the safety net.  Lucky me, I could.

For many attorneys, the choice will not be theirs to make.  Technology is coming for their jobs.

Junior attorneys in bigger firms spend most of their time in some sort of document review and document processing roles.  This is necessary grunt work, and it is how junior attorneys learn, when they pay attention.

Billable rates have continued to increase, and clients push back when they can.  However, discovery in litigation and due diligence in transactional work must get done.  What happens when software can take the place of expensive junior associates?

It is about to happen.

There have been a number of articles lately about first generation artificial intelligence tools for this type of work and their early adopter law firms.

Last week, Bloomberg reported on JPMorgan’s COIN, or Contract Intelligence, program.  It reviews commercial loan agreements, something that consumed 360,000 hours of work by lawyers and loan officers each year.  That task now takes seconds, has fewer errors, does not ask for vacations or have the other baggage associated with human employees.

In addition, JPMorgan’s machine learning and big data system helps automate software coding.

In legal circles, litigation document review was seen as the low-hanging fruit for AI software.  However, any white collar position that provides a service that is based on rote activities can and will be replaced by software.  It may not be tomorrow, but it is sooner than you think.  JPMorgan is already planning to license its service to its bigger clients who are staffed to the rafters with white collar “thought employees” who are about to be replaced by code.

Many people believe their job cannot be at risk to computers because computers do not have the judgement capabilities of humans.  But:

As for COIN, the program has helped JPMorgan cut down on loan-servicing mistakes, most of which stemmed from human error in interpreting 12,000 new wholesale contracts per year, according to its designers.

The software is doing other tasks that lots of humans now perform:

For simpler tasks, the bank has created bots to perform functions like granting access to software systems and responding to IT requests, such as resetting an employee’s password, Zames said. Bots are expected to handle 1.7 million access requests this year, doing the work of 140 people.

I am not writing this as a doom-and-gloom article about lost employment.  I think this is ultimately a good thing.  No one knows about the opportunities that will arise from this shift.

It does mean that people should recognize the shift and their place in it.  Stability, comfort and complacency in large organizations has been an antiquated notion for a while.  Maybe Going Solo and finding your place in the Freelance Economy is a path forward.

Artificial intelligence drives the Freelance Economy, eats white collar jobs.
Artificial intelligence drives the Freelance Economy, eats white collar jobs.  Some large enterprise companies are beating startups to the AI revolution.

Better Than Bitcoin? Fund Manager Discusses Disruptive Tech In Finance

Former co-head of largest bond fund discusses what can really disrupt entrenched businesses.

Logo - Bitcoin
Not the most disruptive finance technology.

Kicking Bitcoin while its down, Mohamed El-Erian penned an article for CNBC about how technology is taking on finance. In his words “via a democratization process that could gradually reconfigure a notable part of the institutional landscape, particularly in consumer finance, while challenging regulators to adapt.”

While most people would think “Bitcoin,” El-Erian doesn’t even consider it a good example. He claims its impact, “both actual and potential, is relatively limited when compared to ongoing attempts to enhance and democratize lending, borrowing, investing, and payments and settlements.”

El-Erian notes his take on the sequence for disruptive tech:

  • A bold innovation suddenly lowers entry barriers for certain activities;
  • Mechanisms emerge to enable a larger part of the population to participate in what is deemed desirable but, until now, had been hard to access;
  • As the disruptive forces gain traction, existing business models face difficult adaptation challenges, and regulators begin to fall behind; and
  • The situation is often amplified by a natural human tendency to overproduce and over-consume hitherto restricted goods and services.

He sees this happening in finance, though the pace is less frantic and less disruptive. According to El-Erian, examples include:

  • Internet-driven lending and borrwoing clubs
  • peer-to-peer initiatives in consumer financial services
  • Digital wallets
  • Mobile transfers

He suggests that they reduce costs and provide “fairer risk-pooling outcomes and better credit underwriting.” He doesn’t mention that none of these ideas are particularly new. He does mention that the prospects for each vary considerably.

While this was not the most insightful article on the subject, it is hard to dismiss El-Erian’s statements, given his former position as CEO and CIO of PIMCO, home of the largest bond fund.

Why Startups Fail – Mint vs. Wesabe

In an old blog entry (that I just found), one of the founders of Wesabe thinks back to why his company lost to Mint.com and shut down. For those who don’t remember, Mint was high-flying personal finance site that was sold to Intuit in 2009 for about $170 million.

Wesabe and Mint
Wesabe and Mint went head-to-head. Mint won. Here's why.

Marc Hedlund writes an honest article about his take on why Wesabe eventually shut down.  First, he knocks out four myths, including that Mint launched first, had a better name and design and went viral.

Then, Hedlund discusses what he saw were the drivers behind the success of one and the failure of another.  At the end of the day, it comes down to familiar themes recognized by those of us who work with businesses, particularly startups.

“I think in this case, Mint totally won at the first (making users happy quickly), and we both totally failed at the second (actually helping people).”

Mint gave people what they wanted and made it easy.  Wesabe wanted to help people change their financial behavior, which is a value judgment with which the consumer himself/herself may disagree.

Hedlund notes that some of the things founders obsess over are really not important:

“You’ll hear a lot about why company A won and company B lost in any market, and in my experience, a lot of the theories thrown about – even or especially by the participants – are utter crap. A domain name doesn’t win you a market; launching second or fifth or tenth doesn’t lose you a market. You can’t blame your competitors or your board or the lack of or excess of investment.”

He does get to the crux of the issue about how to succeed:

“Focus on what really matters: making users happy with your product as quickly as you can, and helping them as much as you can after that.  If you do those better than anyone else out there you’ll win.”

That’s it.  Give people what they want to meet their needs and solve their problems.

Hedlund still believes that there are problems to be solved.  However, imposing your judgment on people’s behavior will not have the same success as meeting people’s needs and desires.

“So, yeah. Changing people’s behavior is really hard. No one in this market succeeded at doing so – there is no Google nor Amazon of personal finance. Can you succeed where we failed? Please do – the problems are absolutely huge and the help consumers have is absolutely abysmal. Learn from the above and go help people (after making them immediately happy, first).”

 

Bitcoin Edges Closer to Mainstream As It Attracts Serious Venture Capital

Bitcoin seems to moving away from its seedy reputation as a digital currency for the underworld.

Coinbase, a San Francisco based startup founded in June 2012.  It provides a Bitcoin “wallet and platform where merchants and consumers can transact with the new digital currency bitcoin.”  If you look at their ‘About‘ page, their kitchen looks spiffy.

Coinbase announced a $25 million funding round led by Andreessen Horowitz and including Union Square Ventures and Ribbit Capital, both existing investors.  This brings their funding to $31 million, including the $6 million they announce on their website.  Representatives of Andreessen Horowitz and Union Square will join Coinbase’s board.

According to Bloomberg, other high profile VC firms have invested in Bitcoin companies, such as Tim Draper and Founders Fund.  Otherwise, we have seen novelty acts in this space, such as the Winklevoss Bitcoin ETF.

Much of the trepidation around Bitcoin stems from the regulatory issues.  Basically, many people (me included) expect the U.S. federal government to view Bitcoin with hostility, despite recent noises that they are okay with it.  To that end, Coinbase says that they will be spending a lot of money for licenses with state regulators.

 

 

How Start-ups Can Increase Their Odds of Success

I had a discussion the other day about how start-ups can increase their odds of success.  Since I do a lot of work with start-ups, in legal and consulting roles, I offered three tidbits of advice:

1.  Business Idea.  Do not pick an idea simply because you think it is cool or you will get rich.  For example, the start-up graveyard is littered with music industry apps created by people who believed it was their entry into a “cool” industry.

Find a problem that you think you may share with many people and build a solution.  This is what good businesses do.  They induce customers to pay them to make the customers’ lives easier in some way.  Yes, this includes the Facebooks and Twitters of the world who are good at aggregating and identifying users to make advertisers’ jobs easier in targeting an audience.

2.  Pick the Right Team.  It is important that founders surround themselves with people they trust to be committed to the venture and, most importantly, to produce quality results.  The start-up world is populated with many “flakes,” but the founders need to be able to trust that their associates will do what they commit to do.  I have seen this over and over.  People show up with visions of options and IPOs and foosball tables, but when it comes to actually working and producing results, enthusiasm and attendance fade.

3.  Know When to Step Aside.  Very often, the skills necessary to start a business are different from the skills needed to grow a business.  For example, founders often underestimate the importance of a skilled and talented sales person.  This is a skill set just as computer programming is a skill set, and they does not necessarily overlap.  In addition, managing an ongoing enterprise is much different than managing the birth of an enterprise.  A skilled manager can often be the difference between a hobby with some potential and a successful, growing business.

Where I Add to the Pile of Opinion Regarding Corporations vs. LLCs for Startups

I got another (non-client) question about whether I prefer corporations or LLCs for startups.

Short Answer:

It depends.

Long-Winded Answer:

I have found that an LLC will often provide more flexibility in terms of division of rights and responsibilities from the default rules in many business entity statutes.  In addition, there is more flexibility in terms of pass-through tax treatment with an LLC than with a corporation, even with a Subchapter S election.

If there are a small number of owners, or it is owned by a single person, they can usually get to the same result regardless of the entity type.  In that case, the most important thing is to have some type of limited liability entity in place, and a corporation and an LLC are similar enough that the same results can be achieved through a variety of strategies.

Many people suggest a corporation because it is easier to attract investors, but that is not necessarily the case.  Only a small portion of small businesses attract the type of institutional investors (such as venture capital firms) that would require the company be organized as a corporation.  Investors in some industries may expect specific organizational forms for their investment.  For example, real estate or natural resources investors may expect the company to use a limited partnership.

If an entrepreneur is in discussions with, or knows it may want to approach, an investor prior to organization, the investor’s concerns can be met up front.  However, in the beginning the organizational form should be driven by the entrepreneur’s and business’ needs.  Unless the entrepreneur knows who will make the investment and what their criteria is, there is no way to predict the terms up front as every situation is different, and there is likely to be some required restructuring done prior to the investment in any case.

Startup Tips and Lessons from Zynga: Knowing When To Step Aside

Sometimes the skills needed to start a company are different from the skills needed to run a company.

Cross-posted at My Gamasutra Blog.

Earlier this week, Zynga made an announcement that was not too surprising to folks following the company.  Mark Pincus was out as CEO.

Zynga was a high-flying casual game developer sailing on the winds of its relationship with Facebook.  Zynga described itself as “the world’s leading social game developer.”  It went public in December 2011 at $10.00/share, and its stock price had traded as high as $14.69/share in early 2012.

Since that time, Zynga’s fortunes have fallen.  Its stock has traded below $4.00/share since Summer 2012 as its daily and monthly active users declined and it continued to lose a lot of money.

What was surprising was the Pincus was staying on as Chief Product Officer and Chairman of the Board.

In addition, reports state that Don Mattrick, the new CEO, was chosen by Pincus as his successor.  Pincus was quoted as saying:

“that if I could find someone who could do a better job as our CEO I’d do all I could to recruit and bring that person in. I’m confident that Don is that leader.”

So, what are the lessons here for startups, particularly tech startups?

I’ve previously written about how startups need people different skillsets at different points in their maturity.*  What is remarkable in the Zynga story is that Pincus seemed to understand that Zynga had grown past his skillset as a CEO, and a different kind of leader at this point in its development.

Most founders, even those that do not name the company after a beloved pet, consider that company to be “their baby,” even after taking VC money and public investor money.  They have nurtured the company from idea-to-business, and they believe that they should maintain control of it, even in the face of mounting evidence to the contrary, like, say, gigantic losses of money and declining user numbers, prying a founder out of a controlling role can be difficult and painful.  This can be particularly painful for the founder, who may be faced with a loss of confidence and sense of shame despite the company he or she may have built.

Pincus will continue to have a powerful role at Zynga, particularly as one of the two members of the Executive Committee of the Board of Directors.  However, if the reports of how this transfer of power took place are accurate, Pincus should be commended for his maturity and foresight in recognizing the changing needs of Zynga.

Or maybe he should be admired for his strategic foresight in maintaining a powerful role before being dispatched entirely by the Board of Directors and angry shareholders.  Maybe Mafia Wars does prepare you for real life after all.

*For Gamasutra readers, see here for a discussion of how companies begin to need salespeople as they mature, a position that founders may not be suitable.