MACKENZIE HUGHES llp Equity Crowdfunding Richard C Engel

MACKENZIE HUGHES llp Equity Crowdfunding Richard C. Engel, Esq. James H. Nicoll, Esq.

MACKENZIE HUGHES llp Richard C. Engel, Esq.

MACKENZIE HUGHES llp WHEN IS A PRIVATE PLACEMENT NECESSARY • Need to raise money over and above, or in place of traditional financing. • Public Offering is too early and expensive – registration statement with SEC and certain state regulators. 1

MACKENZIE HUGHES llp WHEN IS A PRIVATE PLACEMENT NECESSARY • Private placements come in three basic forms: – Equity investment where passive investor is given partial ownership of the venture – no loan to repay; – Debt investment where passive investor is given a secured promissory note; – Limited partnership. 2

MACKENZIE HUGHES llp DEFINING “PRIVATE PLACEMENT” • A private placement is a direct private offering of securities to a limited number of sophisticated investors. It is the opposite of a public offering. Securities issued as private placements include debt, equity, and hybrid securities. In the United States, private placements are exempt from public registration under the Securities Act of 1933. 3

MACKENZIE HUGHES llp HOW TO COMPLY • The most common private offering issuer exemptions under the Securities Act are the following: – Section 4(a)(2) of the Securities Act, which provides a statutory exemption for "transactions by an issuer not involving any public offering. " – Rule 506 of SEC Regulation D, which provides a regulatory safe harbor for an issuer engaged in a non -public offering. 4

MACKENZIE HUGHES llp WHO IS ISSUER? • The following types of entities can raise money by utilizing a Regulation D Offering: (a) Corporations (b) Limited Liability Companies (c) Limited Partnerships (d) General Partnerships 5

MACKENZIE HUGHES llp WHY RULE 506 IS MOST POPULAR EXEMPTION? • Pursuant to National Securities Markets Improvement Act of 1996 ("NSMIA") – Rule 506 offerings preempt state securities laws except for applicable mandated notice and fee requirements. – Offerings made pursuant to Section 4(a)(2) do not preempt any state laws. – Rule 506 allows firms to raise an unlimited amount of money in a twelve month period 6

MACKENZIE HUGHES llp RULE 506: NO. OF OFFEREES • Need to ensure that the offering is made to accredited investors and/or not more than thirty-five (35) sophisticated investors. – Accredited Investors defined in Rule 501; – “Sophisticated Investor” = someone having sufficient knowledge and experience in financial and business matters to make them capable of evaluating the merits and risks of the prospective investment. 7

MACKENZIE HUGHES llp “ACCREDITED INVESTOR” An "accredited investor" is: • a bank, insurance company, registered investment company, business development company, or small business investment company; • an employee benefit plan (within the meaning of the Employee Retirement Income Security Act) if a bank, insurance company, or registered investment adviser makes the investment decisions, or if the plan has total assets in excess of $5 million; • a charitable organization, corporation or partnership with assets exceeding $5 million; • a director, executive officer, or general partner of the 8 company selling the securities;

MACKENZIE HUGHES llp “ACCREDITED INVESTOR” (con’t) An "accredited investor" is (con’t): • a business in which all the equity owners are accredited investors; • a natural person with a net worth of at least $1 million, excluding primary residence; • a natural person with income exceeding $200, 000 in each of the two most recent years or joint income with a spouse exceeding $300, 000 for those years and a reasonable expectation of the same income level in the current year; or • a trust with assets of at least $5 million, not formed to acquire the securities offered, and whose purchases are directed by a sophisticated person. 9

MACKENZIE HUGHES llp RULE 506: INFORMATION DISCLOSURE REQUIREMENTS • There are no informational requirements for accredited investors – but disclose anyway, or at the very least issue a “Letter Offering”. • Non-accredited investors must be provided: – Two years audited financial statements; – Or, if none, audited balance sheet within 120 days of offering. – If you provide information to accredited investors, you must make this information available to the non -accredited investors. 10

MACKENZIE HUGHES llp RULE 10 B-5: SECURITIES EXCHANGE ACT ‘ 34 • Still subject to anti-fraud provisions of Rule 10 b-5: • “It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange, a) To employ any device, scheme, or artifice to defraud, 11

MACKENZIE HUGHES llp RULE 10 B-5: SECURITIES EXCHANGE ACT ’ 34 (con’t) b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security. ” 12

MACKENZIE HUGHES llp RULE 10 B-5: GENERAL SOLICITATION ISSUES • No advertisements, articles, notices or other communications published in any newspaper magazine, or similar media or broadcast over television or radio. • No seminars or meetings whose attendees have been invited by any solicitation or general advertising. • Under new Rule 506(c) issuers are permitted to use general solicitation in connection with the sale of securities in private placements if: (i) the purchasers of all securities are “accredited investors; ” and (ii) the issuer takes reasonable steps to verify that the purchasers 13 are accredited investors.

MACKENZIE HUGHES llp CROWDFUNDING • The JOBS Act was signed into law by President Obama on April 5, 2012. • An issuer may sell up to $1, 000 of its securities per 12 months, and, depending upon their net worth and income, investors will be permitted to invest up to $100, 000 in crowdfunding issues per 12 months. 14

MACKENZIE HUGHES llp CROWDFUNDING (cont. ) • Since the 1930 s, the U. S. Securities and Exchange Commission (SEC) had imposed severe restrictions on an entrepreneur’s ability to raise capital using “general solicitation” or “general advertising. ” The idea was that you had to actually know people, and know them fairly well, before you hit them up for money. 15

MACKENZIE HUGHES llp James H. Nicoll, Esq.

MACKENZIE HUGHES llp What do we mean by “Equity Crowdfunding”? • In this context, equity crowdfunding refers to crowdfunding where the crowd receives a security in exchange for cash. • The SEC recently adopted rules pursuant to Title III of the JOBS Act that permit equity crowdfunding. • This presentation does not address project crowdfunding. 1

MACKENZIE HUGHES llp History of equity crowdfunding • Historically, equity crowdfunding was not feasible due to restrictions under the federal securities laws. • Proposed equity crowdfunding rules under Title III were issued by the SEC in October 2013. • Final equity crowdfunding rules under Title III were issued by the SEC in October 2015, which rules will become effective in May 2016. 2

MACKENZIE HUGHES llp What kinds of companies are likely to benefit from equity crowdfunding? • Companies with limited capital needs. • Companies that are able to create a “buzz” within a specific geographical area or community. • “Concept” companies. • High technology companies are not expected to be significant users of equity crowdfunding. 3

MACKENZIE HUGHES llp Which types of companies may not engage in equity crowdfunding? • Public companies. • Foreign companies. • Companies that have engaged in “bad acts”. • Companies that have completed an equity crowdfunded offering but have failed to comply with ongoing disclosure obligations. • Investment companies. • Blank-check companies (i. e. , companies with no specific business plan or that have indicated a business plan to merge with an unidentified company). 4

MACKENZIE HUGHES llp Preparing for a Crowdfunding Offering • Form the issuer. • Amend the company’s certificate of incorporation/formation. • Address due diligence issues. • Determine the type of security that the crowd will receive. • Determine the size of the offering and the closing date. • Engage a broker dealer or funding portal. • Obtain SEC filing codes. 5

MACKENZIE HUGHES llp Advantages of equity crowdfunding • Unlimited number of investors. • Investors need not be accredited investors. • Preempts state “blue sky” law. • Exemption from Section 12(g) of the Exchange Act. • No integration with other exempt offerings. 6

MACKENZIE HUGHES llp Drawbacks of equity crowdfunding • Limited to $1 million in any 12 -month period (only funds raised through equity crowdfunding count towards this limit). • Ongoing reporting and disclosure requirements. • Requirement to use a broker-dealer or a funding portal. • Requirement to use an escrow agent and a registered transfer agent. • Lots of investors = lots of relationships to manage. • Lots of investors = lots of potential plaintiffs. 7

MACKENZIE HUGHES llp Drawbacks of equity crowdfunding (con’t) • Investors can rescind their offers until 48 hours before the closing. • Communication can occur only through the platform that hosts the offering. • Resale restrictions. • Absence of a secondary market/illiquidity issues. 8

MACKENZIE HUGHES llp Crowdfunding platforms • The rules require an issuer to use a single registered broker-dealer or funding portal. The registered brokerdealer or funding portal must: – Provide investors with educational materials. – Take measures to reduce the risk of fraud. – Make available certain information about the issuer and the offering. – Provide communication channels to permit discussions about offerings on the platform. – Facilitate the offer and sale of crowdfunded securities. 9

MACKENZIE HUGHES llp Crowdfunding platforms (Con’t) • Funding portals are prohibited from: – Offering investment advice or making recommendations. – Soliciting purchases, sales or offers to buy securities. – Compensating promoters and others for solicitations or based on the sale of securities. – Holding, possessing or handling investor funds or securities. 10

MACKENZIE HUGHES llp Issuer Disclosure Requirements • Issuers must disclose the following: – Information about officers, directors and >20% shareholders. – A description of the issuer’s business and the use of proceeds. – The price of the securities or the method for determining the price, the target offering amount, the deadline to reach the target offering amount, and whether the issuer will accept investments in excess of the target amount. 11

MACKENZIE HUGHES llp Issuer Disclosure Requirements (Con’t) • Issuers must disclose the following: (con’t) – Related-party transactions. – Information regarding the issuer’s financial condition. – Financial statements that are, depending on the amount offered and sold during a 12 -month periods, accompanied by information from the issuer’s tax returns, reviewed by an independent public accountant, or audited by an independent auditor. 12

MACKENZIE HUGHES llp Issuer Disclosure Requirements (Con’t) • Issuers are required to amend their disclosures to reflect material changes and to provide updates on the issuer’s progress toward reaching the target offering amount. • Issuers are permitted (and encouraged) to provide additional disclosures about themselves and the offering on the applicable platform. 13

MACKENZIE HUGHES llp Individual Investment Limitations • If an investor’s annual income or net worth is less than $100, 000, the investment is limited to the greater of (i) $2, 000 or (ii) 5% of the lesser of annual income or net worth. • If an investor’s annual income and net worth are equal to more than $100, 000, the investment is limited to 10% of the lesser of annual income or net worth. • During any 12 -month period, the aggregate amount of securities sold to any particular investor through all crowdfunding offerings may not exceed $100, 000. 14

MACKENZIE HUGHES llp Liability Issues • Material misstatement or missions are prohibited. Disclosures need to be updated when they become stale. • Issuers, as well as their directors and officers, may be liable for material misstatements or omissions. • Insignificant deviations safe harbor exists. • Obtaining insurance for crowdfunding liability may be challenging. 15