In its recent rulemaking, the SEC added new Rule 3a-9 under the Investment Company Act to allow for the use of “crowdfunding vehicles” for Reg CF investments. It is important to recognize that crowdfunding vehicles are quite limited, and not at all similar to the special purpose vehicles (“SPVs”) used to aggregate accredited investors in angel or venture capital funding rounds.
In that type of SPV, there is often a lead investor or manager who may act on behalf of the investors in the SPV. Those persons could be exempt reporting advisers under the Investment Advisers Act, or even fully registered investment advisers. In this way, SPVs create real separation between the investors and the underlying issuer, with some person or entity acting as an intermediary when making decisions or providing information to investors.
For crowdfunding vehicles, on the other hand, the SEC requires that investors receive the same economic exposure, voting power, ability to assert claims under law, and receive the same disclosures as if they invested directly in the issuer itself. In particular, a crowdfunding vehicle:
- Is organized and operated for the sole purpose of directly acquiring, holding, and disposing of securities issued by a single Reg CF issuer;
- Does not borrow money and uses the proceeds from the sale of its securities solely to purchase a single class of securities of a single Reg CF issuer;
- Issues only one class of securities in one or more offerings under Reg CF in which the crowdfunding vehicle and the Reg CF issuer are deemed to be co-issuers;
- Receives a written undertaking from the Reg CF issuer to fund or reimburse the expenses associated with its formation, operation, or winding up, receives no other compensation, and any compensation paid to any person operating the vehicle is paid solely by the Reg CF issuer;
- Maintains the same fiscal year-end as the crowdfunding issuer;
- Maintains a one-to-one relationship between the number, denomination, type and rights of Reg CF issuer securities it owns and the number, denomination, type and rights of its securities outstanding;
- Seeks instructions from the holders of its securities with regard to:
- The voting of the Reg CF issuer securities it holds and votes the crowdfunding issuer securities only in accordance with such instructions; and
- Participating in tender or exchange offers or similar transactions conducted by the Reg CF issuer and participates in such transactions only in accordance with such instructions;
- Receives, from the Reg CF issuer, all disclosures and other information required under Reg CF and the crowdfunding vehicle promptly provides such disclosures and other information to the investors and potential investors in the crowdfunding vehicle’s securities and to the relevant intermediary; and
- Provides to each investor the right to direct the crowdfunding vehicle to assert the rights under State and Federal law that the investor would have if he or she had invested directly in the Reg CF issuer and provides to each investor any information that it receives from the Reg CF issuer as a shareholder of record of the crowdfunding issuer.
The result is that no lead investor or manager can be used, and investors will have the same rights and responsibilities as if they invested in the issuer directly.
The biggest practical effect is that Reg CF investors will appear on one line on the issuer’s cap table (addressing the “messy cap table” issue), and that line will represent the full number of beneficial owners, who each must still be notified by the issuer in the event of any decisions requiring investor action. The issuer could hire an administrator to handle communications with the investors in the crowdfunding vehicle, but there was nothing preventing an issuer from doing that previously.
However, by only existing as one line on the issuer’s cap table, and confirmed in its rulemaking, crowdfunding vehicles will count as one “holder of record” for the purposes of Section 12(g) of the Securities Exchange Act. This is the provision that says that a company has to register with the SEC and become fully-reporting when it reaches a specified asset and number-of-shareholder threshold. Up to now, crowdfunding companies have relied on a conditional exemption from Section 12(g) but some companies have worried about what will happen when they no longer comply with those conditions.
The SEC further opined that with these changes, it is possible that issuers will provide greater voting rights than has been common in Reg CF offerings. I am not sure that will be the case, as use of crowdfunding vehicles will not simplify obtaining votes for any necessary corporate consents unless the rights of investors are curtailed by the use of drag-alongs or similar provisions.
Setting up a crowdfunding vehicle will require documentation tailored to follow the terms of the securities being sold in the crowdfunding offering, and arranging for administrative tasks such as issuance of K-1s to the investors. CrowdCheck is available to talk through the implications of using crowdfunding vehicles and whether it makes sense for your Reg CF offering.