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Editor's Note: The following was written by Laurie Thomas Vass, a registered investment advisor, and regional economist. Vass manages The Private Capital Market, a crowdfunding platform. Guest contributors' opinions are their own and do not necessarily represent the views of Crowdsourcing.org.
A Review of Jim Verdonik’s Book: Crowdfunding Opportunities and Challenges, SECTEC Publications, 2016
Introduction To The Challenge
Just about every initial discussion that I have with a CEO about accredited investor crowdfunding quickly devolves into their sole burning question: How do I find investors who will buy my securities?
Their direction of causation for the process for raising capital is backwards because it assumes that someone is going to “buy” their securities.
This mistaken belief is based upon the CEO’s prior experience with the venture capital model of raising capital. In that model, the CEO goes from VC group to VC group, hoping to find a VC who will buy their securities. Given the odds of success in the VC method, it is surprising that this model continues to have such a hold on the imaginations of CEOs.
The industry statistics on raising capital in the venture capital model are that a VC firm reviews hundreds of business ideas and plans every year. Out of every 100 business plans that the firm reviews, they reject 90 plans, and further review 10 plans.
Out of those 10 plans, they make an investment in 2 plans.
Out of those 2 plans, the VCs will kill about 60% of all of their portfolio companies within 3 years of their initial funding because the company did not meet the VC’s internal criteria for success. This is called the “assisted suicide” method of raising capital.
Out of every 10 plans that the VCs invest in, 1 plan hits the VC homerun on returns, which is an 800% capital gain within 2 years.
In contrast to the venture capital method, in accredited investor crowdfunding, securities are sold, not bought, a subtle, but important distinction. Selling private securities is like selling publicly-traded stocks, except that there is no formal market exchange mechanism in place to sell private securities.
Verdonik carefully examines this newly emerging market, under Reg D Rule 506(c), also called the accredited investor crowdfunding model.
And, the greatest securities salesperson for the company in this nascent market is the CEO. The job of the CEO is to sell the company’s securities, under Reg D Rule 506(c). Unlike the former VC model where VCs buy the securities in private negotiations, or the public broker/dealer market in public securities, where stock brokers sell the stocks, in accredited investor crowdfunding, the CEO becomes a stock jockey for the company’s securities.
The language the SEC uses for the CEO is “issuer,” because the CEO is “issuing” her securities to investors.
In my conversations with CEOs, when they learn of the hard work involved in selling their own securities, their response is along the lines, “Sheesh, that sounds like a lot of work for me. Isn’t there an easier way?”
But, luckily, Jim Verdonik has written a book that explains the process for selling securities in crowdfunding.
While the book does not offer an easier path to raising capital for the CEO, it does explain how the CEO can sell securities without ending up in the hoosegow.
Everything and Anything Is A Security, and Anything You Say Is An Offer to Sell
Verdonik spends about 100 pages, out of 550 pages of his $9 ebook, (available at LuLu), explaining the rules a CEO must follow for selling securities. This very detailed analysis can be boiled down into three main points for the CEO to understand:
Any item of any possible current or future value is a security.
Any statement made by the CEO about a security can be construed as an offer.
Any statement that could possibly be an offer can easily be considered fraud.
The complexity in understanding these three points is that the law about crowdfunding securities is intertwined with the technology of multi-media communications. As Verdonik notes, “A big part of securities regulation involves building walls around how people use media and devices to sell securities.”
He notes that communication technology allows the CEO to bypass the venture capital firms, and sell directly to the public, which is the main point of crowdfunding. “New technology,” Verdonik notes, “is making it easier to communicate with investors without going through the traditional gatekeepers.”
While the communication technology makes it easier to crowdfund securities, every communication about something of value can be construed as an offer. The common term to describe a crowdfunding offer is “general solicitation.”
At any point in a CEO’s communication about the company, before, or during, or after, a general solicitation, the CEO may make a statement that could possibly be considered fraud. As Verdonik notes, over and over again, “the most fundamental concept of securities law is fraud: Fraud is Bad.”
Among the many reasons that fraud is bad is that potential fraud leads to the CEO being sued by disgruntled investors who claim that a statement, at any point along the way, made by the CEO was misleading. Verdonik notes that under Section 10 and Rule 10b-5, the disgruntled investor must prove in court that the “CEO knew about the misstatement or omission of material fact or that the defendant acted in reckless disregard of the truth.”
Once a Rule 506(c) offering begins, it becomes very difficult for the CEO to change selling strategies or statements about the company, the offering, or the expected future benefits of an investment in the company.
As Verdonik states, “After you start advertising or conducting a general solicitation, you can’t pretend you didn’t do it, even if you didn’t actually sell any securities in your Rule 506 (c) offering. After you begin to advertise or conduct general solicitation, your alternatives for selling securities using another private placement exemption become limited.”
This good piece of advice applies to both the current crowdfunding effort, and also affects the future capital raising efforts. As Verdonik notes, “your later offering may become “tainted” by your advertising and general solicitation efforts.”
An offer to sell private securities includes soliciting an investor to “make an offer” to buy securities. That means that the new communications technologies, which make it easier to sell securities, also includes barriers to selling securities to investors who may have been “solicited” in a past or future offering that had different solicitation rules.