by Zachary Robins, Esq., Winthrop & Weinstine, P.A.
Capital is the lifeblood of any growing business. And, for far too long, the disbursement of it has been in the hands of the few.
That's a shame, because those lacking the proper pedigree, connections, high-growth plans or collateral may never get their idea off the ground. To wit, one such study found that companies headed by male executives received 98 percent of all venture capital (VC) investments; the same study found 83 percent of VC-backed founders were Caucasians. Concentrating wealth and limiting access to capital to a particular gender or race stymies economic development and bypasses entire communities from our economy.
There is good news. Crowd-based financing solutions have evolved in the past decade, providing unconventional means for entrepreneurs to fund enterprises with support from the masses. Now is a great time to explore the new world of investment crowdfunding, learn about Minnesota's newly created securities exemption, MNvest, and understand how you, as a CPA, can help clients gain access to the capital they need for their growing businesses.
Federal, regulation crowdfunding
Investment crowdfunding offers private companies the ability to publicly raise funds by selling equity or debt securities with the expectation of a financial return to investors. Lauded by bipartisan politicians as a breakthrough for small businesses, this form of capital raising was the centerpiece of the 2012 JOBS Act. The intent was a federal securities exemption permitting private companies to raise capital (up to $1 million) from investors nationwide, regardless of "accredited investor" status. This exemption was enacted by the Securities and Exchange Commission in May 2016, and is now known as Regulation Crowdfunding (Reg CF).
Reg CF provides a beacon of hope for young companies, but suffers from cumbersome restrictions, including company and investor caps on total dollars invested, and audit and reporting requirements.
So, what is MNvest?
As a friendlier alternative to Reg CF, states have passed intrastate crowdfunding exemptions allowing homegrown companies to raise capital from state residents. On June 13, 2015, Minnesota became the 25th state to legalize investment crowdfunding and, in June 2016, final rules were approved. Our state exemption, known as MNvest, is regulated by the Securities Division of the Minnesota Department of Commerce.
The following is a summary list of MNvest features. Full text of the law can be found at www.tinyurl.com/mnvestfeatures.
- Issuers may raise up to $2 million per offering per 12 months.
- Issuers raising between $1-$2 million must provide audited or reviewed financial statements.
- Internal financial statements will suffice for less than $1 million offerings.
- Issuers must provide a detailed disclosure document.
- Investors may be accredited or nonaccredited.
- Investors must be residents of Minnesota.
- Nonaccredited investors may invest up to $10,000 per offering.
- Accredited investors may invest an unlimited amount per offering.
- Offerings must be sold online through MNvest portals, approved by the Minnesota Department of Commerce.
- MNvest portals may be third parties or the issuer of securities itself.
- MNvest portals may sell Small Corporation Offering Registration (SCOR) or MNvest offerings.
- Depending on whether an issuer raised under MNvest or SCOR, additional requirements exist concerning use of proceeds and company sales, amongst other items.
- Broker-dealers and non-broker-dealers alike may become MNvest portals.
- Non-broker-dealer MNvest portals cannot receive transaction-based compensation.
- May be eligible for Angel Investment Tax Credit.
As of the date of publication, four MNvest portals have been approved and three offerings declared effective by the state of Minnesota. It remains to be seen how many young and growing companies take advantage of these new means to raise capital. Nonetheless, more options for entrepreneurs can only be described as a good thing.
Before diving in ...
Investment crowdfunding is not without important considerations, such as managing a larger investor pool, designing a marketing strategy to reach a desired audience and properly conveying your message. The following are questions and options investors should analyze before journeying into the investment crowdfunding world, and where you can offer sound advice.
Investment crowdfunding begs the questions: What type of security is best suited? For example, equity may be the obvious or assumed choice, yet it involves the most risk for companies as investors become members/shareholders with certain inherent rights by statute and per operating agreements. Debt, on the other hand, provides for a specific return and exit date, yet interest payments may be too onerous for young companies without strong cash flow.
Perhaps convertible debt is the best solution due to its ability to convert into equity if certain conditions are met. Additionally, new forms of securities exist, such as Simple Agreement for Future Equity (SAFE) & Keep It Simple Security (KISS), which are neither equity nor debt, but intended to convert into equity under certain conditions. These securities act most like convertible debt, but without interest payments and no guaranteed return of principal.
It is incumbent upon prospective crowdfunding issuers to ensure their corporate structure is appropriate and best suited for their offering and future growth. While a single member LLC may have served the founder's purpose in year one, is such an entity prepared to take on 50 or 100 members? Likewise, are the company's accountants able to generate K-1s for all members on a reasonable timeline and in a cost-efficient manner?
Solutions for these and other related issues will weigh heavily on founders considering a crowdfunding offering. Entrepreneurs with a strong team of professional service providers, such as lawyers and CPAs, will be best served.
Prospective issuers must also consider the best way to govern the company. Under the new Minnesota LLC Act, companies may be member-managed, manager-managed or board-managed, and each structure has its own pros and cons. Some companies will seek to provide crowdfunding investors with a say in company decisions by granting the class of investors a seat on the board. Other companies may go to great lengths to limit investor voting rights by ensuring all decisions are made by a manager. Once again, there is not a one-size-fits-all approach, so receiving sage advice makes all the difference.
Embrace the new
These new tools exist for companies seeking to grow, and will level the playing field for those without a rolodex of angel investors. This gives a great deal of hope for entrepreneurs who can mobilize support online by sharing a compelling business plan and vision.
We are embarking in a new era of investing and there will certainly be failures. There will also be success stories. I hope you can be a part of this new funding revolution in one way, shape or form.
Zachary Robins is an attorney with Winthrop & Weinstine, P.A. in Minneapolis and one of the co-founders of MNvest.org. You may reach him at firstname.lastname@example.org or 612-604-6487.
DISCLAIMER: Securities laws and compliance thereto are complicated subjects. Companies should consult with a securities attorney before conducting a securities offering. The above information should not be construed as legal advice. Investments in private companies are risky and investors should be prepared to lose their entire investment in an offering. Investors should review all disclosure documents and consult their legal, financial and/or tax advisers prior to investing.