The Encrypted Economy
The Encrypted Economy
Crowdfunding for More Than Money. Eric Hess and Andy Greenstein, Hess Legal Counsel. - E94
On this week’s episode of The Encrypted Economy, our guest is Andy Greenstein, fellow lawyer at Hess Legal Counsel. We share observations we have made while working on several crowdfunding deals and explore the state of digital asset offerings for small issuers in the U.S. Be sure to subscribe to The Encrypted Economy for more insights on the regulatory landscape in web 3.
Topics Covered:
· 0:00 Introduction
· 2:10 Andy’s Background
· 6:00 Overview of Hess Legal Counsel's Involvement With Crowdfunding
· 8:00 Discussing Crowdfunding and the Burdens of Smaller Issuers
· 15:40 Breaking Down The Legal Terminology
· 31:15 Limitations With Regulation CF
· 37:20 Testing the Waters and Reg CF
· 41:40 Popular Reg CF Platforms
· 44:00 Closing Thoughts Benefits of Crowdfunding
Resource List:
· Andy’s LinkedIn
· Hess Legal Counsel
· Hestor Pierce Safe Harbor
· Reg X
· Reg D
· Reg CF
· MiCa
· Lummis-Gillibrand Bill
· Digital Commodities Protection Act
· Wahi Case SEC
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Eric: [00:00:00] On today's episode, I have Andy Greenstein, fellow lawyer at Hess Legal Counsel. Between the two of us, Hess Legal certainly, we've done a ton of crowdfunding deals and wanted to use this opportunity to share some things that we've learned along the way, but also to share an observation that I have about the state of digital assets offerings for small issuers in the U.S. It's the regulatory landscape even. No matter what you've heard in terms of new legislation, none of it really specifically covers the interest of the small issuer. There have been efforts, Hestor Pierce's SAFE Harbor, LeXpunKs, Reg X, but the current legislation doesn't really focus narrowly on it.
Notably, the MiCa, the EU final rule, actually does address the need for assessing the, whether there's a disproportionate impact on small and medium size [00:01:00] issuers. But in the U.S., we're more focused, on the institutions and not as focused on the bootstraps and the fair launch projects.
So, in short, this episode was a long time coming. So, it covers digital asset, it covers nuts and bolts of crowdfunding and I think you'll get a lot out of it cuz there's a lot of knowledge here and happy to share. So, if you like it, share it with others and we'll continue to build the all the episodes and the knowledge base for everyone to enjoy.
Thank you.
Welcome to The Encrypted Economy, a weekly podcast featuring discussions, exploring the business laws, regulation, security, and technologies relating to digital assets and data. I am Eric Hess, founder of Hess Legal Counsel. I have spent decades representing regulated exchanges, broker dealers, investment advisors, and all matter of FinTech companies for all things touching electronic trading with a focus on new and developing technologies.
All right, so [00:02:00] today on The Encrypted Economy, we're gonna be covering crowdfunding SAFEs, and digital assets. Both myself and Andy Greenstein from Hess Legal Counsel. Welcome Andy.
Andy: Hey, Eric.
Eric: All right we'll touch on a little bit of background just so people know a little bit about you and then we'll just dive right in.
You were Deputy General Counsel at Knight Capital Group back in the days when the flash crash happened. That exciting time. And actually, you were with them for a number of years prior to that, you actually had a lot of public company experience as well as strategic experience there. But I don't know, do you wanna share anything from that time?
Andy: Sure. I spent 15 years at Knight Capital. As you said, did a lot of managed a group of eight attorneys and a lot of interesting aspects I dealt with throughout that time. Obviously, the flash crash was what most people talk about, and that was when we lost there [00:03:00] was a code programming issue which resulted in a 400 million loss in about 45 minutes of which we then spent about six days, me and a dedicated group of people, in the office pretty much the whole time
in an attempt to keep the company afloat, obviously after such an issue. And was although it was one of the lowest points in my career, it was also one of the most satisfactory at the end when we were able to survive literally with about 20 minutes left before the SEC was gonna put, suspend our stock from trading going forward.
And a lot of that was due to not burning bridges over the years with people who you dealt with and who were former employees and things like that. Ultimately, in our time of trouble, a lot of people came out from all over to offer assistance to us and help us in that incredible situation.
And ultimately, we survive, which was [00:04:00] great. Obviously, we got acquired about a month or two later. But one of the more fulfilling moments at the end when we did survive and knowing we saved, a whole group saved about 1200 people's jobs and we're able to keep a business afloat.
Very exciting times and also very sad at the same time but a great experience
nonetheless.
Eric: And years later you went from, I guess, the frying pan into the boiling pot with Labenthal.
Andy: So, I was General Counsel and kind of came towards the very unfortunately, unbeknownst to me in many respects,
when their business started to struggle and had some kind of shareholder issues, which resulted in some departures of key backers the business. And there another issue, situation of crisis management and trying to work with people to salvage the company, negotiate kind of settlements and releases to land [00:05:00] it gracefully and a graceful exit, which we ultimately did.
It did file for insolvency at the very end from a legal kind maneuvering type of situation. But there's a lot accomplished there. But yes, have a lot of crisis management experience in addition to obviously capital raising and just regular corporate governance and the more traditional M and A work that we all, that we do, as well.
Eric: Excellent. And not to minimize all the other strategic deal experience that you've had along the way. Certainly, since joining Hess Legal Counsel, we've done a large number of deals both Reg CF, crowdfunding deals, Reg D work you've assisted on other stuff related to Reg A here and there.
But certainly, that's what we're gonna talk about today. We can dive right into it.
Andy: That sounds great. Thanks.
Eric: So, a [00:06:00] little bit on, on my or Hess Legal's fascination with crowd funding and why it's particularly irrelevant. Before crypto, I was actively involved in lobbying for the Jobs Act.
Maybe about 10 years ago or so, when I was General Counsel of a US registered Stock Exchange known as Direct Edge. Direct Edge was acquired by BATS, BATS was acquired by CBOE. Just the way things go with this space. Also tried to create a new over the counter trading markets much the pink sheets ATS broker dealer.
We had file become an ATS ultimately for other reasons it didn't work out. But basically, this has been a, the early-stage space has been a passion of mine for some time. And when crowdfunding finally came out, it was great to finally start getting a lot of referrals.
We've gotten, we've probably done over a hundred of crowdfunding deals. We've done a lesser number of other types of securities registration exemption deals like [00:07:00] Reg D, but it's hard to beat a hundred, even if you do a ton of Reg D deals. So, we come into this episode, wanted to talk about think what we've learned from all our crowdfunding experience also to talk about the significance a as it relates to digital assets.
You know what we're gonna cover here? We're gonna talk about what these financings are, how like a Reg D and a Reg CF work together and facilitate formation over, over time and a detail, which is not covered enough, I think. Also wanted to touch on how it all relates to fair launch digital assets that are building communities in the U.S.
And how they really need to consider the crowdfunding option, even if they get VC's, angels, what have you. Again, use complimentary with those. But it's very important. So why are we doing this today? Why didn't we do this like a [00:08:00] year ago or so? And I'll get into it before we, we launch.
So, the SEC has taken a broad view on what constitutes a security as it relates to digital assets. Obviously not something that I particularly agree with the broadness of it, but nonetheless, it is what it is. And a lot of projects that I see, the Hess Legal Practice has a, I do a fair amount of the digital asset work, Andy does a fair amount of the crowd funding work.
We work collectively on Reg D and other types of financings. He works on digital assets. I worked on crowd funding. But there are two reasons why this is particularly compelling for digital asset projects operating in the U.S., particularly early-stage startup. One is regulators, in my view, certainly haven't shown themselves as coming to the rescue, nor has the legislators.
If you believe that Congress is gonna take action on stable stablecoin protocols. Nothing has really been said specifically about assisting [00:09:00] early stage, fair launch crypto projects. And they're facing potential designation if they're trying to launch a native token to be a security.
The Wild West narrative that's come out of Washington and the regulators hasn't, has really been to the detriment of small to medium size. And when you, cuz wild wests means you need a lot more controls, those controls are often a barrier to entry. I was reading the Lummis-Gillibrand Bill this morning and the Stabenow with the Digital Commodities Protection Act, and there's a whole slew of others.
But one thing is pretty clear. Is that SMEs, small to medium size enterprises really just isn't mentioned in it, and it's not likely to, to gain traction in, in Washington Right now the focus is much more on the more institutional or the institutionalization of it.
Under the premise of controls, I contrast this with MiCa, which is the European rule regarding digital assets that just got in final [00:10:00] form. Presumably there's still some negotiations, but what's not, what's very notable there is they do specifically call out the concerns of disproportionate impact on small to medium size enterprises as well as the burdens.
And furthermore, they also call for an assessment to be undertaken to fully understand that impact again, which is something that the US has, so far, has not done now. The jobs act took years to happen. And there's nothing like the reg crowdfunding or Reg CF that would specifically help digital asset projects looking to leverage their community.
So, at any rate one is the regulatory construct. The other one is, quite frankly the efforts of small to medium size companies to achieve sufficient de centralization. There's no such thing as an immaculate [00:11:00] conception, almost any path to sufficient decentralization
probably requires walking through the valley of centralization and thus you run into the risk of being a security while you hope at some point to achieve sufficiency, centralization, to not be I think that's it's too challenging of a path. I think the regulatory environment in the U.S. Is too challenged.
Just because a company proclaims or a group of people proclaims themselves to be a DAO does not mean they are truly DAOs and which is why like Hester Pierce's SAFE Harbor Proposal or LeXpunKs or Reg X proposal we're so critical, they're just not getting the uptake that they should.
With all that being said, you had the Ookie DAO complaint last week that uncovered some of the issues with trying to be decentralized. And so, it, despite how you may feel about it, it does seem [00:12:00] this is not the time for small to medium size companies, particularly in the early stage to launch a native token in the U.S., if they have developers in the U.S, if they have a project team in the U.S. If they've got investors in the U.S., It all doesn't seem to be particularly a good time to do that.
With all that said I believe that there is a strategy. For these early-stage digital asset projects. And obviously we're not confining our talk today just simply about digital asset fair launch projects. But I think it's also important to consider these projects, they should now look to crowdfunding if they wanna leverage their communities because crowdfunding is phenomenal for that, as we're gonna get into and think about coupling it with a strategy.
For doing Reg D for if they wanna raise larger amounts and deferring this notion that potentially having their native token trade on the [00:13:00] public blockchain as a way of raising capital. This may be controversial to some people. It's not forgetting the space; it’s not forgetting those challenges.
I just think as an early-stage startup, you really need to, you don't necessarily need to a hundred percent do it, but you should definitely be contemplating the value of leveraging your community through crowdfund while coupling it with a Reg D strategy. So, with that said, that was a lot.
Andy: Just to jump in for a second, we do have, as you know, several clients who are taking that approach, who are in lieu of maybe doing a direct native token offering for now, are raising capital through the holding company instead under Reg CF and leveraging their community and trying to build their community at the same time, which hopefully then will help them for a later subsequent token issuance down the road.
Eric: And I think one thing that should, that's gonna resonate through this through this episode is with regulation crowdfunding. They're not [00:14:00] all effective provi- particularly where a project or a company will just say they have to be a company so it's where a company doesn't have a community to bring.
In other words, if you don't have the reach, just simply launching on a crowdfunding platform isn't gonna make all these investors magically appear out of the sky, particularly if you've not done anything to cultivate that community. But what's critical for companies that, that want to build a presence with their community through the offering or give non-accredited investors or other participants the ability to be to get a stake and to become their advocates, crowd funding is phenomenal in a way that Reg D and others may not even accomplish. Sometimes I even tell clients like, if they're doing a Reg D, think about your community. You may actually, even if you can raise all the money through a Reg D and we'll get through the importance of a Reg D versus [00:15:00] CF contemplate reserving a little bit for a crowdfunded option where you can leverage that broader base community.
Andy: Yeah, and just to touch on that, if I can for a second. To that point, obviously digital assets, new and exciting area. Maybe not that new anymore, but exciting area. A lot of people are involved. But the demographic probably tilts towards a younger demographic which may not meet some of the requirements for Reg D investing, aka credit investor in definitions.
And the Reg CF may be a great alternative to reach that community of people that couldn't be reached otherwise and helped build the community, as they say.
Eric: All right, so now that we set the table, let's start to break it down. Cuz for some people they may not even know what Reg D or Reg CF, and it's just words.
Let's start to break it down. So, there are some critical questions that we have to break down. We have the one, what is an accredited investor? Most people. [00:16:00] Know what an incredible investor is. We also have to talk about a SAFE, or what is known as a simple agreement for future equity. And what this is an agreement that really simplifies the process of an early-stage company that doesn't know their how they wanna price their securities.
It's really a way of saying, hey, we're not pricing it today. We're pricing it in the future. And then of course, we also talked before briefly, about reg CF and Reg D. So, Andy, easy question. Softball. What is an accredited investor?
Andy: Maybe I just step back for one second. Just say, Overall securities laws are designed for either registrations or exemptions from them, and there's splits between accredited investors and non-accredited investors.
Credit investors deemed as sophisticated investors that may not require as much protection, so to speak, versus noncredit investors who deemed to need more protection, which may be in the way of disclosures, additional [00:17:00] disclosures information that's provides them in the like. So, with that being said, a credit investor is usually defined as a person who has an average annual income of over $200,000 or $300,000 if it's joint income or jointly married for the last two years, or a net worth exceeding 1 million either individually or jointly, as well.
Eric: Great. And then we talked a little bit about what a SAFE is.
And the SAFE originated from something that Y Combinator did. YCombinator was a I, I don't think I wanna go down to road a defining what YCombinator is, but they basically they were nurturing early-stage companies and they created this open-source version of an agreement that quickly became the standard
for a lot of venture raising. And there are some variations, but I'll let you tip pick it up from there, Andy.
Andy: No, that's true and obviously saves are a good way for early stage [00:18:00] companies to get investors involved without having to go through more complex negotiations as far as determining value lots of documentation that may be behind it, whether its investor rights agreements, loan agreements, right at first refusal agreements and the like. And so, it's just a simpler way to do it from the outset, less costly and time consuming as well, which is important for startup companies or early-stage companies who don't wanna have to go through that process.
And also takes out the whole process of figuring out exact valuation, usually set up valuation cap. And it also helps the kind of from a governance perspective, the founders and management allow them to continue operating the company since SAFEs don't have voting rights to start. And so, it's a great way at the early stage to maintain control, be able to execute on your strategy while bringing in necessary capital to fund your business.
And I would just [00:19:00] say there's three pieces, that are generally key to a SAFE, one is the valuation cap, which determines kind of the value that your conversion is gonna be based when your SAFE is ultimately converted into equity of the company, and so that's an important piece obviously, cuz that gives you the upside.
So, if you do something today and you think the stock, the company's going to dramatically increase in value, you're locked in at a lower valuation cap, you get the upside going forward. So, you get the same protections as if you had equity at the start in that you're gonna be able to get the upside.
The other piece is a discount rate, which is usually a discount in the event there's a down raise following your issuance of a SAFE. So, for example, you got a SAFE at 10 million. All of a sudden there's a down raise at 8 million, let's say or more. Let's and you, if you had a 20% discount rate, you would really begin it at 20% from the down rate at eight.
[00:20:00] So it'd be, that's 6.4. So, you get the benefit of a down for side protection, which is important for a lot of companies for a lot of investors, I should say, not companies who, want the protection of taking a chance on early-stage company. Now, as we've seen in the past, companies that kind of grow up in value very quickly, I think the discount becomes more important for people than others for investors than other things.
It's an important piece, and you see it in about, I'd say 40% of what we see on like the Reg CF side. People offer discount rate, but it does depend little bit. There's also a final piece that sometimes people offer mount most favor nations clause, which gives you the best terms if there's a subsequent equity financing and it's a better, gives you those terms.
Fully protects someone for valuation, everything else that comes with it.
Eric: Yeah, certainly SAFEs in the [00:21:00] last over the last decade have been seen as more of a way to participate on the upside that's beneficial possibly for the company. I'd say, particularly as they deal with a slower economy.
It still incentivizes investors to come in because of the because you get a discount and it's priced in the future, so you don't have to worry. If you put your money into a public company and then the price goes down, not so great. But if you put your money into a SAFE price goes down
if the company's still solid and they do a price around at that as an equity holder, you convert at a, basically at a better valuation. And then if they bounce right back up, you're in a good position. So, say I actually remember the days when there weren't SAFEs. It was just a very, it was a very different.
Andy: You and me both.
Eric: Just, yeah. It's just it's amazing how not surprising how SAFE is just like Yeah, of course. If you're your early stage, you're gonna do a SAFE. Before the Y Combinator came out with it, it was, you had to price it. And typically, I'd [00:22:00] say, a lot of the same dynamics would apply if you were a company and you had, a lot of leverage.
You'd be able to get a higher price around, but you spent a lot more time talking about the pricing.
Yeah.
They're negotiating factors and it just you could burn a lot of time on lawyers. SAFE just basically you can sign a SAFE flight without any review. So, when you go on like a funding portal site and you buy a SAFE as an investor
you really like, the most important pieces are already provided for, which is around valuation, and you're protect. You're protected on the, you're, you have upside with the valuation cap and the discount, but you also have downside protection.
Andy: Yeah. I would also just
say that in addition, obviously it's standardized as you mentioned, but it, they do vary a little bit depending on if it's a private SAFE, which are more in line with the Y Combinator and generally pre post money valuation caps they use.
Whereas kind of some of the platforms that are [00:23:00] used for a Reg C. For example, maybe pre-money like for example, Republic uses a pre-money evaluation for theirs, so there are some different flavors to it, so to speak. And are somewhat customized in that regard. Also, like Republic doesn't do like an automatic conversion upon an equity financing versus a Y Combinator one.
So, there are some differences. But in the end, when it's all said and done, a SAFE is a much simpler document and instrument to use to raise capital at an early stage for a company, and that's why it's
so attractive to people.
Eric: Yeah. We'll be raising Republic as an example. We work with all types of crowd funding, but we're bullish republic.
So anyway. So, let's talk a little bit about Reg CF. CF is an exemption from the full securities registration requirements of an offering, but there are requirements
Andy: Reg CF, all the transactions must take place online usually through either a broker dealer or what's called a [00:24:00] funding portal.
The maximum amount, aggregate amount that a company can raise within a 12-month period is $5 million. Recently, there's been some changes as far as kind of, and we'll get into this a little bit later as far as amounts can be raised with audit financials, which is the 5 million and reviewed financials, which is a different number, and we'll get into that in a little bit.
There's also limits on the amounts that unaccredited investors can invest across all crowdfunding offerings in a 12-month period. The nice thing about Reg CF Forum C, which is filed, is its simpler disclosure is not nearly as involved as a s one public company type of registration statement or a Reg A offering statement, so to speak.
And the other piece that's important to know is that although it is filed with the SEC, it's not something that requires preapproval and clearance from the SEC. Prior to filing, which helps as far as minimizing the amount of time it [00:25:00] takes to draft and file a Form C versus if you were doing like Reg A type offering or a Form S one, which can take many months and lots of back and forth with the regulators. These things can get reviewed after by the regulators, but again, not required beforehand, which goes back to the whole concept of ease as far as cost time and everything else that goes with it.
Eric: And like in, with regard to ease, all the transactions must occur online.
There's no calling up your broker and participating at Reg CF unless they give you a link to an online platform. What's interesting is there's a maximum aggregate amount within a 12-month period. Of 5 million, but that's 5 million through crowdfunding. So, you could raise substantially more through Reg D offerings during that time.
But, and then after the 12-month period passes, you can raise another 5 million. You can continue to raise money through the crowd funding. And for a lot of early stage, those limits are completely doable. [00:26:00] And even the limits on unaccredited investment unaccredited investors apply within a 12-month period.
So, when you think about it, the accredited investors, you're arguably not limited because you can still go to Reg D, but for unaccredited investors those limitations are gonna apply within a 12-month period because there really is no other viable way. You can do it through Reg D, for all practical purposes, really making a public offering to unaccredited investors, Reg CF is generally a preferable option, and we'll get into why.
So, let's talk a little bit and that gives us a good jumping point for Reg D. Andy, why don't you, why don't you introduce Reg D?
Andy: Sure.
Reg D obviously is exemption from securities law, from registering your securities.
It's a very common regulation that people rely on to [00:27:00] raise capital in a private setting most typical is a, what's called a 506B most call it. Where you can sell to an unlimited number of accredited investors in a single offering and a limited number of nonaccredited investors.
So, it's, usually if you involve non-accredited investors in a Reg D type of offering, then that will require a private placement memorandum will be provided and drafted as part of that which gets into kind of, it's more thorough, more complicated, more expense and time to do. And so, it can at times, we prefer doing most of our 506B offerings solely to accredited investors.
It makes it a lot simpler for the issuer, a lot less potential liability exposure down the road. And it's just an, it’s just avoiding kind of potential missteps that could come along the way and gives you more protection. So, from our side, we generally [00:28:00] recommend, not saying we don't, we say never do it, but we generally recommend doing Reg D raises to accredited investors only.
Eric: And there are restrictions as a purchaser of Reg D, as well. Generally, if you buy restricted securities through a Reg D, they can't be sold for at least six months, generally a year before they can be registered. And then, Reg D, it doesn't permit a secondary market.
It, it does permit private sales, private resales.
Andy: Yeah, that's true.
And obviously the one thing I should probably also mention too is Reg D is a simple filing as far as a form that you file as far as how much you're raising. PPM is not filed publicly or with the states depending on where the capital raise is.
And it’s a [00:29:00] very simple filing as far as it goes. Obviously, you still have anti-fraud provisions that you gotta comply with and you wanna avoid violating those for potential implications that you would not want. The piece about the secondary market is very important because you are limited as far as what you can do and have to be in a private transfer after holding periods of six or 12 months spent on the rule that you're relying on.
The other piece, the PPM as I talked before, you'd have to draft that. There are some financial statements that most people require or forecast, but it's a little bit different than a Reg CF for example, where financial statements are required. Now, obviously the level of it, whether it's reviewed financials, Audit financials are self-certified, depends on how much you're raising.
But again, it's not a little bit different standards are what it comes down to.
Eric: While there are a few different categories of Reg D the most [00:30:00] important thing to take away as listener is for accredited investors. It is an optimal way of raising a, you're not subject to limitations as you are under Reg CF.
And if you wanna do not accredited, probably not as how should I say? Not as elegant. I think as Reg CF, although you can do it. Don't anybody listening to say, "Hold it! You can solicit accredited investors!" Yes, you can, but you have to, the verification requirements are much higher and we're already complex enough on this podcast, on this particular episode.
So, we still have to get through the rest of the Reg CF. So, we're gonna,
Andy: Lemme just add one other thing, Eric, to the Reg D piece for a second, is, obviously we just talked about this one part of Reg D 506B. There are obviously other pieces to it. There's also 4(a)(2), which is a broader, Reg D is a subset of 4(a)(2).
So, for example, SAFEs that are done in a private transaction for the most part are actually done outside of Reg D unless they're done through like an accredited investor [00:31:00] platform or something like that. And they're done under section 4(a)(2). So, I just wanted to make, sure if anyone's listening, we are aware of all the different exemptions, but just wanna point out some of the nuances.
Eric: So, let's turn back to Reg CF. What can nonaccredited investors invest in? There's been some recent inflation adjustments. Who knows if they can keep caught up the way inflation's going, but what are some of the limitations?
Andy: Nonaccredited investors who earn less than 124,000 in annual income or net worth, they can invest $2,500 or 5% of their annual income or net worth, so whichever's greater. For those that make at least 124,000 in annual income or have net worth above that, it's 10% of the greater of your annual income or your net worth. So, you do have some limitations, and as you pointed before, it's across all your crowdfunding investments that you've done over 12 months.
So, it's measured along that.
Eric: So [00:32:00] now I had said earlier the maximum amount you can raise on an annual basis is 5 million. But there's a catch. You have to get a financial audit by an accounting firm. If you say, "Hey, I'm a startup. I don't wanna get a financial audit." Reg CF also works for you, but there's certain limitations.
Do you wanna go through those?
Andy: Sure. We'll briefly go through them. These days you can raise up, as you said, 5 million with audit financials. The, as of September 20th, 2022, the SEC, as you noted, did an inflation adjustment. So now you can do what's called reviewed financials, which is a lower standard than audited financials.
So, a lot easier to prepare and comply with. Usually, you do gap financials and then you have it reviewed by a third-party accounting firm. In that instance, you can raise now up to $618,000. Or excuse me, let me step back. 1.235 million you can raise up to, if it's [00:33:00] your second offering of a Reg CF you can with, if you're only gonna do reviewed financials, you can only raise up to $618,000.
And then obviously if there's something below $124,000, you can self -certify, but we don't see that anymore. During Covid, it was at $250,000 and we did see some of those, but that's thankfully no longer applicable. And again, just so I don't confuse people, it was 1.235 million up to for reviewed financials, if it's your first offering on Reg CF.
And this is your second offering on Reg CF and you're not doing audit financials, the max you can raise at $618,000.
Eric: I know I foreshadowed it in the in the opening, but we'll, let's just talk a little bit about the different strategies of using Reg CF and Reg D collectively. What have you seen that works particularly well?
Andy: Obviously
what we've seen. [00:34:00] People do, sometimes they do a mix of both. So, for example, they'll do a Reg CF offering to go after accredited and non-accredited investors, especially if it's towards their demographic and the product that they have is more towards that demographic is a great spot to be.
And they'll raise that because obviously as we noted, ease compliant costs, governance reasons, things like that, it's a great opportunity. But they also generally supplement it, whether it's before they do a Reg CF offering concurrently with the Reg CF offering or after with the Reg D or a section 4(a)(2) type offering for which they will raise separately to generally accredited investors. And so, we'd see a mix, like I said, on the private capital rise under either Reg D or 4(a)(2). That's usually done either in a private context with no solicitation. It can also be done obviously with a solicitation [00:35:00] privately also and then there's the third component, which you're seeing more and more of these days, which is a credit investor platforms that are out there that are, whether it's like a Seed Invest or a Republic or some others that are trying, doing these accredited investor platforms under communities for which they offer certain of these issuers under the platform for people to invest in.
You see it a mix, but, as I've always said, I view all these as not mutually exclusive. So, you can get as most people know, if they're early-stage issuers, you're looking to raise capital from all over. So, it's a great way to access different areas. So, you can do a Reg CF offering on a portal, you can do a private raise under Reg D, and then maybe you wanna do something on an accredited investor platform also through a third party and raise capital in a number
of different ways.
Eric: And so, one doesn't preclude the [00:36:00] other unless they find out about you through the crowdfunding. So maybe we talk a little bit about that.
Andy: Yes, you're right.
You can't, obviously, if someone learns of you, of your company through a Reg CF offering that's been on a portal, they can't go to you as an issuer and say, "Hey, I wanna invest in you privately" and you take their money immediately. You'd have to stop the campaign, wait 30 days. There's a bunch of different rules that come into place.
That's when you get counsel to give you advice. There are some rules and you gotta be careful of misstepping and falling into some securities traps that are out there. The other piece I just should have mentioned though, that's important, is you know, a lot of early-stage issuers, they don't start with a Reg CF
they've probably raised capital either from friends and family or through maybe some issuance of a SAFE or convertible notes or some small common or preferred before they get to that stage. And then they start, the process then of trying to raise more capital and that's when they look at kind of a CF and a private raise as well to supplement [00:37:00] that.
The other piece that's important with the Reg CF is just the whole community piece. So, it may not be as important from a financial amount side as far as what you're raising, but it's important to build a community, leverage your community, and build a following, which has a lot of great implications for you down the road.
As part of future raises and building a successful business as you
grow.
Eric: And that's a good segue into testing the water. So, don't you talk a little bit about what testing the water is and why is that important for Reg CF?
Andy: Yeah.
Testing the waters is sometimes called a reservation campaign.
It allows the issuer to, so to speak, test the waters prior to filing the Form C that's required for a Reg CF offering. A lot of times if you're going through a portal, you have a campaign page that goes up people can look at. It allows them to learn about your company, your product, the people behind it, investors, and a great way for them to get an [00:38:00] understanding and decide whether or not that something they'd be interested in once you go live.
So, they can make a reservation, which then is turned into an investment commitment. After it goes live, you have seven business days to do that. And you can convert into an actual commitment at that time. It is, for me, it's a wonderful opportunity to kinda market your company, get your company out there, a lot of eyeballs on it.
So, the bigger platforms obviously get a lot of eyeballs that look at these different products that go up or issuers that go up. And so, it's a wonderful way to get exposure. It is not only almost free marketing in a way. Because a lot of people are looking at, it, allows them to take a chan- look and evaluate before you actually go live.
The one thing that we have seen for us, at least anecdotally, and Eric, I'm sure you'll agree with this, is, we think testing the waters is important. We think that it helps kinda get you off and [00:39:00] running quick when you launch, which is important. So obviously there is some sites where, you know, if you get above a certain amount, you start trending.
That is where it catches people's attention. So, getting off to a good start, it's very important because if someone sees that you haven't raised much money in the first week or. They will tend to likely think that there's something wrong, what they're missing. It’s not that interesting and they may back away, but if something starts initially hot and starts getting up $25,000 or more right off the bat, someone's Whoa, that there's something there that's interesting.
I may fall. It is the hurt mentality a little bit, right? It is an important piece. And the only other thing I just wanna add quick is like for us testing the waters, we think it should be somewhere between two to four weeks. As far as time. Cause if you go too long, it can get a little stale, right?
Someone keeps going to the site, keeps seeing you’re up there, seeing the company up there is taking reservations, but then sees that nothing else is happening and says, "What's going on? Why is it taking so long?" You may forget about it, a whole number of [00:40:00] reasons, and so then that can cause additional, concerns from an investor.
The longer you go, the less effective it is. And so, from our perspective, a short two to four weeks is more than appropriate, we think, to just get some momentum, let people see it before they make the investment decision.
Eric: Yes, ultimately, I like to use the analogy of a train leaving the station, right?
Cause any time you are trying to raise money you, you're trying to get some momentum. People must believe that there's something exciting about it, and they're very well may be, but they also need sometimes to be convinced. So, if you're at a, at the train platform and you're trying to get wave people in from a field to rush to get the train if they start to come up to the train, they see rust forming on the tracks around the wheels.
That is probably not a good sign. They may be like, "You know what, I probably don't need to run for this train. Do you know what? I'll catch the next one." And you will be like "No, you gotta catch this one!" So, I think the same holds true with building that community base, testing the [00:41:00] waters, getting the momentum.
And again, the train analogies particularly apt when you're on a funding platform. That, there are people on those platforms, but what's gonna attract their attention? Which trains are they gonna try to catch? They are gonna try to catch the trains that other people are going on.
If they don't know all that much about any of the individual trains, you want to build some early-stage momentum going into it. Or else I will be like, "Hold it. I do, I really wanna be the first person on this train?" No. And that is a very helpful way I think of looking at it. Before we start talking about our connection for crowdfunding and even touching on digital assets again, what are some of the more popular Reg CF platforms?
We work we work with a number of them. Republic is very popular, the one that we see the most of, and we actually liked their platform. What are some of the other ones that, that we
Andy: there's Start Engine there's we funder, Seed invest, [00:42:00] Deal maker which has a little bit different variation to it.
There's a number of 'em out there and they're all have their pros and cons. Obviously you can talk to anyone and some will not like one, but they'll like the other. It's just, it's, there's different kinds. They're all similar in some respects, but different, as well. A Republic generally has its own kind of template that it uses.
We funder or Start Engine may offer more like an equity type of offering and just different review processes in all of 'em. So, they all have different flavors as far as it goes. But definitely an area that obviously is hotter. And I should mention, just as we're on the subject, obviously all these portals, the nice thing about a Reg CF versus kind of a Reg D or 4(a)(2) in many respects is you can access people
and get investments that are very low. So, you can go like $100, $150 from people. [00:43:00] Whereas obviously if you're doing like a Reg D or something like that, or a big section, 4(a)(2) type of raise, those are usually $5,000 and above type tickets which makes a big difference. To our point earlier, it's access and you're trying to tap as many markets and people as you can to try to raise money to help grow your business.
So, you wanna not exclude any areas if you don't have to.
Eric: And again, as we start to talk more about versus a digital asset or even just anybody who's an early-stage company, we are talking about primary issuance. We're not talking about secondary issuance. And one of the reasons why Digital asset ICOs or SAFS or what have you have been popular is because it provides the opportunity for people who acquire those tokens to, at some point engage in secondary trading without the issuer having to do a full-blown registration.
With [00:44:00] that now, I guess in question in the U.S., the Reg CF is a way to raise that capital continue in small increments, engage in non-accredited base, and engage your community. And it doesn't mean that if the regulatory environment in the US strains out in a way that you're not subject to that jeopardy, you couldn't take advantage of it later on you could arguably even provide for the ability to convert into a token that is a security or subject to an exemption from securities registration
at some point in the future. Again, that side of the market hasn't really taken off to date, but it might in the future. Certainly, going down this route one that engages your community could be a lot better than worrying about enforcement or even potential investors later on asking, "Hey, are you definitively not a security?
Why do you think you're not a security? Maybe we don't wanna touch it because there's we think you might be a [00:45:00] security." These are considerations that, that you now have to weigh. And as Andy noted before we are seeing an evolution in the kinds of clients that come to us thinking of creative ways to achieve the same objectives as they may have originally thought about with their initial token offering like a native token.
And this works particularly well when there's actually a clear revenue model, either, in the imminent or in the near-term future or one that they are building upon. So rather than leveraging revenue through a native token offering, maybe there's a fee or a commission for transactions occurring through the platform, again, assuming that they're not engaging in prohibited transactions.
So, we're also seeing traditional projects asking us about ways to incorporate tokens into their offering even though they're traditional equity, like maybe an NFT or some sort of perk that [00:46:00] can be offered. A lot of platforms have the ability to also offer these perks that just by virtue of being the owner or having purchased under the crowdfunding platform, you can take advantage of these things. This is why if you have a community, it becomes particularly compelling you can achieve some, maybe not all of the dynamics. Another inherent limitation though is the globalization. A SAFE or, or even something that's convertible into a, I guess an exempt from registration security in the future may not have that same global reach.
As if you were on an ERC 20 token that can trade worldwide. Again, hopefully there, there might be some regulatory respite in the future that you can take advantage of and structure into that might be one way of potentially looking at it. Again, these are these are considerations. It doesn't necessarily mean that a project has to say, "Oh, we're never gonna issue a [00:47:00] token or we're never gonna issue a native token."
It just says, "maybe right now isn't really the best way to do it. Maybe I can't, maybe I can't, I don't have that level of confidence that I've achieved sufficient, decent centralization such that a regulator won't deem me to be a security, won't deem the project to be a security." That's an important consideration.
As well. Some in the SEC would say if there's a group of people asking a lawyer about whether they can issue a token that's not a security, that's probably a good indication that they're not sufficiently decentralized since somebody has to make that decision to list again, these are unfortunate considerations. I've talked in previous podcasts about like the Wahi case with the s sec were the mere act of trying to put a token up for secondary trading on Coinbase was itself deemed to be an indicium, that it was in fact a security. Against that kind of regulatory backdrop, it's very hard to know
how things are [00:48:00] gonna, or how things are gonna roll for the small and early-stage projects. And honestly, unless something changes with some of the things proposed from a legislative perspective, I don't see that respite coming anytime soon. I'd love to be proved wrong though.
Andy: I would just add, obviously we, as I mentioned, I think at the beginning, we do have a few insurers who are taking the approach we're talking about and, raising capital for the holding company and reserving down the road, the offering of a token later on,
but at the same time working to build their community and using the CF to help them build their community. So, when they do issue the offering the token down the road, it may actually, they have a community that's already built and put in place, or at least has started to be put in place, which is very helpful for them.
And the other piece that also I wanna close loop on is we were talking a little bit about financials before. And what we do see at times is some people start with reviewed financials. So, they'll raise up to [00:49:00] 1.235 million and then they'll either switch to get an audit performed while that's happening, or they'll close that offering and then they'll do a subsequent one with audio financials to raise the rest up to 5 million. So, I just wanna make sure we mention those as part of our discussion and didn't miss those important points.
Eric: Excellent. Anything else we miss?
Andy: Nope. Nope, We're good.
Eric: Okay. So, I guess the upshot for everybody listening is we're bullish on Reg CF as providing for early-stage ventures.
We're bullish on it for being a temporary alternative for consideration for even digital asset space. We love when projects are able to combine both like a Reg D or 4(a)(2) at the same time as a Reg CF, cuz that gives the optimal amount. Of ability to raise the capital without having to go full through a full board registration.
And Reg CF is great for crowd. You want a community that's staked around you. [00:50:00] You need all the help you can get. I think it goes full circle to what Andy was saying early at the beginning of the podcast about knight. When the chips were down in their case, they learned how important their community was and those people believed they were staked in other ways.
But staking, you need all the help you can get to build it. It takes an army to build things sometimes and crowdfunding I think allows you to build out that army a little bit and in conjunction with, if you have strategic investors, you use other methods for that.
But again, I think when thinking, when approaching capital raising, I always say, I always say one thing to our clients early. It's like when we're talking about raising money, it's there's money and then there's money plus. And you always want money plus. Money plus is much better than money.
You want to have that exponential aspect. You want to have that multiplier on that money by having the right parties engaged.
Andy: I think you sum that up really well, Eric. [00:51:00] Clearly, smaller companies looking that are growing, you wanna try to raise as much capital as you can at any point in any avenue you can get.
Because the more money you have, the better chances you are gonna be successful down the road. And capital's hard to get. Most issuers of that stage will tell you; they spend an ordinate amount of time at raising capital. So, if there's ways them to really get a bunch of it and make it easier for 'em to raise capital so they can focus on running their business.
That's ultimately what the goal of all this is. And so, they have a much better chance of them succeeding in developing their business product and their community, as Eric pointed out.
Eric: Excellent. Anybody wants to learn more about what we do, we're at hesslegalcounsel.com. Obviously theencryptedeconomy.com, that's another website.
My email is Eric@Hesslegalcounsel.com. Go figure. Andy's is at, can you guess? I don't know. If you can't guess, then, I don’t know, I don't know what to, I don't know what to say to you [00:52:00] at this part of the podcast, but so anyway that's it and Andy, thanks for coming on and talking about crowdfunding and SAFEs.
Andy: Thanks.
Eric: Take care.
Andy: I enjoyed talking about it and obviously anyone has any questions or wanna learn more, feel free. Please reach out. We're very approachable and always happy to answer any questions and guide you along the way because it's not, there's a lot of Swiss and terms that you just gotta make sure you follow
to make sure you do it all correctly and properly.
Eric: Yeah, excellent point. I probably didn't emphasize that enough. It's if you're an early-stage company and you're thinking about, hey, can I use I was thinking about Native Token, can I leverage this to, to leverage a community?
What are some creative strategies that we can use to allow me to achieve some of my objectives without, running afoul of any regulation? Again, sometimes you have to be more thoughtful in devising this. Reach out, we talk, I take a lot of [00:53:00] calls and sometimes I just take calls because I help people.
There you have it. Thanks for listening.
Andy: Yeah, we're happy to help.
Eric: Yep, 100%. All right. Take care, Andy.
Andy: Thanks for having us. Bye.