By: 2 November 2022

Mat Goldstein from DealMaker breaks down the process of pressing ahead with an equity crowdfunding raise into three must-follow steps

Navigating compliance in equity crowdfunding

Recently, you likely saw that the US Securities and Exchange Commission (SEC) is charging Kim Kardashian with breaking its rules around investment promotions. At first glance, this seems to have very little to do with the compliance around equity crowdfunding and raising capital via Regulation Crowdfunding (Reg CF) or Regulation A (Reg A), but it is a surprisingly good example of ‘who’ is qualified to provide investment recommendations or testimonials and ‘what’ those individuals and/or issuers may be required to disclose.

Licensed broker-dealers may recommend investments in securities in the form of a research report, but they must do so only upon completing due diligence on the company and with the added responsibility of reviewing the recommendation’s suitability as required under Regulation Best Interest (Reg BI).

Licensed broker-dealers fulfil several important functions in the financial industry. These include providing investment advice to customers, supplying liquidity through market-making activities, facilitating trading activities, publishing investment research, and raising capital for companies. As the name implies, they perform a dual role in carrying out their responsibilities. As dealers, they act on behalf of the brokerage firm, initiating transactions for the firm’s own account. As brokers, they handle transactions, buying and selling securities on behalf of their clients.

First: You need a broker-dealer

Because of the regulatory environment and rules pertaining to offering securities to the general public and what must be disclosed when considering such an offering, it is crucial in the early discussions of your equity crowdfunding raise that you speak with a broker-dealer to understand the steps required to successfully launch your crowdfunding raise.

Kim Kardashian is not licensed or qualified to make any recommendations, but in this particular instance, she was engaged to promote the issuer and was paid for this promotion. Unfortunately, she was not advised that under federal securities laws, she was required to disclose the details of her engagement to the investing public.

“The federal securities laws are clear that any celebrity or other individual who promotes a crypto asset security must disclose the nature, source, and amount of compensation they received in exchange for the promotion,” said Gurbir S Grewal, director of the SEC’s enforcement division. “Investors are entitled to know whether the publicity of a security is unbiased, and Ms. Kardashian failed to disclose this information.”

Including a broker-dealer is good practice: they will provide you with the steps to consider for a successful crowdfunding raise—from compliance to distribution. While not a requirement under Reg A that you engage use a broker-dealer, as a practical matter, most issuers do engage one.

Engagement of the broker-dealer generally occurs at the outset of the raise. You will not likely go back and engage the services of a broker syndicate after the offering has commenced. Under the regulations, the broker-dealers involved in an offering are required to file with US Financial Industry Regulatory Authority (FINRA) and this information must be disclosed in the offering circular filed with the SEC.

In some cases, we’ve seen excluding a broker-dealer may result in the raise goals not being achieved. For example, an automobile company offering was a tour-de-force of consumer marketing, but the company ended its raise at $17m, even though it intended to raise $25m. Had the company included a broker syndicate, it’s assumed it would have easily raised the full amount—because there seemed to be broker-dealer interest in the offering.

Second: Regulations are there for your protection as well

The process of raising capital is not without some friction, but the filings and approvals are the checks and balances required to protect both your company and your potential investors. It’s critical that in the interest of moving fast and infusing capital into your business, you don’t unwittingly expose your company to additional risk. You could consider discussing additional directors’ and officers’ insurance or coverage if you are raising a substantial amount, and expect to add potentially hundreds or thousands of unaccredited investors to your cap table. 

Third: Plan ahead, because raising capital can take two to six months worth of pre-work

If you need a cash influx in a month, doing an equity crowdfunding raise will be a risky endeavour as the filing, audits, and approvals just simply take time. You need some runway. A good rule of thumb is to plan your raise four+ months in advance, so if you are still selecting which capital raise platform or tech you’ll leverage, just keep that in mind. 

We have also seen issuers give serious consideration to how much they are planning to raise. Setting this goal is more science than art, so read this piece by Jonathan Stidd, our resident expert for best practices around raising targets and cadence. 

Finally, there will always be cheap options in the market for you to consider. It’s worth noting that when the price is scaled down, so are the service levels, capabilities, and functionality. Sometimes, going with the cheapest option seems like a good idea at the time—until you begin to feel under-serviced or left on your own to figure things out. And with a crowdfunding raise, if you’ve never done one before, we don’t recommend learning as you go. It will be an expensive lesson.

Mat Goldstein - DealMakerMat Goldstein is co-founder and chief strategy officer of DealMaker, Canada’s third fastest growing company as cited in the Globe & Mail’s Report on Business. Named one of North America’s most innovative lawyers by the Financial Times and a finalist for 2022’s EY Entrepreneur of the Year, Goldstein is a proven cross-border leader. With a JD in both Canada and the US, the experience Goldstein brings to growing the DealMaker team is invaluable. His comprehensive background in decision-making and operational excellence drives DealMaker forward. Under his guidance, DealMaker is disrupting the private equity markets and democratising access to capital. 

Image sources: Canva and DealMaker