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11/15/2013 McKinsey & Co - Why crowdfunding appeals to the Middle East
12/30/2013 KQED Radio - Richard Swart - A How-To Guide to Crowdfunding 12/20/2013 Gulf Times - Silatech Hosts Seminar...

2nd Annual UC Berkeley Crowdfunding Symposium - LIMITED TICKETS

The UC Berkeley 2nd annual academic symposium on crowdfunding will be held September 11th & 12th. Like the first, this gathering will bring together academics, practitioners, and policy makers. This symposium will take a global look at the developing phenomena of social finance for SMEs and Innovation - whether strictly “crowdfunding” or more broadly the application of social finance mechanisms including Peer-to-Peer lending, Peer-to-Business lending, and all other forms of crowdfunding and crowdfund investing. Since the 2013 conference, the number of platforms has more than doubled, and despite significant delays in enacting rules to allow equity crowdfunding in the United States, many nations have adopted laws and rules to allow crowdfunding.Screen Shot 2014-08-05 at 12.29.20 PM

There has also been significant interest from NGOs, Foundations, Philanthropic groups, universities, and other groups in the application of crowdfunding mechanisms to solve both complex global challenges as well as fund hyper-local programs. The conference will begin with lunch on Thursday, September 11th and includes dinner that evening. It concludes in the afternoon of September 12th. Consistent with the model from last year, distinguished scholars will present their views during moderated panels, as well as top thought leaders internationally. This format allows for the exchange of best practices, questions and research insights from leaders in the international community.

Tickets are $99 for academics and $199 for nonacademics.  Tickets are reserved and must be applied for.  In order to apply, please contact Richard Swart at This email address is being protected from spambots. You need JavaScript enabled to view it.

3 Key Takeaways from the LendIt 2014 Conference

What a difference a year makes.  The 2014 LendIt conference had nearly 1,000 attendees and 100 online lending companies represented in the space – nearly 4 times the 2013 event.   What was also interesting is that over 50% of the attendees classified themselves as professional investors.  While there were many interesting speakers and sessions (LendIt will make these available online soon), here are three of the topics that garnered a lot of interest at the conference:Screen Shot 2014-05-08 at 8.51.41 AM

  1. P2P is no longer an accurate label/descriptor for onlineNew players and verticals have emerged in the space. Financial institutions are rapidly entering and helping lending platforms achieve scale. As such, P2P is no longer an accurate title.  During a presentation on the $1 Trillion dollar market size of this industry, Charles Moldow, of Foundation Capital, suggested using “Marketplace Lending” instead of P2P lending to better describe the phenomenon because it is a new online market with many types of participants to source and use credit products.   This is the term I will use going forward to describe this market. 
  2. This is not a winner take all market (Amazon), nor is it a free-for-all (Groupon).  While there will be consolidation in the market, unlike Amazon in e-commerce, there will an ecosystem of funding sites that will continue to exist andThis is due to the high barriers to entry in the market including regulatory burdens and scale required to break even. Several speakers indicated that platforms needed to reach at least $1B in origination to reach break even.
  3. The UK and German marketplaces continue to experience massive growth and are interesting to watch for lessons learned to apply in other markets.  While the traditional lenders largely ignore them companies like Funding Circle, Ratesetter, Assetz and Zopa, continue to experienceThey are seeing more than twice the annual growth in loan originations, while maintaining default rates of between 0.7%-1.7%.  While these platforms began as peer-to-peer or peer-to-business lenders, they now (to varying degrees) are seeking institutional capital while they scale up inventory and operations.  Also, unlike some of the marketplace lenders in the US, they cap their gross yields at 12-15%.  In the case of Funding Circle, the SME lending platform, the UK government continues its program of co-investing in certain loans to UK businesses as a way to support lending to SMEs that traditional banks continue to refuse to do. 

A year from now, it will be interesting to see the developments that will have taken place in this market, the development of secondary markets, the securitization of these loans, the globalization of platforms and the development of an ecosystem of companies that will support advances in underwriting, due diligence and transparency.    If the marketplace lending space were a 1000 page novel, I’d say we were only at page 70 today.  

Hey Oculus Twitterverse, You're Angry at the Wrong People

Last week Facebook announced it would acquire Oculus Virtual Reality for US$2 billion. 18 months earlier Oculus used crowdfunding platform Kickstarter to raise US$2.5 million from supporters. Unfortunately, none of those backers were equity holders. Owning equity in Oculus wasn't an option for these supporters because the JOBS Act, which was signed into law in April, 2012 and legalizes the ability for companies to use crowdfunding platforms to sell debt or equity, hadn't gone into effect yet. (It still hasn't 2 years later). Outside of Kickstarter however, there were some seed investors that were able to invest in Oculus at a $2.5M valuation.  So you can understand why there are some pretty upset Oculus Kickstarter backers whose dollars didn't earn them an 800x return like the investors but feel they are partially responsible for the success.   

This is not another rehash of the Occulus acquisition by Facebook.  I am only focusing on one thing; misdirected anger. Occulus and Kickstarter did exactly what they offered in their kickstarter campaign. They didn't create the laws that prevented people from investing in private companies unless you are the wealthy 1%. They also didn't create the laws that made it illegal to use kickstarter-like platforms to raise equity for a business until the JOBS Act goes into effect.

It is time to stop directing their anger at Oculus or Kickstarter. Instead, supporters should shift their dismay to the group that prevented them from making an investment in that company (that had the chance to reap a financial gain in the process) in the first place: The Securities and Exchange Commission (SEC).  If the SEC had moved faster to write and approve the rules for equity crowdfunding for unaccredited investors (a.k.a. the vast majority of people living in the U.S.), then Occulus could have made the decision to raise money via either equity or debt crowdfunding (likely equity since it had no revenues or prospects for very near-term revenues to support a debt repayment).  IF they had made this decision to raise money via equity crowdfunding and IF individuals made these investments, they would have reaped the same rewards as other stockholders with the same class of stock.  

My point in not to say that everyone is going to get rich on investing in startups.  My point is that if the SEC had moved more quickly in their rule making progress (remember, it is now 2 years since the President signed the bill), tens of thousands of businesses and startups across the US could have had new options to consider in raising capital for themselves. This would have created more jobs and innovation for our economy and potentially other companies that might have created a financial gain for their investors. Not the "truth is stranger than fiction" type of returns Oculus delivered, but returns (via equity or debt investments) none the less. Let's congratulate innovation and hard work and let's direct the frustration with the inability to make investments in startups and private companies, at those that can can help alleviate it.  

If the SEC will move forward and issue final rules that provide companies with the opportunity to raise capital, other companies will have a shot at building their vision and regular investors will have the chance to be a part of it if they choose to be.  

PLEASE NOTE:  It is entirely unlikely and insanely rare for a company to sell for $2B in less that 2 years (or ever, for that matter).  Historically, most startups fail and historically, most people who make investments in early stage companies or small businesses loose money. Making investments in startups and small businesses is very high risk and if one chooses to make these high risk investments, they should be limited to a very small percentage of their total portfolio.  

Why is September 24th a Huge Day for Entrepreneurs? Title II of the JOBS Act and Crowdfunding for Accredited Investors Begins

More Investment Money Means Potentially More JOBS!

On September 24th, there will be a sea change in how entrepreneurs can seek money from early stage investors - one of the largest changes to securities laws in 80 years.  On September 24th, Title II of the JOBS Act (a seven-part Act signed into law by President Obama on April 5, 2012) goes into effect.  Here are the key questions to be asking.

             

Screen Shot 2013-09-20 at 7.52.19 AM

 

Question: What is the change is that is going into effect?

 Effective as of September 24, 2013, Issuers of shares (under New Rule 506c) may use general solicitations and general advertising to effect a private placement. Prior to this any public means of communication like magazines and television were excluded from avenues for raising money for companies unless they were public. You really needed to know someone who was raising money in order to invest. There must have been a pre-existing relationship. Now that pre-existing relationship doesn’t have to be there. So businesses can reach more potential investors, faster, via the Internet and social media.

Now private companies can use those mediums as well as the Internet and the social network to reach millions of potential investors.  This reverses an eight-decade-old law. 

Question: Can anyone invest?  Is this crowdfunding for unaccredited investors that we’ve been hearing about?

No, not anyone can invest. While anyone can see the solicitation for funds, the completed sales, must only be to “accredited investors” and the Issuer (the company, broker/dealer or 3rd party Web platform) has the burden to verify that the investor is “accredited.” An accredited investor is someone who makes over $200,000 for the last 2 years or has a liquid net worth of $1M.  Crowdfunding for unaccredited investors is still waiting on the SEC to come out with the proposed rules. Unaccredited investors that might see these solicitations cannot invest in these offerings. Companies accepting funds must be careful to verify accreditation.

Question: What is the maximum amount that can be raised?

Unbeknownst to many people there is no cap on the amount that can be raised.  While this has always been there, the ability to use the Internet to reach more investors has the potential to lead to a lot more investment money. This influx into the economy could be a boon for businesses and jobs. This can be beneficial for startups, small businesses and even Venture funds.

Question: What are the risks?

There are many. 

    1. First, as with any investment there are no guarantees that you will see a return, that you will get your money back or a timeline attached to if and when you see a return.
    2. Second, there is no review of the offering by the Securities and Exchange Commission. Solicitations can be online or offline and made to any potential investor. While forms need to be submitted to the SEC, there is no requirement for review of the offering by any State Securities Commission. Since State Securities police the markets there is an opportunity for fraud.
    3. Third, this is really buyer beware.  Investors need to be cautious before they invest.  Investors should only invest in people they know and trust and opportunities they believe in. They should take time to educate themselves about investing in the private markets and understand that in many cases the securities they buy will not be liquid, meaning they are not converted into cash easily.  As a matter of fact in many cases you might have to hold on to them until the business sells, merges or goes public.

             Question: What are the benefits?

The majority of wealth in corporations happens at their early stage.  While there is a tremendous amount of failure after 5 years, companies that succeed not only create a vast number of jobs but a return on investment that exceeds many other investment opportunities.  That being said, investments into high-risk companies like startups and small businesses should never equate to more than 10% of an individual investor’s portfolio.

DRILLING DOWN

  1. What does this change mean?

    1. Issuers can reach moreWhy is this important?
      1. According to the IRS there are around 6M accredited investors in the USA.
      2. According to the Angel Capital Association:
        1. Only 10% of them invested in private companies
        2. However, those investors pumped $23B into those companies
        3. With the lift on the ban the potential to reach every 1% more of accredited investors represent another $2.3B into the economy and jobs
  1. Is this Crowdfunding?
    1. Crowdfunding is using the social network to solicit funds for an idea via an online platform likeIf a website like this is used under the new law and the solicitation is targeted to accredited investors, you could consider this the first wave of equity or debt-based crowdfunding.
    2. However the change in the law does not require the use of websites to facilitate theWe think this might be problematic because crowdfunding websites bring transparency to the process by forcing all the documents related to the offering online.  This means there is a digital footprint of everything that happens.  Digital footprints have been shown to increase transparency since people are afraid of repercussions.  Not having a footprint of what people are offering or saying can lead to problems.
    3. When Title III of the JOBS Act goes into effect, businesses will be able to solicit both accredited and unaccreditedHowever there is a $1M cap on how much issuers can raise as well as caps on how much investors can risk.  In what just went into effect, there are no caps on issuers or investors.  This means investors can lose a great deal if they aren’t careful.
    4. By not forcing this to happen on SEC registered websites, it might be difficult to police theTitle III of the JOBS Act requires that these transactions take place on websites that are registered with the SEC.

EDITORIAL

Net-Net This could be a huge influx of capital upwards of $2.3B for every 1% more of accredited investors that begin to invest in private companies.

  1. All issuers and participants in the offer and sale of securities who may elect to utilize the new freedoms afforded by Rule 506(c) should proceed carefully and to generally solicit and market the offering of unregistered securities in a manner that doesn't draw unwanted attention.
  2. Issuers should consider hiring a law firm like Ellenoff, Grossman and Schole to review their documents and assist with filing their forms with the SEC.
  3. Issuers should consider listing their offerings through an “accredited investor crowdfunding platform” like SeedInvest that can help them follow the steps to be compliant.
  4. If you are an entrepreneur and you have never raised money before, you need to EDUCATE yourself before you getThere are resources:
    1. Success With Crowdfunding– Provides online step-by-step training and education including:
      1. Introduction to Crowdfunding
      2. Title II for Issuers
      3. Title II for Investors
    2. Crowdfund Investing for Dummies – Lays the groundwork for raising money using the Internet and is a resource for issuers looking to raise money from both accredited and unaccredited investors.

The Law

This isn’t easy.  Companies trying to raise money will have to work for it.  Here’s a breakdown of what issuers need to confirm.  (Some of this is repetitious to above).

  1. All solicitations must be accurate
  2. Companies need to make sure each potential investor receives a full private placement memorandum (these require lawyers and can cost at minimum $25,000) so this will likely mean that people using this means of raising money will be raising more than $500,000
  3. Companies, as mentioned above, must verify each investor is indeed “accredited”
  4. Form D will be expanded and require addition information including:
    1. Issuer information
    2. Issuer website
    3. Type of securities
    4. Details about purchasers (individuals or entities)
    5. Use of proceeds
    6. Description of general solicitation
    7. Description of verification methods
    8. File Form D within 15 days before general solicitation begins
    9. File an amendment to Form D within 30 days after completion of the offering
    10. Include a legend in offering materials for generally solicited deals
    11. For a period of two years, submit offering materials to the SEC for review and analysis (these materials will not be available to the public via the SEC website)
  5. For the first time in history the ban on general solicitation is lifted.
    1. No need to engage a middleman, no need for a broker
    2. However, they can only take funds from accredited investors.
  6. Prior to this change accredited investors self-certified their status
  7. Now the burden of certification falls on the shoulders of the issuers
    1. Con – Investors might not want to release their privateIssuers might not have the manpower to read through all the documents to confirm accreditation.  If issuers do not follow reasonable verification procedures, they may be in violation of the 1933 Act resulting in significant penalties, including rescission rights on behalf of investors.
    2. Pro -  Accountants or lawyers can act as the proxy forThere is talks about US Treasury creating a plug-in to the IRS tax tables for investors to print off a government issued accreditation certificate which would solve this problem

Crowdfunding: Income or Gift

Although Internet based crowdfunding has been around for at least five years, a large degree of ambiguity still exists around how to file taxes for money raised. With no definitive ruling from the IRS as to how crowfunded money is to be taxed, the burden of making sure that everything is in order rests completely on the head of the person (or entity) raising the funds. This is a scary responsibility to take on for most people raising money via crowdfunding. However, listed below are some recommendations by experts in tax law, whom we interviewed, that should help to simplify the task. (Disclaimer- These are general guidelines and should in no way replace the advice of a professional accountant):

Are rewards being issued?

The majority of campaigns are being hosted on reward-based platforms. Depending on the structure of the campaign and the level of donation, the rewards offered may be intangible, such as a thank you e-mail or an honorable mention on the company’s website, or it may be tangible, such as a small token of gratitude or a pre-sale of a product. Tangible gifts may include products or services.

If the perks are not tangible then it’s not taxable, as no sale has occurred. In this case, donations are considered gifts, which according to the IRS, is the responsibility of the giver. This donation is not taxable up to $14,000 per person for a single donor or $28,000 per person for married couples.

If the reward is diminutive compared to the amount given, such as a gesture of gratitude, then no transaction has taken place. For example if a funder were to donate $50 and they were to receive a mug or a calendar as a thank you, this would not count as a transaction but rather a gift.

If the rewards issued are tangible and comparable to what the market price would be for that good, then it is a business transaction, and any profit derived from the sale is considered taxable income. If production expenditures match or exceed business earnings, then you may not owe anything. In other words, if the difference between the amount received and the cost of providing the perk/merchandise comes to zero or less, no tax payment is required.

If you are a registered non-profit organization or are partnered with a non-profit organization, and have applied to the IRS for tax exemption status, then you will owe no tax on income earned.

Does the reward have a well-defined market price?

If the reward has a well-defined market price and is being pre-sold or sold at a comparable price, your state government may expect your customers to pay a sales tax. Check your state laws regarding sales, particularly concerning Internet sales. (http://www.nolo.com/legal-encyclopedia/50-state-guide-internet-sales-tax-laws.html)

Are you an artist?

Pre-selling or offering up as a perk paintings, movies, publications, or other forms of physical media where the amount donated to receive a particular perk is comparable to the market price of the good may be subject to a sales tax. 

If you are offering a reward where your costs of production are less than the amount earned through crowdfunding, then the profit is considered income and is subject to an income tax.

However if production costs exceed the amount received then no income is earned and income taxes are not applicable.

If producing an audio record, for example, and all the money received go to studio fees, no taxes have to be paid. Any income, meaning any monetary gain derived after considering the costs of production, is subject to a tax.

Are these funds being raised for a charity or registered non-profit organization?

The IRS lists the types of organizations that fall under charity and non-profits that qualify for tax exemption as well as criteria required to achieve exemption. Note that even if an organization is recognized as a non-profit it is the organization’s responsibility to apply for recognition. (http://www.irs.gov/Charities-&-Non-Profits/Types-of-Tax-Exempt-Organizations)

Donors can only receive tax deductions if they donate to a registered 501(c)(3) non-profit organization or a qualified charity organization. If a perk was received, the donor can only deduct the amount that exceeds the market value of the perk. (http://www.irs.gov/uac/Eight-Tips-for-Deducting-Charitable-Contributions) Donations to a cause, unless associated with a non-profit organization or qualified charity organization is not tax-deductible.

Did you raise more than $200,000 from more than 200 transactions?

Crowdfunding platforms do not handle any of the monetary transactions; those services are outsourced to third parties such as Amazon Payments or PayPal. The IRS therefore requires that you fill out form 1099-K, which ensures that online sales are reported and allows the IRS to track transactions for tax purposes. You should receive Form 1099-K upon earning $200,000 from 200  transactions. (http://www.irs.gov/uac/Form-1099-K,-Merchant-Card-and-Third-Party-Network-Payments) If you don’t receive a form, contact the company that processes these transactions to make sure a form hasn’t been filled out for you.

Do you have international donors?

Backers should not have to worry about customs fees because backers are making donations and not necessarily purchasing goods from retailers.

One difficulty may arise your campaign includes perks that fall under multiple taxation criteria, whereupon best judgment based on the information above must be made. Regulations associated with crowdfunding are still under development, but it is the campaigner’s responsibility to evaluate the appropriate criteria for taxation. 

Special thanks to Ron Worsham, Associate Professor of Accounting at Brigham Young University, and Randy Stucki, Audit Intern at Ernst & Young