Many are familiar with the rewards-based model of crowdfunding popularized by websites like Kickstarter and Indiegogo. The basic idea is that a group of individuals — the “crowd” — contributes funds to a company or project in exchange for goods or services. This model has been attractive to wineries looking to capitalize on their ability to offer unique social benefits, such as discounts on wine, access to rare or special releases, and VIP events or services.
A set of new rules recently adopted by the U.S. Securities & Exchange Commission will expand the possibilities for crowdfunding by allowing businesses to sell equity to, or borrow money from, their supporters. Under these rules, set to take effect in May, a company can raise up to $1 million in any 12-month period from its friends, followers, customers and community via SEC-registered funding portals. Individual investors are permitted to invest anywhere from $2,000 to $100,000 — depending on their annual income and net worth — in a 12-month period across all crowdfunded offerings.
Unlike many of the SEC’s other fundraising exemptions, crowdfunded offerings are open to all investors, regardless of whether they are “accredited.”
With all the excitement of the new rules, it is important to realize that selling securities to the public is a highly regulated activity. There are a number of considerations that should be addressed before proceeding with a crowdfunded offering.
COST OF CAPITAL
Although the SEC removed the proposed requirement that issuers must submit audited financial statements, there are still substantial costs associated with a crowdfunded offering. For all but the smallest offerings, financial statements must be reviewed by an independent public accountant. In addition, given the significant disclosure requirements and the consequences of noncompliance, legal costs are likely to be high relative to the amount raised.
Funding portal fees, broker-dealer fees and marketing expenses also can add up. And since issuers are required to file annual reports following the offering, the costs will not stop at closing. With some investigation, however, you should be able to find entrepreneurial accountants, attorneys, funding portals and other businesses that offer these services for a reasonable cost and help bring transaction expenses in line with more traditional types of financing.
The new rules contain significant disclosure requirements, designed to ensure that you are as upfront and transparent about your business as possible. This means you will have to disclose anything that is material to your business, including financial statements, a detailed description of your business and business plan, information about your major shareholders and capital structure, risk factors, information about transactions with related parties, and major customer and supplier relationships. These disclosures must be made at the time of the offering and on an annual basis after the closing.
Since this information will be available for all to see, you will need to get comfortable with the idea that the public — including your competitors and customers — will have access to sensitive information about your business.
POTENTIAL LIABILITY AND SHAREHOLDER RELATIONS
Any investor in your offering may bring an action against you for material misstatements or omissions in connection with the offering. For example, a misstatement in your disclosure documents, an error in your financials or an off-handed comment by one of your directors or officers could lead to liability. If you are found liable, you could be required to pay damages or return all the proceeds of the offering to the investors.
Be prepared to devote some time and personnel to managing shareholder relations. From the minute you close your offering, you will have potentially hundreds of new shareholders, many of whom will be unfamiliar to you.
For wineries that are family-owned or otherwise closely held, this could be a rude awakening. Your new shareholders may be unsophisticated or have unrealistic expectations about the performance of their investment. They may be more likely to bring a claim against you for a perceived breach of fiduciary duties or mismanagement of the business.
CERTAINTY OF CLOSING
When you launch your offering, you will have to set a funding target. If you fail to meet that target, you may not keep any of the money raised and will have no ability to recoup out-of-pocket costs. Moreover, even if you hit your funding target, investors must be given at least 48 hours to rescind their support prior to closing.
Therefore, it is important to set realistic funding goals and aim to exceed them so you have a buffer in case any investors change their minds.
The new crowdfunding rules offer exciting fundraising opportunities that have never existed before. Thinking through the issues discussed above is the first step to having a successful and efficient transaction.
Jesse Debban (firstname.lastname@example.org) is a business transactions partner at Farella Braun + Martel, a law firm with offices in San Francisco and St. Helena. Debban advises clients on a wide range of transactional matters, including mergers and acquisitions, joint ventures, asset sales and securities offerings. Vine Notes is a monthly column by Farella Braun + Martel and Rabobank.