The SEC has granted AngelList relief on accepting transaction based compensation for crowd funding, exempting it from the broker-dealer rules. A couple days ago, the SEC granted relief to thefundersclub.com. Makes you kind of wonder what is going to happen next.
These holes in the broker-dealer-rules are big enough to drive a truck through. Since they are based on granting the crowd funding site a carried interest, they will cost founders a lot of money. FINRA registered broker-dealers might charge 6% plus some warrants, not a 20% carried interest. Founders should be saying “Ouch.”
To provide persepctive, a crowd funding platform may have to register with FINRA as a broker-dealer if it accepts commissions or their equivalent from the sale of securities because that makes the crowd funding site a broker-dealer. Otherwise stated, when a crowd funding site collects money from investors or the issuer, it has to be sure it is not transaction based compensation which makes it a broker dealer, requiring FINRA registration. The crowd funding sites always collect money sometime, and hence the requests for no-action relief.
For those of you interested, in this paper we examined the perils of dealing with unregistered broker-dealers such as other crowd funding sites that may be broker dealers and the consequences, along with other ground rules for raising money for start-ups.
Note in this case AngelList represents it was going to register with the SEC as an investment advisor, but that is different from registering with FINRA as a broker-dealer. Among other things, this distinguishes thefundersclub.com, which represents it is exempt from registration as an investment advisor as a venture capital advisor under the Dodd-Frank Act.
AngelList Advisors proposes to offer investors two investment models in which to invest in an Investment Vehicle on its platform: one is called an “Angel Followed Deal” and the other is an “Angel Advised Deal.” In an Angel Followed Deal, the Lead Angel will not be required to take an active role with respect to advising the Investment Vehicle or the Portfolio Company, and may not even be aware that it is being “followed” by the other Investors. In an Angel Advised Deal, the Lead Angel will be aware that it is being followed; and will agree to take an active role in identifying the investment opportunity, leading negotiations with the Portfolio Company, and providing (or offering to provide) significant managerial assistance and financial guidance to the Portfolio Company. AngelList represented that the Lead Angel will not provide investment advice to the Portfolio Company, AngelList Advisors or Investors, unless it is appropriately registered as an investment adviser with the SEC or a state securities authority, or is properly exempt from registration as an investment adviser.
AngelList Advisors represented that it will not receive a commission or management fee as compensation for its advisory services, but will be entitled to receive compensation (i.e., carried interest), as described in each Investment Vehicle’s offering documents. This compensation would be equal to a portion of the increase in value, if any, of the investment as calculated at the termination of the investment in the Investment Vehicle. Under the Angel Advised Deals, the Investment Vehicle will also provide the Lead Angel with compensation based on the overall profitability of the Investment Vehicle. AngelList also stated that AngelList Advisors may, upon distribution of the Investment Vehicle’s assets, be entitled to recoup any initial expenses it paid in the formation ofthe Investment Vehicle.
Let’s thank the SEC for their advice on these two matters which will undoubtedly lead to capital formation for small businesses. But a piece really missing is we need SEC guidance on whether these models constitute a general solicitation, destroying the private offering exemption.
In the meantime, what are practitioners to think? These entities broadly advertise their wares on the internet, and the SEC must be aware of that. When will the SEC (hopefully) state this is not a general solicitation?
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