Rules are always changing in the crowdfunding space. Make sure that it is the best way for you to raise private capital by understanding the mechanics of this process. In this episode, let one of the leading Crowdfunding and FinTech attorneys, Mark Roderick, get you up to speed with the new laws and technology, and how the internet has disrupted this industry. Mark also talks about three flavors of Equity Crowdfunding and the rules for each type. Get an investor’s point-of-view and determine factors that dictate how much money you need to raise.
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Understanding Crowdfunding With Mark Roderick
We are going to be changing the name of the show. I’m going to change the name to reflect my book. If you ever purchased my book, the number one bestseller on Amazon. Please go to Amazon and look it up. It’s called Real Estate Without Renters. That’ll be the new name of the show. That’s good news there. I’m excited about this particular topic. I find it very intriguing and so much has changed in the industry. The last time I raised private capital to what’s going on now is crazy and it’s tough to keep up with. There have been some amazing changes in that industry. I’ve got an expert on here that is going to guide us through many of these topics. It’s going to be something you are going to be interested in. At some point in time, all of us run into situations where we want to build our business. That requires capital many times. What’s the best way to do that? How do we raise capital? I’ve got a Crowdfunding and FinancialTech Attorney expert on, Mark Roderick. Mark, how are you?
I’m doing very well. Thank you. How are you?
I’m doing great. Thank you so much for taking the time out of your busy schedule to participate in the show here. What a great topic for people. I’ve been training people on the note business for many years and before that, in the real estate business. I’m in both and inevitably get people who build up a business and then it becomes, “I can’t expand unless I get some capital,” and things have changed now.
They have changed. The word to describe why they’ve changed and how they’ve changed is the internet. What I do is crowdfunding. I always say fortunately there are a lot of complicated legal rules because otherwise, who would hire me? I’m not very interesting and I’m not very good looking but I know the crowdfunding rules. For all the legal rules, it’s the internet. That’s what this is about. If you think about other industries like Amazon, Airbnb, Hotels.com, Uber and all these other companies, they’re all just the internet. The internet over the years is disrupting and transforming a lot of businesses. No matter what the industry is, the specific service or product being offered, the internet directly connects buyers and sellers. Whether you’re buying books on Amazon or cars or making a room reservation on Hotels.com or you’re an entrepreneur raising capital, the internet gives you a way to connect with your buyers and your customers anywhere in the world right away. That’s all that’s going on but it’s a huge deal that’s going on.
I was doing a presentation and one of the things I was talking about in the industry that I and most of my audience are in, which is the real estate and real estate note industry. I used that word disruptor. I look back at how things changed in the note business specifically. I was talking about the fact that it didn’t happen smoothly. It seemed to happen in dramatic shifts. When I drilled it down, what I noticed was new laws and new technology is what it all comes down to. That’s what you’re talking about here. There have been some new rules that allow you to create certain funds or crowdfunding techniques. The accredited and non-accredited has changed, but also the platform, being the internet, where people can go direct. It’s an amazing thing to see. If somebody at that point where they want to start thinking about raising capital, do you have two or three questions that they should ask themselves to see if they want to proceed with raising capital and what that might look like?
The two or three might append to ten or fifteen. It does depend on things like how much money you were trying to raise and from whom you are trying to raise it. In particular, whether you’re okay with sticking only with accredited investors or also want to include non-accredited. It’s not really fifteen questions. It is a couple. It’s how much you’re trying to raise?
There are positives and negatives in everything. You can almost raise too little money if you’re not going for enough money sometimes. That’s harder than raising a lot more money. What are your thoughts on that first question?When raising capital for your business, you should raise as much money as you can justify spending. Click To Tweet
My answer is always idealistic. You should raise as much money as you can justify spending. Sometimes people ask me, “Mark, you’re my lawyer. How much should I raise?” I say, “I’m just the lawyer. What is your business plan?” Sometimes that question, “Do I have a business plan?” The question of how much money do I need forces people to get up, open their Excel spreadsheet and figure out. How are you going to use the money? Sophisticated investors, which is admittedly not every investor, they want to see how much money you’re going to use and where it’s going to take you. Let’s say you’re opening a restaurant. If the money you’re raising only takes you to not quite opening the restaurant, then your investors are throwing their money away.
An unopened restaurant and $2.25 gets you on the Subway. Sophisticated investors want in that restaurant example to see that you’ve got enough money to open, you’re going to be cashflow negative for some months. They want to see that you’ve carefully thought those things through. In general, businesses always need more money than you think they’re going to need. Once you’ve carefully figured it out, add and rounded it up by 10% or 20%. It’s both an art and a science. The question is, what do you need to have a viable business?
Some of them can be specific where we want to buy this commercial building or we want to build this commercial building and then lease it out where you can raise funds for a specific project. There’s also the open-ended of a fund where we want to buy as many of single-family homes or in my case, notes that we possibly can get. Without a business plan, how are you going to attract investors?
In your case, you have a relatively easy business in that respect because if you raise $10 million, you’re going to buy $10 million in notes. If you raise $500,000, you’re going to buy $500,000 of notes. If you’re starting a restaurant and you’re buying an apartment building, you can’t say, “I need $5 million to buy the apartment building.” If I only raised $2 million, “I’ll only buy 20% of the building.” It doesn’t work that way. Your business is a great business for raising money when you don’t know how much you can raise.
As far as the accredited and non-accredited investors, give us the brief definition and then benefits and drawbacks to attracting one party or the other or both.
If we’re talking about individuals as investors, an individual is accredited if one of two things is true. Your income reaches a specified level. Either $200,000 yourself or $300,000 with your spouse or your net worth is at least $1 million without your home. Those two things. There are a whole bunch of other corporations, partnerships, LLCs, trusts that each have their own little definition of accredited investors. Most of the time, we’re talking about individual investors as opposed to the pros and cons. The reality is that almost all the time, it is simpler, faster, cheaper, easier to deal only with accredited investors. That’s not a coincidence. The American Securities Laws since the 1930s, when they were all put into law have one fundamental concept. It’s that rich people can protect themselves.
They can hire expensive lawyers and accountants. Rich people can protect themselves, poor people cannot protect themselves. They need the protective arm of the government around their shoulders. That system has worked pretty well. When you’re dealing with accredited, there are no rules or far fewer rules. That makes it cheaper, simpler, faster, etc. If you can do it with only accredited, it’s usually what you should do. However, there are some businesses, not note buying, like my restaurant example where it makes total sense to include non-accredited investors because they’re going to be your customers. Under the new Crowdfunding Law, every customer that walks into your restaurants, you can put right on their placemat, “Become part of our team, invest in our company.” You’re getting 300 people a day, potential investors sitting down and looking at your advertisement. In that case, it makes a lot of sense to go to the extra trouble to allow non-accredited investors. That is the exception rather than the rule. General accredited investors are easy and they have more money.
You need potentially fewer of them versus a lot more of the non-accredited. This term crowdfunding now has taken on some broader definitions. You’re using it in that context of crowdfunding, of raising capital. There are several different ways that you can apply a business type of entity to crowdfunding, correct?
Yes. Let me be a little more accurate. The next time you were at a cocktail party and someone says, “What is crowdfunding?” You can say, “Crowdfunding is anytime you’re raising money using the internet.” You sound sophisticated. Only attractive women come over and talk to you because they love securities lawyers. Within that very broad universe, there are two kinds of crowdfunding. There is donation-based crowdfunding or rewards-based crowdfunding. That’s Kickstarter, Indiegogo, GoFundMe and others like it, where people are making gifts to you. You put your ad up on the side, “I have a great idea. I’m a nice person, please give me money and in exchange, I will give you a baseball cap. I will give you a free watch if they are ever developed,” but it’s donation-based.
The other world where I spend all my time is what we call equity-based crowdfunding. That is where people are making actual investments and expecting financial returns. That’s where all the laws are because that’s what securities laws are all about. People are making investments and how do you protect those people. Within the world of equity crowdfunding, then there are three flavors of equity crowdfunding, each with its own special rules. That’s why companies need people like me who know what all those rules are.
What are the three flavors of crowdfunding then?
We referred to them using the word Title because when laws are passed in the United States, the different pieces of the law are called Titles. The law that created crowdfunding was called the JOBS Act, signed into law in 2012. Within the JOBS Act, there is Title II, Title III and Title IV crowdfunding. Title II is Accredited Investors Only. As I suggested, there are no rules. It’s basically Wild Wild West except for the one rule that all your investors have to be accredited. You can advertise to anybody but you can take checks only from accredited investors. I’m going to skip Title III and you’ll see why. Title IV is very similar to a public offering. You can sell to non-accredited investors, but the arm of the government is coming into the picture frame in the form of the requirement that you register your company with the Securities and Exchange Commission. That means going through a long and sometimes arduous and relatively expensive process with a lawyer like me to get your offering approved by the SEC. Title IV is like a Public Offering, also referred to as Regulation A to avoid confusion.
There’s Title III, also referred to as sometimes Regulations CF or Regulation Crowdfunding. The reason I leave it for last is because it’s such a new and unusual animal in the world of American Securities Laws. Unlike anything that came before it, you are allowed to raise money from non-accredited investors, all those widows and orphans. To limit the damage you can do as an unscrupulous company, the rules under Title III Crowdfunding impose very strict limits. They imposed limits on how much money you can raise. They imposed limits on how much each person can invest, which is a very small amount. They have this elaborate set of rules about how the website where these companies are offered, how that website has to function. Title III, is very unusual. It’s an experiment and for the first time, allowing you to raise money from non-accredited investors without all the protections built into a public offering. Because it’s an experiment, they included all these limits. That’s Title II, Title IV, Title III and again, by far the easiest, cheapest and fastest is Title II.
Title II, that’s your Regulation D, am I correct on that?Rich people can protect themselves, poor people cannot. They need the protective arm of the government around their shoulder. Click To Tweet
Another word for it is Rule 506(c) and it is part of Regulation D. People use all different words to describe these things.
Regulation D was very popular years ago. A lot of people did that through private placements and such. We’re looking at attracting those Accredited Only Investors. You’d run into that stumbling block and once again, if you don’t have a very good business plan and a model that can attract those investors, they’re going to be quick on it to say, “You don’t have enough or it’s not the right thing. I don’t like the management that’s in place. I don’t think you have the experience for that.” With some of these newer regulations, when did Regulation A, in particular, come about where it allows you to do more things in the Regulation D attracting both parties and some restrictions but an ease on the restrictions as well? That’s the newest. Some of the new rules on that?
They all became law in 2012. They were all the law by its terms delay the effective date until the Securities and Exchange Commission had issued Regulations. Title II, the Accredited Investor Only became effective in September of 2013. Regulation A or Title IV became effective in June of 2015 and Title III became effective in May of 2016. Title II has now been a couple of years. It seems like a long time.
They made some modifications along the way or the SEC finally figures out, “Here’s how we’re going to implement this or restrict this.” Putting myself in the place of someone who might be reading and say, “How would I get started in this?” It comes down to so far, we said the money that you want to raise, which may be specific to a particular business or property. Number two, it might be open. The second thing being the type of investor that you would be interested in that. What’s the procedure? What will somebody do if they’re looking into that and they say, “I do have a dollar amount in mind and I do want to attract sophisticated investors. I don’t want to get a bunch of investors. I’ve got some investors who have some capital?” What would be the procedure from there to start to research, to reach out to an attorney right away? What do you think some of the approach someone should take on that?
There are a lot of different ways to start. The first thing is you may not want to use crowdfunding at all. The cheapest money is your own money. If you have to raise money from other people, it’s expensive in the sense of having to give them part of the deal. The first thing is can you raise the money yourself? Can you borrow it? Do you want to borrow it? You think about friends and family. Do you have rich aunts, rich relatives? Those are all possibilities. Credit cards are also possibilities. Once we jump into the world of crowdfunding, which is certainly possible for anyone raising money. Talking with someone like me would be a terrific idea of going to my crowdfunding blog which is full of amazing material including what I call a Crowdfunding Cheat Sheet that summarizes in one table the different kinds of crowdfunding and the different rules. I would definitely look at that cheat sheet.
Where do we find that?
My Crowdfunding blog is located online. It is CrowdfundAttny.com. When you open it, you’ll see there are hundreds of articles that I’ve written there. Right along the top, there’s something called the CF Cheat Sheet. That’s the Crowdfunding Cheat Sheet and that is the place to start looking at the different types. Once you’ve done that, what I would suggest is going to register at a couple of crowdfunding sites. For example, you might register at a Title II site like RealCrowd or CrowdStreet. You might register at a Title III sites. I have a bunch of clients who do Title III. I’m not sure who to leave out here because some of my clients may get mad at me if they read this blog but one is called SmallChange.com. You and I have something in common, the Money with Meaning Fund and that is a Title IV offering. The best way to find out about this stuff is go on those sites and click around. Seeing it yourself is worth an hour of me telling you about it. If you do those things, it’s going to give you a pretty good background as to what it’s all about. My email address is on my blogs. Shoot me an email and we can talk if you’d like.
That blog once again was at the website CrowdfundAttny.com. It’s that on the website and check out all the information there. Coming back to the internet, it’s crazy how much free information is out there for people to research this stuff. That’s great if you’d put these blogs and such together. Do you have a podcast as well?
No, I do a lot of podcasts but I don’t host one. There’s a ton of material there. I once got an email from someone at Harvard Law School who said about my blog. He said, “Your blog is like a crowdfunding textbook.” I’ve always got a kick about that.
You can write a book out of that stuff.
I could but if you do, it’s going to be outdated by the time you finish it. That’s the issue.
It’s great information on that. It gets that process, a very similar process but access more information. Do some research on it and go to his blog. Pay attention to that, listen to some of the podcasts that he’s been on and start to figure out what’s best. When they do reach out to you and starts very conversational. Are there forms that they’ll fill out or dial in on what they want to accomplish?
Do you mean if they’re speaking with me?
Yes.The issue with writing a book about crowdfunding is it's going to be outdated by the time you finish it. Click To Tweet
We spend a little time figuring out what we want to do. It’s like you want to build a house but you’re not sure what you want it to look like or do you want a colonial or whatever? You go to an architect and sit down with the architect. Figure out what you want the house to look like generally, then we are able to implement that plan or build that house. The first part is the most valuable on per minute basis because figuring out what you want to do and what you should do is the most important part. A lot of times people call me and say, “I’ve decided I want to do this.” I never take that at face value. I always say, “What are you ultimately trying to accomplish here? Let me help you decide how to do it.” That is always a very constructive conversation.
I’ve told people before in my presentations and such where they go, “I know exactly what I want to do. It’s all in my head.” I said, “If it’s all in your head, it should be easy to write down because if you can’t write it down and make sense to somebody, you really don’t have the blueprint. This story stuck with me. Years ago, another speaker was talking to somebody who attended a class on real estate investing. The instructor asked the attendees, “If you’re doing that, that’s like building a house without a blueprint. You would never do that, would you?” The guy said, “Never again.” He’d done that before.
If you drive down a street, at least where I live. You can often tell the houses that were built without blueprints. They thought it was going to come out one way. They started building from the bottom and got to the top and it didn’t quite fit. That’s what will happen in any legal enterprise. Have the plan and the good news is it’s easy if you talk to someone, it’s not just me, who knows what he or she is talking about. The human brain is an amazingly powerful tool. Whether you’re talking to an accountant, a lawyer or an architect, it is incredible how quickly the human brain, the brain of the professional, can analyze all these different permutations and alternatives and get to the place that you should start. That makes all the difference. I’m sure in your business too, the earlier the better. Any mistakes in the foundation go up through the whole structure.
You mentioned The Money with Meaning Fund and TJ, Rick and I are affiliated with The Money with Meaning Fund and they chose the A+ Tier 2 type of fund of that. It’s a process and I know they went through a lengthy process to get that done but it’s done right. What are some of the benefits to that type of fund? You mentioned that’s under Title IV and that’s almost like a Full Public Offering. There’s a lot more involved with that. If somebody wanted to go big on that, what are some of the benefits to the A+ type of funds?
It’s funny you should ask that. The benefit of Title IV, Regulation A, Regulation A+, whatever you want to call it, it’s all the same, is that you can raise money from non-accredited investors. In some businesses like maybe a car business or restaurant business for the reasons we’ve talked about, it may make a lot of business sense to raise money from non-accredited investors because the same person can be your investor and your customer at the same time.
That’s what we liked about that too with our fund. We wanted to invite in those non-accredited investors into the notes because what we saw with note investors is there are a lot of them who paid money for training. By the time they’re getting ready to buy their own individual note, they get a little scared off sometimes. The next thing you know, they’re not getting involved. That’s why one of the things when they Plus Fund, we wanted those investors to be able to participate and invest in small sums along with investors who are placing larger fund.
Let me tell you because I’ve known TJ and Rick now for longer than they’d like to remember. They also did it for a completely altruistic reason. I’ve had other clients do the same thing. They wanted to give good investment opportunities to middle-income Americans. In the past, the best investment opportunities in our great country have been limited to the extremely wealthy, to the New York hedge fund family office people. As a result, they started out being wealthy. They are given exclusive access to the best deals. They get wealthier and the rest of the country doesn’t.
We get this increasingly troublesome wealth caps in this country, economically, socially and morally. Where the top 1% owns 40% of the wealth or something and that’s not America. If we can give ordinary working-class, middle-class, lower-class Americans access to investment quality deals without having all the middlemen taking their pieces, hopefully, that will begin to ameliorate some of those dangerous wealth inequalities. I went into that depth. I tip my hat to you guys for doing that. It is a socially important thing to do, which is one of the reasons I’m so amped up about crowdfunding generally, to begin to level the playing field and make these high-quality deals available to us and not just Wall Street hedge funds.
That was always the other side of the coin of that whole these people don’t need our protection, they’re sophisticated. These people who aren’t, do need our protection. We’re not going to let them in but you’re also holding them back from the potential returns that they could get. I love to see that that is changing and these funds make it very possible to do that. I’m going to read some more of your blogs. That’s at CrowdfundAttny.com and he’s got a lot of information on there, which is great and is going to be helpful to people. Make sure that you do that. All of his contact information is there on the website. Be sure to check that out. Mark, thank you so much for being on.
Thank you for having me. It has been a pleasure.
I look forward to seeing you again soon or talking to you in the near future. Thank you, Mark.
Thank you very much.
Thank you, everybody, for being on. Please, if you like the episode, go ahead and click that star rating that helps me out. If you have other people that you think would enjoy this, please share it at your real estate investment clubs, real estate meetings, note meetings, meet-ups, whatever it is that you’re doing. I do appreciate that.
- Real Estate Without Renters
- Mark Roderick
- Crowdfunding Cheat Sheet
About Mark Roderick
Mark Roderick is one of the leading Crowdfunding and Fintech lawyers in the United States. Expanding on his in-depth knowledge of capital-raising and securities law.
Mark represents many portals and other players in the Crowdfunding field. He writes a widely read blog, crowdfunding.com, which provides readers with a wealth of legal and practical information of portals, issuers, and investors.
He also speaks at Crowdfunding events across the country and represents industry participants across the country and around the world.