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VABIO Panel Explores Impact of SEC Regs on Crowdfunding

Monday, September 30, 2013  
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Review of September Virginia Bioscience Luncheon
Guest Writer:  YooRi Kim


In the aftermath of the 1929 stock market crash, the federal government enacted the Securities Act of 1933 to help investors make informed decisions about investments and to eliminate misrepresentation and fraudulent activities in the securities market. Under this legislation, companies that seek to raise capital through the sale of securities must register the securities offering with the Securities and Exchange Commision (SEC). Otherwise, they must rely on an exemption from registration, such as the widely-used Rule 506 of Regulation D (Reg D). As panelist Christina Plaza, a partner at Cooley LLP, indicated, the initial public offering process takes an average of 6 months and can cost $850,000 to $1.5 million. Reg D thereby allows smaller companies to obtain funding faster and avoid the high costs associated with registration through the sale of private offerings.


Through Rule 506 of Regulation D, issuers can sell unregistered securities to an unlimited number of accredited investors and a limited number of nonaccredited investors. An accredited investor is an individual who satisfies the SEC-defined sophistication or wealth standards, or certain institutions that meet a minimum asset level. However, general solicitation or advertisement of securities is prohibited. Thus, companies must identify potential purchasers and establish some pre-existing relationship with them before conducting a private placement.

From a historical perspective, in which these regulations were set forth due to concerns about the accuracy and reliability of information in the early 20th century, the law served its purpose of bolstering investor confidence to support the recovering US market. Today, however, we live in a worldwide web, where information is easily accessible via the Internet and various social media and networking platforms; we have efficient means to do due diligence on and connect with individuals from all over the globe.


For modern day entrepreneurs such as panelist Mat Dellorso, who has founded and co-founded WealthForge, LLC, the reality of how an 80-year old federal legislation now significantly limits the ability to find and raise capital has become increasingly apparent in recent years. In a personal account on trying to fund his first startup companies, Dellorso identified the lack of an outlet to reach out to potential investors. He then realized that the investors were also affected as there was no centralized marketplace for them to review curated quality innovations; they were missing out on many investment opportunities. A centralized platform of this nature, however, is not possible with the standing Reg D.

On September 23, 2013, the SEC rules changed.  As required by Title II of the 2012 JOBS Act, the SEC issued new regulations, including the addition of Rule 506(c), which allows general solicitation and advertising of a private offering under certain circumstances. While this represents a fundamental change in access to capital, the SEC aims to continue protecting investors through additional safeguards. Christian Plaza highlighted these important limitations, including major departures from past practice. First, issuers under Rule 506(c) can only sell to accredited investors. Secondly, issuers must take reasonable steps to ensure that their purchasers are in fact accredited investors. Whereas companies typically rely on investors to self-verify their statuses, those seeking to generally solicit or advertise private securities must conduct an objective assessment via reviewing bank statements and IRS forms. A registered broker-dealer, investment advisor, licensed attorney, or a certified public accountant may also provide accreditation services. The SEC has proposed additional amendments to Rule 506 of Regulation D, which are currently in comment period. The proposed rules include filing an advance notice of sale (Form D) at least 15 days prior to general solicitation, providing more detailed information about the issuer and the offering, and submitting written general soliciation materials to the Commission. In any case, the existing Rule 506 provisions are not affected by the new regulations; Companies not publicly soliciting or advertising their securities can continue conducting Rule 506 offerings in the same manner.


Title III of the JOBS Act addresses crowdfunding and the SEC is expected to issue regulations in the upcoming months. The concept of crowdfunding entails large numbers of investors each investing relatively small amounts in an issuer, which many believe gives early-stage companies access to more capital while minimizing the risk to individual investors. Importantly, the new SEC rules will allow non-accredited investors to participate in equity crowdfunding. A non-accredited investor will be able to invest a minimum of $2,000 per year in any private company. By making entrepreneurial investing available to individuals who do not qualify as accredited investors, the private investment market is projected to grown by approximately $1.3 trillion across all sectors. The provisions plan to leverage Internet platforms that connect issuers and investors from all over the country. The role of these online private placement platforms, such as Dellorso’s, will then be to ensure that the offering process is conducted properly. These groups would help protect the investors by keeping them well-informed and help the companies by making sure that they are effectively using their funds to grow their businesses and ultimately produce returns.


Crowdfunding is gaining interest from institutions of higher education that are keen on developing translational research as well. In May 2013, U.Va. Innovation launched the University of Virginia’s first crowdfunding website, initiating a six month philanthropic crowdfunding pilot project to advance university research. Recent studies indicated that university donor motivations have changed; donors are now more directed in their giving, more cause-oriented, and are interested in seeing impact. Through its crowdfunding platform, UVa seeks to engage alumni, students, parents, faculty and staff in a culture of innovation and entrepreneurship by providing opportunities to make tax-deductible donations in support of specific research and development projects at the University. The site will feature a total of 10 translational research projects throughout the six months with 2 or 3 up at a time for 45 days each. Funding goals range from $10,000 to $40,000 for each project.


Panelist Deborah Donnelly, senior development officer for research and innovation at UVa, provided tips for success with philanthropic crowdfunding based on the University’s experiences thus far. Emphasizing that this is a peer-to-peer, relationship-driven model, Donnelly suggests that the project team have a strong network involving at least 200 contacts to assure minimal success. In selecting projects to invest in, look for passionate project leaders and vetted, milestone-driven projects. Awareness building is important and should be maximized through social media (particularly Facebook, LinkedIn, and Twitter), disseminating articles to the media, and/or partnering with advocacy groups. Communicate progress throughout the entire project, providing updates, spurring further e-mails and social sharing. Finally, Donnelly recommends following up with the donors after the project is complete and creating plans for continued engagement.


As for limitations, philanthropic crowdfunding is staff intensive and has so far generated low funding levels. According to Donnelly, the average gift has been approximately $75. However, there are promising benefits for this new system as the early data indicate that the University’s crowdfunding website is engaging a pool of interested individuals: The site has accumulated more than 7,000 visits since its launch a few months ago and out of the donors, 70% were first time givers. Although it is uncertain whether philanthropic crowdfunding experiences will be applicable to equity-based crowdfunding, they may help establish good practices for selecting projects and catalyzing new contacts.


How will biotechnology companies utilize crowdfunding in light of the published and anticipated regulations? Under the rules mandated by Title II of the JOBS Act, companies will now be able to generally solicit and advertise their private securities offerings. Although the securities can ultimately be purchased by accredited investors only, companies will experience increased access to capital and in turn, this will propel the development and commercialization of valuable biotech products. The Title III provisions will allow companies to gather crowdfunds from non-accredited investors, purposing to increase engagement by the general public and expand the private investment market. While it may be easy to picture how a video game developer or a restauranteur may take advantage of the wider investment community to fund the production of a new game or the opening of a new diner, the future for biotech entrepreneurs is rather unclear. Due to the extremely time and capital intensive nature of  biotech product development and commercialization, the panelists do not expect that companies will achieve their typical funding goals via crowdfunding. However, there are other possibilities, such as "asset-based models”, in which companies could use equity crowdfunding to complete a smaller scale project, which they could then sell or spin off to a larger company for returns. Biotech companies could also utilize philanthropic crowdfunding in order to fund more socially-focused projects. Plaza noted that the new SEC regulations will not affect the current system of private offerings and that due to the novelty and uncertainty surrounding these regulations, many will proceed with the traditional means, at least initially. Nonetheless, crowdfunding continues to generate interest among bioscience entrepreneurs because of the promise to reach untapped sources of capital. The panelists all agreed that only time will tell what place it will have in the biotechnology industry and in the private investment world.


Watch the video of the panel in the  VABIO Archive.

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