Show Me the Money: Crowdfunding Your Brewery

A Technical Guide to Securities Laws and Crowdfunding

Brian Kaufenberg // The Growler Magazine

Brian Kaufenberg // The Growler Magazine

Editor’s note: this content was underwritten by Lommen Abdo Law Firm. This series focuses on legal issues facing small breweries and beverage makers.

No legal issue involved with starting a brewery is more complicated and costly than obtaining equity capital. There are numerous requirements in both federal and state securities laws that must be adhered to. In recent years, websites such as Kickstarter have provided a means for breweries to raise a limited amount of funds by providing “rewards” in exchange for a contribution.

The success of rewards-based crowdfunding led to the inclusion of “equity-based” crowdfunding in the 2012 JOBS Act, which for the first time would allow breweries to tap large and small investors alike with the promise of ownership in the brewery business itself. In the meantime, the solicitation rules for larger investors were significantly loosened to allow breweries to cast a wider net for funds with the goal of simplifying the fundraising process. Nonetheless, despite recent regulatory changes, legal compliance when tapping investment capital remains a minefield.

What is a “Security”

The key issue in raising money for a brewery is whether or not what is being sold is a “security.” With websites such as Kickstarter, businesses offer rewards in exchange for a contribution with the clear understanding that the contribution does not entitle the person to any profits in the enterprise. Legally speaking, a “‘security’ means any note, stock…evidence of indebtedness, certificate of interest, or participation in any profit-sharing agreement.” In other words, you do not have to be selling shares of stock to be engaged in the sales of a “security” under the law.

Breweries frequently offer “memberships” at various rates to individuals, which may include gifts of t-shirts, glasses or other brewery-related marketing products, or even free or reduced priced beer. These types of non-equity based membership do not entitle purchasers to any profits from the business and are indicative of the rewards-based crowdfunding exemplified by Kickstarter rather than a sale of “securities” and are thus exempt from federal and state securities laws.

A Brewery For the People, By the People – Registration vs. Exemption

The sale of securities became heavily regulated when, in the aftermath of the 1929 stock market crash and in the midst of the Great Depression, Congress enacted the Securities Act of 1933. This Act created the Securities and Exchange Commission (“SEC”) as the federal regulatory agency having jurisdiction and oversight over the raising of investment capital. Under the Act, a company seeking to raise funds, defined in the Act as the “issuer,” must either register its offering with the SEC (i.e., a “public offering”) or qualify for one of several exemptions. Most small private company offerings are made under exemptions set forth in Regulation D, and particularly Rules 504, 505 and 506.

Accredited Investors Need Only Apply – Rule 504

Rule 504 provides an exemption for the offer and sale of up to $1 million of securities in a 12-month period. General offering and solicitations are permitted under Rule 504 as long as they are restricted to “accredited investors”— which for individual investors, means persons having $1 million net worth not including their primary residence; or income exceeding $200,000 in each of the two most recent years; or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year. The issuer need not restrict purchaser’s right to resell securities.

A Mixed Bag of Investors – Rule 505

Rule 505 provides an exemption for offers and sales of securities totaling up to $5 million in any 12-month period. Under this exemption, securities may be sold to an unlimited number of accredited investors and up to 35 “unaccredited investors” who do not need to satisfy the sophistication or wealth standards associated with other exemptions. Purchasers must buy for investment only, and not for resale. The issued securities are restricted, in that the investors must own them for two years after purchasing before reselling them . General solicitation or advertising to sell the securities (such as posting information about the offering on the issuer’s website or sending out a mass mailing to potential investors with whom the issuer has no prior relationship) is not allowed. Under Rule 505, the SEC must be notified within 15 days after the first sale of the offering. Issuers seeking exemption under Rule 505 must also comply with certain financial statement requirements, namely:

  • Financial statements need to be certified by an independent public accountant
  • If a company other than a limited partnership cannot obtain audited financial statements without unreasonable effort or expense, only the company’s balance sheet, to be dated within 120 days of the start of the offering, must be audited
  • Limited partnerships unable to obtain required financial statements without unreasonable effort or expense may furnish audited financial statements prepared under the federal income tax laws

Unlimited Capital with Strings Attached – Rule 506(b)

A company that satisfies the following standards may qualify for an exemption under Rule 506(b) and can raise an unlimited amount of capital:

  • The company does not use general solicitation or advertising to market the securities
  • Sales of securities can be an unlimited number of accredited investors and up to 35 other purchasers. Unlike Rule 505, all non-accredited investors, either alone or with a purchaser representative, must be sophisticated—that is, they must have sufficient knowledge and experience in financial and business matters to make them capable of evaluating the merits and risks of the prospective investment
  • The seller must be available to answer questions by prospective purchasers
  • Financial statement requirements are the same as for Rule 505
  • Purchasers receive restricted securities, which may not be freely traded in the secondary market after the offering

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