Show Me the Money: Crowdfunding Your Brewery

Attention: Investors Wanted – New Rule 506(c) Exemption

On September 23, 2013, the SEC lifted its long-standing prohibition on general solicitation and general advertising for certain private securities offerings under Rule 506 of Regulation D. The new Rule 506(c) creates another means of raising funds from accredited investors under Rule 506. Rule 506(c) allows issuers to engage in general solicitation and general advertising to market their offerings, so long as: (1) all purchasers of the securities are accredited investors; (2) the issuer takes “reasonable steps to verify” that the purchasers of the securities are accredited investors; and (3) all terms and conditions of Rules 501, 502(a) and 502(d) are satisfied.

“Reasonable steps to verify” is the key verbiage of this new way to raise funds. Under Rule 506(b) offerings, the issuer verifies accredited investor status via a check-off box in its subscription agreement. That is not enough under Rule 506(c). An issuer looking to engage in general solicitation of investors under Rule 506(c) must review tax returns, bank statements, personal financial statements, or receive a written opinion from an attorney, CPA or financial advisor. This is a cumbersome task that goes well beyond finding the right location, determining what to name your brewery and beers and where to source your raw materials from.

State “Blue Sky” Laws

In addition to Federal exemptions, an issuer must comply with state securities laws, known as “blue sky” laws. State laws require an issuer to register the offering with the state securities division or find an applicable exemption from registration. It is important to note that an issuer must find an exemption for each state in which an investor resides.

JOBS Act & “Equity Crowdfunding”

In recent years, websites such as Kickstarter have popularized “rewards-based” crowdfunding. Kickstarter is a web portal that allows individuals to make a contribution to a particular project in exchange for some reward, typically some type of tangible product. These web-based crowdfunding sites, however, could not historically be used to raise capital for a for-profit business such as a brewery. In response to the success of rewards-based crowdfunding and demand from the startup community to streamline businesses’ ability to raise capital, Congress passed the JOBS Act in 2012.

The centerpiece of the 2012 Jumpstart Our Business Startups Act (the “JOBS Act”) was the creation of an exemption to permit securities-based or equities-based crowdfunding without registering the offerings with the SEC. Until the JOBS Act, crowdfunding was not a legal means of raising equity capital.

The SEC’s proposed crowdfunding regulations scheduled to be enacted this fall will permit companies to raise up to $1 million through crowdfunding offers during any 12-month period. Investors would be permitted to invest during any 12-month period up to $2,000.00 or 5 percent of their annual income or net worth, whichever is greater, if both their annual incomes and net worth are less than $100,000.00. Investors may invest up to 10 percent of their annual income or net worth, whichever is greater, if either is equal to or more than $100,000.00. Investors would not be permitted to purchase more than $100,000.00 of securities during any 12-month period through crowdfunding.

Securities that are purchased in a crowdfunding transaction may not be resold for a year under the regulations, and holders of the securities would not count toward the threshold that requires a company to register with the SEC under Exchange Act Section 12(g).

Companies that conduct crowdfunding offerings must file certain information with the SEC and make it available to investors and to the intermediary that is used to facilitate the offering. The offering documents must include information about officers, directors, and holders of more than 20 percent of the issuer’s securities. The disclosure would include a business description, a description of the use of the proceeds from the offering, and the price of the securities being offered.

The proposed disclosure also would include certain related-party transactions, a description of the financial condition of the company, and its financial statements. Companies would be required to update the offering document to include material changes and to provide updates about the progress in reaching the targeted offering amount. Crowdfunding issuers also must file annual reports with the SEC and provide annual reports to investors.

The new framework requires that crowdfunding transactions take place through an SEC-registered intermediary, which will be either a broker-dealer or a funding portal. The intermediaries will conduct the offerings through online platforms. Intermediaries will be required to provide investors with educational materials that outline the risks of investing. They also must take measures to reduce the risk of fraud. In the brewery space, an early entrant into the crowdfunding market is crowdbrewed.com.

Funding portals may not offer investment advice or make recommendations. They may not solicit purchases, sales, or offers to buy securities offered or displayed on their websites. The proposed rules impose restrictions on compensating people for solicitations and prohibit the funding portals from holding, possessing or handling investor funds or securities. The proposal includes a safe harbor under which funding portals can engage in certain activities consistent with these restrictions.

It should be noted that the SEC’s proposed crowdfunding rules affect equity-based crowdfunding only; websites such as Kickstarter will continue to be avenues for rewards-based crowdfunding and are outside the scope of the SEC’s regulations since they do not offer “securities” for sale.

Conclusion

Whether the new law changes actually streamline fundraising for breweries remains to be seen. In the meantime, traditional exempt offerings are still available alternatives, even though they take time to prepare and are not cheap. However, the cost of compliance pales in comparison to the consequences of non-compliance, which include civil and criminal penalties and is why you need to ask whether your attorney is insured to perform securities work. If not, you should find one who is.

Jeffrey C. O’Brien is an attorney and shareholder with the Minneapolis law firm of Lommen Abdo, P.A. As Chair of the firm’s Food, Beverage and Leisure Activities Practice Group, he works with over two dozen breweries and distilleries on a wide variety of issues including securities law compliance. He can be reached at (612) 336-9317 or via email at [email protected]

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