JOBS Act: Interview with Douglas Ellenoff of Ellenoff, Grossman & Schole LLP
By David Drake, LDJ Capital and The Soho Loft
In this edition, David Drake consults with Douglas Ellenoff of Ellenoff, Grossman & Scholle LLP to probe the legal intricacies revolving around the JOBS Act – how these impacts the crowd funding scene in the next months leading to and right after its much-anticipated full implementation.
Question: Douglas, what will be the impact on the US when crowdfunding for equity becomes legal?
Answer: The impact of the introduction of crowdfunding for equity and debt securities will be significant. Non-accredited investors, who will for the first time be able to meaningfully invest in new businesses, represents an untapped pool of capital that tens of thousands of entrepreneurs will be able to access to capitalize their investments.
Q: How will US crowdfunding for equity affect foreign countries?
A: We will see more inflow of capital from international sources, so we will see more investments in U.S. domiciled entities—absolutely creating jobs here.
Q: When will crowdfunding for equity become legal in the US?
A: Although it is merely a guess, we are indicating that Q2-3 ought to give the SEC and FINRA more than ample time to consider the issues necessary to implement the intent of the JOBS Act. Even if there are changes at each of these agencies, it should still occur at a reasonable schedule.
Q: What’s your response to reports Mary Schapiro of the SEC will step down after the election?
A: In relation to the context of her tenure at the SEC, she has maintained the helm of the agency during a tumultuous period of time and has had to navigate through some tough and sensitive issues. I would fully appreciate if she has had enough and wants calmer waters.
Q: What’s going to be the total cost for issuers to do crowdfunding for equity when it is legal?
A: The industry fully recognizes that for crowdfunding to be viable that offering related expenses need to be reasonable as a percentage of the amount of capital that they raise—we have heard that that they may range on the low side of 15% ($15,000 on $100,000) and in the case of larger target numbers, 10%.
Startups run by younger entrepreneurs who have not raised capital before and don’t have independent resources may have a tough time in this environment as there will be a few thousand dollars of up front costs involved.
Q: How will Fortune 10,000 companies get involved in Crowdfunding for Reward?
A: Major corporations ought to be observing the pre-order model as there will be a way for them to have meaningful crowd participation and real time feedback through campaigns on crowdfundng sites . Currently, many companies are testing products on crowdfunding sites to gauge a product’s consumer appeal. Beverage companies do this all the time with taste tests and advertisers do it through pilot testing groups. Take the fundraising drive for Ouya on Kickstarter – crowd intelligence allowed Ouya to switch the capabilities to adjust the offering. Focus Groups are also important in this way.
Q: What are the three things you would advise an issuer on crowdfunding for equity to be cognizant of?
A: 1. Disclosure, 2 Disclosure, 3 Disclosure. The business plan needs to be an honest and forthright attempt by the management of the company raising the money through the campaign to properly and adequately disclose the opportunity, what the money will be used for (and later they need to stick to this use), what the management relationships are to other principals involved (if any), the risks associated with the opportunity and give the general advice that this risk may and probably will lose the investor’s money. It’s about setting expectations and giving accurate descriptions.
Q: What are the two biggest challenges for the industry?
A: 1. Properly responding to and addressing the statutory requirement of the JOBS Act relating to the education portion of the crowdfunding provisions, which mandates that portals provide investors with education.
2. Working with SEC and FINRA in response to the initial proposals they have and help revise those proposals so they are practical and enable funding portals to operate in a financially profitable manner.
Q: What are two things obstructing the ability of crowdfunding for securities to run efficiently?
A: The biggest difficulty in getting crowdfunding to the starting line is going to be to get the investor protection advocates to acknowledge that there is a certain societal balance within which it is acceptable for investors to invest in early-stage, potentially higher risk enterprises, and yes possibly lose (may be even make) money and at the same time facilitate capital formation for entrepreneurial activities and create jobs. Congress clearly recognized in the design of the statute that while investors may very well lose money, investors ought to have an opportunity to invest a small percentage of their income and net worth into these endeavors, which will in turn ease the flow of capital to benefit our economy and much needed innnovation.
In response to the inherent and broad based populous appeal of crowdfundng, there is a concerted tactical effort to cause negative articles to be published about existing donor and rewards crowdfunding in order to condition the public against securities based crowdfunding next year. As the argument goes, fraud supposedly occurs in a significant amoutn of the funded campaigns and that the products and rewards are not delivered to crowd fund donors, and if you follow that logic, the same will inevitably occur when and if securities crowdfunding begins. Delay in achieving the funding objective however is not fraud in my estimation, that happens in nearly every entrepreneurail activity that I have ever observed as both a securities lawyer (both (private companies and publc) as well as an investor. Crowdfunding for securities will also be regulated by both the SEC and FINRA.
Q: Douglas, what are the biggest opportunities for your firm positioning yourself as a leader and where do you see most of your business emanating?
A: As a Firm, we decided that the crowdfunding provisions of the JOBS Act made sense as an initiative for both entreprenuers and investors, and while both regulators and securities professionals were typically negative towards the legislation, we believed to the contrary and thought that given our history of being actively involved in numerous other capital markets programs and facilitating financing products, we ought to devote substantial time and energy to working with the crowdfunding industry. With 10 crowdfunding lawyers actively involved with regulators, portals, investors and entrepreneurial clients, we are the only law firm in the U.S. that has publicly devoted our reputation and expertise to assisting with the implementation of the crowdfunding vision and hope to further coordinate with any potential clients that seek to participate in this exciting and emerging industry.
Q: How big do you see this industry be in dollar amounts in 2014?
A: While it is impossible in our judgment to respond to that question with any responsible figure, it would be fair to say that we are all likely to be surprised in the end by how rapidly crowdfunding is embraced by portals, investors and entreprenuers and the significant impact it actually has on how ideas get funded in the future.
Douglas S. Ellenoff, a member of the Firm since its founding in 1992, is a corporate and securities attorney with a specialty in business transactions and corporate financings. Mr. Ellenoff has represented public companies in connection with their initial public offerings, secondary public offerings, regulatory compliance as well as general corporate governance matters. During his career, he has represented numerous broker-dealers, venture capital investor groups and many corporations involved in the capital formation process.
Mr. Ellenoff and the rest of the corporate department distinguish themselves from many other transactional lawyers on the basis of their ability to be part of the establishment of new securities programs, like PIPEs, SPACs, Registered Directs, Reverse Mergers and CrowdFunding, where the Firm’s professionals have played leadership roles within each of those industries, assisting in the creation, formation and strategies relating to those financings, as well as working closely with the regulatory agencies; including the SEC and FINRA; and the listing exchanges – AMEX and NASDAQ. Ellenoff Grossman & Schole has been heavily involved in CrowdFunding since its inception. The Firm has sponsored conferences, webinars and has been invited to speak at different events on the topic. And recently, Mr. Ellenoff met with the SEC to discuss many aspects of the new law, how the industry currently operates and how both the SEC and FINRA will register and regulate the portals.
In the last several years, he has been involved at various stages in numerous registered public offerings, including 100 financings and, with other members of his firm, over 400 private placements into public companies (see PIPEs and Venture Capital), representing either the issuers of those securities or the registered broker-dealers acting as placement agent. Along with other members of his Firm, Mr. Ellenoff has been involved at various stages with over 70 registered blind pool offerings (commonly referred to as “SPACs”; 27 of which have consummated their IPO’s raising over $1.5 billion). In addition to our IPO experience with SPACs, he has been involved with 20 SPAC M&A assignments. He also provides counsel with regard to their respective ongoing (SEC, AMEX and NASD) regulatory compliance.