Crowdfunding for equity solutions Part 5: Dealing with “held-of-record” issues

editoral-policyDavid Drake of LDJ Capital continues today with his fifth article on his series regarding crowdfunding for equity solutions.

Crowdfunding is exempt from ‘held of record‘ calculation in regards to registration requirements under 12g of SEC 1934 Act. But among the issues that could effectively kill the crowd funding provisions in the JOBS Act, is the practical matter of “held of record.”

For the first investment year, when investors cannot transfer shares except to directors of the issuing firm, direct relatives or accredited investors, there is little problem. Crowdfunding is exempt from the calculation in respect to registration requirements.

However, after one year, the registration requirements of Section 12g apply.

This represents a huge added burden when thousands (or tens of thousands) of investors transfer shares. Unless this requirement can be made more efficient through automation – or the exemption extended to 2 to 3 years – it will simply cost issuers too much.

If an issuer is burdened with this requirement, at a $2 overhead cost per investor, ownership changes could easily surpass the amount originally raised.

Maybe the drag along clause where an issuer puts in the operating agreement that if he sells the company or part of the company or gets investors coming in, the rest of the crowd funders are part of a “drag along” and have to sell — as long as they realize a minimum of some target amount in returns and profits.

A drag along clause is not standard in the world of Angels and VCs.

The question is whether such a clause should be required by the SEC, only recommended, or something that would fall under issuer/platform self-regulation.

Furthermore, what is a reasonable minimum return for the investor getting caught selling under a drag along?

We have some serious questions that if left unresolved, would make this bill sterile in practice.

It simply isn’t going to happen if it cannot be made both practical and profitable.

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