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Fundist Founder Speaks at American Bar Association Business Law Spring Meeting

With some 20 lawyers in the room, the topic at hand was the legal status of the new(er) regulation CF statutes the SEC passed rules on to implement this spring, and the usability of the rules writ large (or, "is anyone going to do anything with these?".  

In the panelists views the answer was that, at a retail level, title III money is an expensive dollar to earn. 

Broadly, we can examine the costs by dividing the group using the laws into three groups: 1) Issuers; 2) Intermediaries (which includes broker dealers and funding portals); and 3) the investors themselves. 

Issuers

Time Cost:

  • How much time will it take to raise $1MM in $4,000 increments? (where 4k is a guess at the average investment); 
  • Is it even plausible to think you can raise $1MM in 4k increments? 
  • An estimated 150 portals will register of the first 3 years. How will investors be divided on those platforms?
  • You need 250 investors to fund $1MM at $4k. 
    • If you assume a 1 in 10 success rate, that's 2,500 people pitched. 
  • If you do manage to raise $1MM, how will you manage 250 investors? 
  • If you reach a second investment round, will professional investors, i.e., PE companies, want to be involved with 250 investors + founders + employees? 

Hard Costs:

  • Will you need an accountant? 
  • Will you need legal advice? 
    • This isn't even included in some of the SEC cost estimates (see Rules at 410). 
  • What will the b/d or funding platform charge? 
    • Various platforms estimated costs at 5-20 of the offering. 
  • SEC thoughts? 

“Thus, we have revised our intermediary fee estimates in the following way: we project (as a percentage of offering proceeds) 5% to 15% for offerings of $100,000 or less, 5% to 10% for offerings between $100,000 and $500,000, and 5% to 7.5% for offerings above $500,000.” (Rules at 503).

  • Compliance costs: submitters guessed anywhere beween $2,500 and $50,000 (Rules at 504 - 05). 
  • Issuers will have to file annual reports. 

Pricing Risk: 

  • Given the types of deals that are likely to be sold under Title III, how do you account for the likelihood of failure (either bankruptcy or litigation?). 
  • Shareholder litigation costs arising from non-professional investors. 
  • Costs of division in estate planning. 

Intermediaries (Broker dealers and funding portals)

Opportunity Cost: 

  • For the majority of the people playing in this space, the decision to operate under Title III means foregoing other opporutnities due to constraints in resources (here, both time and money being probabie).  

Hard Cost: 

  • Broker dealers don't play for free; SEC fees: 

“We estimate that the cost for an entity to register as a broker-dealer and become a member of a national securities association in order to engage in crowdfunding pursuant to Section 4(a)(6) will be approximately $275,000, with an ongoing annual cost of approximately $50,000 to maintain this registration and membership. In addition, we estimate that the cost to comply with the various requirements that apply to registered broker-dealers engaging in transactions pursuant to Section 4(a)(6) for these new registrants will be approximately $245,000 initially and approximately $180,000 in each year thereafter.” (Rules at 433).

  • Or modifying your existing registration: 

"We estimate that the incremental initial cost for an intermediary that is already registered as a broker-dealer to comply with the requirements of the final rules will be approximately $45,000, with an ongoing cost of approximately $30,000 in each year thereafter.” (Rules at 433). And a technology cost, to boot (Cost to build/modify/adapt): “We estimate that for the average intermediary, the mid-range initial external platform development cost will be approximately $425,000 and the ongoing cost will be approximately $85,000 per year.” [...] “We expect that intermediaries (whether broker-dealers or funding portals) that already have in place platforms and related systems that will need only to tailor their existing platform and systems to comply with the requirements of Regulation Crowdfunding, resulting in a lower initial cost on average of $250,000. We expect the ongoing cost to remain approximately $85,000 per year for an intermediary that already has in place a platform and related systems.”

  • Other costs: Aside from the government projected costs, platforms expend a huge amount of capital in advertising and marketing, reaching $30,000 to $50,000, monthly, to attract investors and companies - for a yearly spend of $360,000.00 to $600,000.00.
  • Funding portals aren’t much cheaper; SEC costs:

“If instead an entity were to register as a funding portal and become a funding portal member of a national securities association, we estimate the initial registration and membership cost will be approximately $100,000, with an ongoing cost of approximately $10,000 in each year thereafter to maintain this registration and membership.1489 We estimate that the initial cost for a registered funding portal to comply with the requirements of the final rules will be approximately $67,000, with an ongoing cost of approximately $40,000 in each year thereafter.” (Rules at 444).

  • Tech Costs: Same as above, $425,000 to build out + $85,000 a year to maintain or $250,000 to add as a service to an existing platform plus $85,0000 to maintain. Certain mandated functionality (chat rooms, issuer information, etc.) 

Pricing Risk: 

  • Litigation Risk: Investors in bad deals sue broker dealers. 

Investors

Time Cost:

  • Should the "average american" earnings $45k be putting cash into this invesment class, or is the opportunity cost too great? 

Hard Costs:

  • Due diligence costs - can they be shared? At $1k - $4k per investment, how much due diligence is enough; where will the litigators be happy? 

Pricing the Risk:

  • How do you price fraud in the market?