Crowdfunding: A capital-raising method that is well-suited for franchising.
By Joel Buckberg
In 2012, President Obama signed into law the Jumpstart Our Business Startups Act (JOBS Act). The Securities and Exchange Commission (SEC) announced in October 2015 the final rules under Title III of the JOBS Act for crowdfunding, the sale of unregistered securities to the public. Franchising is uniquely suited for the JOBS Act’s crowdfunding process.
Crowdfunding enables businesses without access to traditional methods of capital financing to raise capital via the Internet and social media, typically from small-dollar investors. The rules mandate disclosure of certain information and affirmative fraud prevention measures. The crowdfunding rules are not yet formally published, so they will not be effective and ready for use until early 2016.
Preparing to Crowdfund
What utility is crowdfunding for franchises? Unlike other potential issuers, franchisors are already subject to rigorous disclosure requirements under the Franchise Rule of the Federal Trade Commission and certain state franchise laws. Much of the disclosure mandated by Title III is already encompassed in a franchise disclosure document (FDD), so many franchisors have already prepared much of the disclosure required to be filed with the SEC. From the franchisee side, the information in the FDD provides some of the disclosure necessary to meet the SEC standards, or at least provides the basis for developing the necessary information.
Crowdfunding offerings are capped at $1 million per year. The issuer must be a U.S. company and cannot be an Exchange Act reporting company or a mutual fund. Individual investors are limited to certain maximum aggregate crowdfunding investments made during any 12-month period.
Investors with an annual income or net worth below $100,000 can invest the greater of $2,000 or 5 percent of such investor’s annual income or net worth. An investor with an annual income or net worth greater than $100,000 can invest up to 10 percent of such investor’s annual income or net worth, with a maximum of $100,000. With limited exceptions, crowdfunded securities are subject to a one-year transfer restriction.
A crowdfunding issuer must prepare and file a substantial disclosure package, similar to a short-form registration statement under the Securities Act of 1933, as amended, that would be prepared for a public offering. Issuers must file with the SEC and deliver to potential investors and intermediaries information that includes:
- Basic information on Form C about the company and the offering. Financial disclosure follows a tiered approach based on the offering amount and whether the issuer is crowdfunding for the first time. The issuer may be required to prepare audited financial statements, accompanied by a signed audit report from the auditors and consent to use the statements in the offering materials;
- Issuers must amend Form C for updates and material changes to previous disclosures;
- Offering milestones trigger filing of Form C-U;
- Crowdfunding issuers must file a Form C-AR annual report within 120 days after fiscal year end; and
- The issuer must file a termination report on Form C-TR within five days after certain events that end or disqualify the crowdfunding offering.
Does this mean that a franchisor can slap a new cover page sheet on its current FDD and launch a crowdfunding offering? No, but with a modest supplement describing the corporate governance documents and equity attributes not otherwise covered in the FDD, a franchisor can quickly be compliant with the SEC’s rules, and the launch of the offering will be more easily achieved than without a FDD.
How often does a franchisee ask whether he or she can invest in the franchisor? Crowdfunding offers franchisors the opportunity to consider paired or paperclip offerings, where the prospective franchisee is also offered the opportunity to invest in the franchisor’s equity.
Existing franchisees that are successful and committed to the success of the franchise concept offer another pool of potential investors, with contact information already listed in FDD Item 20. Communications vehicles between a franchisor and its franchisees offer the opportunity to promote the offering to a group of potential investors without the need for any public or portal solicitation.
Although the disclosures required by Form C and FDDs are quite similar, franchisors and franchisees new to SEC reporting should be prepared to spend additional resources on securities law compliance. The benefit is leveraging compliance resource allocation for franchising and securities law compliance. An audit is an audit, and the skills and reporting for one area are not dissimilar to the other. Even if the crowdfunding target audience is not the franchisee community, the FDD remains the primary disclosure tool.
Administrative efficiency opportunities can be exploited, compared with crowdfunding issuers who are not engaged in franchising, and therefore sustain all of the compliance burden without franchise revenues to offset compliance costs.
Joel Buckberg is a shareholder with Baker Donelson’s Nashville office, where he leads the firm’s commercial transactions and business counseling group and co-chairs the hospitality industry service team. He counsels clients involved in franchising, hospitality and distribution matters. He may be reached at 615-726-5639 or firstname.lastname@example.org.