Crowdfunding- Waving the Red Flag


There are lessons to be learned by crowdfunders from mainstream brokerage firms.  Just about one year ago, when Reg. A+ offerings were just beginning, I wrote two blog articles in which I questioned whether two of the earliest offerings that had been approved by the SEC, Elio Motors and Med-X, were kosher. The Med-X offering was subsequently halted by the SEC for failing to disclose required financial information.  Elio Motors, which was applauded by the crowdfunding industry for separating $17 million from small investors, is teetering on the brink of bankruptcy because it cannot get the government loan it promised but for which it never qualified.

In the ensuing year, a lot of people have told me that these two patently lousy offerings were a result of the immaturity of the crowdfunding industry; just “growing pains”.  So I thought that I would take a look around at some of the current offerings and see if the industry has gotten its act together. Sorry, not yet.

I recently finished preparing the paperwork for a solar energy fund that is conducting an institutional private placement.  I am a fan of renewable energy and I was pleased to see that a crowdfunding portal dedicated to that industry, Gridshare, had opened for business.

Two of the first three offerings listed on that portal are from a company called Pristine Sun.  The company is run by a gentleman named Troy Helming.  Mr. Helming was the subject of two cease and desist orders by the State of Missouri in 2002 and 2005.

The portal is aware of these past transgressions but chose not to require Mr. Helming to disclose them.  Mr. Helming’s biography in the offering covers this time period and leaving out the disclosure is misleading to investors. There were some other questionable things about Mr. Helming’s disclosures that I brought to the attention of the attorney who runs this portal.

The attorney told me that Mr. Helming was a personal friend who “agreed to put an attractive offering on Gridshare to assist us.  Pristine is an outstanding developer of quality projects, notwithstanding Troy’s legal problems in the past.”  I have no reason to doubt this attorney’s word but I still question the non-disclosure.

What he meant by “attractive” was that investors are being paid 20% interest on the loan that they are making to fund one of these projects.  Pristine Sun claims to have over $80 million in assets and cash flow from its over 200 solar projects that generate electricity and money whenever the sun comes up.  I read the 20% return as a red flag. It is significantly higher than the rate that junk bonds pay.

This offering is being made under the new Reg. CF meaning that the securities are being offered to smaller, basically uneducated investors.  If an investor asked my advice, I would wave them off any loan paying 20% interest as a matter of course.  To me, a return that high, coupled with the questionable disclosures about Mr. Helming’s past, is a clear “red flag” from a  due diligence perspective.

Someone asked me to look at the offering for the GreenLeaf Investment Fund (GLIF). This is a Reg. A+ offering that is listed on a platform called CrowdVest. The fund intends to purchase commercial warehouses and rent them to the cannabis industry in states where cannabis is legal.  The website says: “When industrial properties are retrofitted for cannabis cultivation they have shown an increase in value by 5 to 10 times.”

The only research I could find suggested that, in Colorado, re-purposing a warehouse for cannabis cultivation might increase the value by 50%, not 500%. But I am willing to assume that CrowdVest asked the fund to provide support for its advertising.

There are other cannabis related, real estate funds available that are not suggesting that renting to the cannabis industry will increase the property value 5 or 10 times.  Most of those funds are structured as LLCs so that the income that is generated from rents can flow directly to the investors.

The GreenLeaf Investment Fund is structured as a corporation, specifically as a penny stock offering.  There is nothing inherently wrong or illegal about this, but neither is there any obvious reason that this fund should deviate from the norm and not pass the income it will receive to the investors.

The fund certainly spent more on legal fees for a Reg. A+ offering than it would have for a Reg. D offering and I do not believe that it was money well spent.  “CrowdVest shall be entitled to receive an administration fee of $10,000 per month and a one-time consulting and due diligence fee of $125,000 from GLIF that will be due upon completion of the offering.” If CrowdVest did not question the penny stock structure for this offering, I do not think that money was well spent either.

When I wrote about both Elio Motors and Med-X, I was of the opinion that I was looking at two companies that were intent upon scamming investors. That is not the case with either Pristine Sun or the GreenLeaf Investment Fund.  I am not questioning their integrity, just their approach to corporate finance.

When a company is paying 20% to borrow money it is telegraphing the fact that it is not a creditworthy company.  When a company structures itself as a penny stock, a market that has been full of fraudsters over the years, it is saying that it could not structure itself better.  In both cases, the crowdfunding “professionals” at the portal and platform should have set these issuers straight before they released these offerings to the public.

Please do not tell me that the JOBS Act prohibits Title II platforms from giving “advice” to issuers.  As counsel for a platform, I always have a conversation with the attorney representing the issuer and I always ask a lot of questions about the company and the structure of the offering.  The issuer and the platform share a desire to see that all appropriate disclosures are made and that the offering is structured to be well received by investors. Attorneys are always charged with acting to further their clients’ interests.

There are really 3 levels of responsibility in crowdfunding. A registered portal (and the Title II platforms and the issuers) are in the business of selling securities.  They need to appreciate that this is a highly regulated process and they need to take their responsibilities as sellers of securities seriously.

In the first place, there is compliance with the federal securities laws and the myriad rules and regulations that have been enacted by the SEC and FINRA. The primary rule is to not offer securities without full and fair disclosure. The only way that compliance is possible is with a comprehensive due diligence investigation. The portal or platform should also take care to ascertain that the company’s website and other advertising comply with the rules.

Next, offerings need to have practical business plans. FINRA was clear about this when it expelled a portal called uFundingPortal.  FINRA specifically questioned the business plans and the valuations of the companies that listed on this portal.  A portal should be able to evaluate a company’s potential for success at least with the money that they are raising. If a company suggests that they are going to raise $1 million and can cure cancer with that amount of money, I would not expect the offering to be listed on any crowdfunding website.

Finally, an offering should make sense from a corporate financing perspective, which is where the two offerings I discussed above fall short. The portal or platform should appreciate that the size, structure and terms of the offering are important to both the issuer and the investors.

An offering for a real estate fund, a restaurant, a film, a tech company and a company selling consumer products would all likely be structured differently. Companies rarely have the expertise to fashion an offering that investors find attractive which is why many are having trouble selling the offerings and raising the funds that they want.  Portals and platforms should have that expertise available for every offering.

I am constantly amazed how many people operate portals without any real experience dealing with investors.  A Title III portal, because they are dealing with small, inexperienced investors, should always have an experienced broker/dealer compliance person either on staff or on call.  They should also be able to assist companies in structuring and pricing their offering.  They should have marketing people available who understand what excites investors, which is not always the same thing that will excite the end user of the company’s product.

Complying with the rules, funding companies with a better chance of success and structuring offerings in such as way as to benefit both the issuers and investors will lead to more success for the industry and happier investors. This will never happen unless and until the industry steps up.  The way in which the mainstream brokerage firms would approach the same offerings should be a model for the crowdfunding industry.

The mainstream brokerage firms are already beginning to appreciate that they can sell securities to investors from a website without paying sales commissions and make a lot of money doing so.  Unfortunately, until that happens or until the current participants up their game, issuers will continue to have difficulty raising the funds that they need and thousands of investors will lose tens of millions of dollars to bad deals that could have been made better if only the crowdfunding industry would hire people who knew how.

 

 

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