How Not to Break the Million Dollar Ceiling in Reg CF
Here’s what companies should know about the 12-month maximum and “Common Control.”
While most companies conducting a Small OPO are thrilled to be able to raise up to $1.07M in capital, one downside is they cannot raise any more than that in a 12-month period. The ceiling exists for that specific company and for any other company which falls under “Common Control” with it.
Here’s how to play by rules for the yearly maximum in Reg CF, and to determine who holds “Common Control.”
The 12-Month Timeline
The $1.07M limit is restricted by a 12 month rolling time period, not a calendar year. It does not restart on January 1. The timeline is determined by the date a company first disburses funds.
How does the timeline look in practice? Here’s an example:
Anne’s Organic Apple Juice launches a Reg CF campaign on Valentine’s Day, February 14, 2017. During the middle of its campaign, the company conducts its first close on St. Patrick’s Day, March 17, 2017, disbursing $500,000. What luck!
The company goes on to raise a total of $1.07M, and closes its 90-day campaign on May 14, 2017. Having raised the total of $1.07M, the company would not be able to raise in Reg CF again until St. Patrick’s Day — not Valentine’s Day — the following year in 2018.
Anne’s company can start next year’s campaign on Valentine’s Day (or any other day that makes sense), but it cannot close and receive funds again until St. Patrick’s Day. This means the the window of their next raise should probably bookend March 17, 2018. The 2018 raise cannot end before St. Patrick’s Day.
There is actually no legal definition of “Common Control,” but most securities lawyers treat either 10%+ voting securities or a board seat as constituting control.
The 10% ownership metric is a reasonable one to abide by. It’s a standard found in other relevant financial reporting. For example — many of the SEC’s registration forms (including Reg A) require certain disclosure of 10% owners; the reporting and penalty provisions of the Securities Exchange Act apply to 10% owners; and 10% ownership is sufficient to deem a stockholder a “holding company” under the Holding Company Act.
The SEC defines the term “control” as the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise.
That means “control” could be held through just one, measly board seat.
Sara Hanks, CEO of CrowdCheck explains,
“I’ve had many clients ask over the years — if I only have one board seat, or if I only have a minority holding, how can I be in control of anything? The answer is partially in the power to cause or cause the direction of the policies part of the definition, and the fact that negative power (eg, the power to veto decisions) directs a company’s policies as much as affirmative power.
Whether a person has control is always going to be a facts and circumstances analysis. When a person has a board seat, even if it is only one seat, and he can be outvoted, he may have the power to influence the policies of a company. Even if the bylaws don’t require unanimous decisions for anything, he can prevent decisions being made by unanimous consent, and thus shape the company’s decision-making.”
Minority shareholders are in a similar position. In some cases there are provisions requiring unanimous or supermajority votes for some actions, in which case even a small holding can have some influence. In any case, a shareholding of this size will always have some influence over the policies of a company; the company’s management is unlikely to disregard the wishes of a large shareholder.
In other words, control is not a question of whether you have a majority stake (and thus could be outvoted) or not. And control does not have to be in the hands of a single person; some companies could have several control persons.”
How could this look in context? Let’s use a Anne’s Organic Apple Juice example again.
Anne’s Organic Apple Juice has 12 shareholders, many of whom own less than 5%. Two of the shareholders are a mother and daughter named Anne and Johanna Beswick. They own 23% and 9% respectively. Anne, the mother, is the second-largest shareholder and Chairman of the Board. Johanna, the daughter, is one of the six directors. She has the power to call meetings and set agenda items.
Both mother and daughter are considered persons with control, even though Johanna owns less than 10% of the company. Her power as a Director could influence the direction of the business. Additionally, the family relationship between them means that they should probably be treated as a “group” under securities law, and Johanna could be a control person even if she didn’t hold a Board seat.
Applying “Common Control” to Reg CF Raises
Companies cannot raise more than $1.07M in Reg CF in the twelve month period. Additionally, people cannot raise more than that amount across companies by which they wield “Common Control.” In some instances, this means one company’s ability to raise in Reg CF may be affected by another company’s 12-month timeline.
Let’s round out our example:
Anne and Johanna, both control persons at Anne’s Organic Apple Juice, are also active investors in local food companies. They are part owners in Ruby’s Gluten Free Bakery, owned primarily by their friend, Ruby.
The mother and daughter told Ruby about the success of Anne’s Organic Apple Juice’s Small OPO, and Ruby is eager to get started.
However, Johanna and Anne each own 15% (30% total) in Ruby’s Gluten Free Bakery. Their control is clear. This means, unfortunately, Ruby cannot launch a Small OPO until next year. Ruby must follow the same timeline that Anne and Johanna must abide by. They cannot close and receive funds on another raise until 12 months after Anne’s first disbursement of funds.
In fact, the two companies may have to strategize how to handle next year’s Reg CF raises so they do not violate the $1.07M mark.
Generally speaking, Regulation Crowdfunding offers a viable opportunity for single, independent companies to raise up to $1.07M in capital per year. The opportunity is not intended for joint ventures or raises with shared interests. If you’re considering a raise for your company, play by the rules every year and you should be good to go.
And if you do happen to raise $1.07M, your business probably has reason to look forward to next year.