How SPVs Fix Legal Structuring for Equity Crowdfunding
Equity crowdfunding was first legalized in May 2016 with the passage of Regulation Crowdfunding (Reg CF), which Wefunder’s co-founders lobbied Congress for back in 2012. We have since referred to that set of laws as “flawed” in a variety of ways - most notably, investment limits ($1M per year) that limit the viability of Reg CF as a fundraising tool for later-stage and capital intensive businesses. Another critical but much less talked about problem with the original rules was that the legal structures they required made it much more complicated for companies to grow and raise more money after raising under Reg CF.
Today, that changes with the legalization of special purpose vehicles (SPVs) for use in Reg CF fundraising (along with an increased funding limit of $5M!). Wefunder is rolling out SPVs as an option for most new fundraises on our platform. This will allow for easy aggregation of investors into one line on the cap table, solve issues with 500 stockholder limits (aka Section 12(g)), allow a Lead Investor to vote on behalf of the SPV and its owners, provide a structure that every VC and startup lawyer is familiar with, and impose no additional fees on companies or investors. We think SPVs are a game-changer.
What’s wrong with the old laws
Let’s take a step back and talk about the problems with the old laws. There are 3 main issues that the original Reg CF failed to address:
Voting & Cap Table. Having hundreds or thousands of investors makes corporate governance a nightmare. Approving later corporate actions - like a financing or acquisition - can be challenging, and it’s practically impossible to get all your investors to sign documents, which is required in some cases. It also makes managing your cap table a challenge.
Section 12(g). Section 12(g) of the Securities Exchange Act requires companies with 500 non-accredited investors to begin reporting as a public company after a transition period. The SEC added a $25M assets threshold for Reg CF companies, but this is easily surpassed by successful companies.
Familiarity. After raising with Reg CF, many successful startups will go on to raise from VCs, hire startup lawyers, and engage in the broader startup ecosystem. The players in this ecosystem heavily favor consistency and familiarity because it lets them get deals done faster and more efficiently - there is a reason why the YC SAFE and NVCA financing documents dominate startup financing. When these players are unfamiliar with a new structure or workaround, it can become heavily stigmatized in the industry.
Workarounds create problems
SPVs are the simplest solution to the three problems above. Unfortunately, until today they were illegal to use with Reg CF. This led to a host of creative workarounds from every major crowdfunding platform - all of which create additional problems. Let’s look at the existing solutions and how they address the points above.
In a custodial relationship, one entity (a custodian) is the “record holder” of the securities sold by a company. The custodian holds those securities on behalf of individual investors, who are the “beneficial owners”.
Custodians are an effective “one line on the cap table” solution, but they don’t solve the voting problem without additional mechanics (e.g., Wefunder’s Lead Investor system, or a proxy granted to the founder). For purposes of Section 12(g), most lawyers believe that the custodian is likely to be counted as one stockholder, but this has never been tested in court and there’s no explicit guidance from the SEC. There is also little familiarity with this approach in the broader startup ecosystem.
- Major cap table providers like Carta may not be willing to list the custodian as one line in their cap table software due to laws around transfer agents.
- If the custodian is outsourced to a third party (e.g. Prime Trust is frequently used), there are costs involved that are likely to be passed on to companies as higher fees.
The Crowd SAFE is an investment contract modeled off the traditional YC SAFE, except that investors convert to equity only at a liquidity event (an acquisition or IPO) rather than at the company’s next financing. There are other forms of “Crowd” instruments available for token and debt offerings.
The Crowd SAFE is not a true “one line on the cap table” solution, since companies still have to maintain a list of all investors on their cap table. Investors don’t have voting rights, which does simplify voting for the company, but we also don’t think that eliminating voting rights is the right thing to do. More importantly, the Crowd SAFE does not solve Section 12(g), meaning each investor is counted separately and if a company raises from more than 500 investors, they must start reporting as a public company once they pass $25M in assets and the transition period expires. (Some platforms solve this by either (i) including a company repurchase provision, which effectively takes away the upside investors bargained for, or (ii) moving investments under a custodian if the company triggers Section 12(g), which is highly likely to be disregarded by the SEC since its explicit purpose is circumvention of Section 12(g)). There is also a lack of broader familiarity with this type of instrument.
Wefunder’s Solution: SPV + Lead Investor
Starting today, SPVs become legal to use for Reg CF fundraises. Wefunder’s new legal structure, which combines SPVs and Lead Investors, solves all three major problems.
Here’s how it works. When a company files their Form C with Wefunder, we’ll create an SPV specifically for the company’s fundraise, as a new series of Wefunder SPV, LLC (a Delaware Series LLC). The SPV will hold all the securities sold by the company, and will be the only entity listed on the cap table. Wefunder investors then receive interests in the SPV that are proportional to the size of their investment. Thus, the economics for an investor are the same as if they had invested directly.
Each company also chooses a Lead Investor, who is featured in their Wefunder campaign. The Lead Investor invests on the same terms as other investors, who grant a proxy to the Lead Investor to vote their securities. This means that the Lead Investor votes all shares held by the SPV and can sign documents directly on its behalf. The Lead Investor’s economic interests are intended to be aligned at all times with the other investors, but in the event there is a conflict of interest our documents have built-in mechanisms to address the issue.
Let’s return to the 3 major problems with legal structuring under Reg CF:
Voting & Cap Table: The SPV is a true “one line on the cap table” solution. The voting power of all securities sold under Reg CF is concentrated in one Lead Investor, who can vote and sign documents on behalf of all investors in the SPV. This Lead Investor can not only help approve subsequent corporate actions, but is intended to function as an advocate and resource for the company, the way a good VC might act.
Section 12(g): The new rule change adds an explicit exemption from Section 12(g) for Reg CF SPVs. This means that there is now 100% clarity that individuals who invest in an SPV will not count towards the 500 stockholder limit in Section 12(g).
Familiarity: AngelList has been syndicating angel investors into SPVs under Regulation D for years. Wefunder has been doing it since 2013. Every good VC, startup lawyer, accelerator, and acquirer knows what an SPV is and how it works. It’s also much easier to explain than prior solutions. We think this simplicity and familiarity will be a game-changer for acceptance of crowdfunding in the broader startups ecosystem.
Other major advantages:
- Fees: No fees are charged to companies or investors for using an SPV, since formation and administration is handled in-house.
- Admin: Wefunder handles all filings and administration. For equity and convertible fundraises, K-1s and other filing requirements will only be necessary upon a liquidity event.
- Flexibility: SPVs can be used with any investment contract, whether SAFE, Convertible Note, Equity, or Debt.
- Transferability: Companies maintain full control over secondary transfers. They can choose to permit secondary trading by default (once the 1 year waiting period under Reg CF has elapsed), or allow transfers only with permission of the company.
After 5 years of workarounds, we are finally able to provide a legal structure that is simple, well-recognized in the industry, and solves all the major challenges in structuring crowdfunding investments. This means companies who raise with us will have easier administration and face fewer barriers in raising money and growing after Wefunder. This is the next step in the evolution of crowdfunding!
 At the time of a liquidity event there may be minor costs associated with accounting for distributions. We do not anticipate any costs prior to that time.