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Compliance with Reg CF: What if you need money during the middle of Reg CF campaign?

So far, Regulation Crowdfunding appears to be doing what it was always intended to do. Small businesses are able to raise funds to begin or expand their business operations. Some companies could be categorized as innovative growth companies, others more main street. In any case, a common theme is that issuers are in need of cash and see crowdfunding as a method that provides additional benefits over traditional loans or angel investment – if those options were even available to the issuer to begin with.

As offerings under Regulation Crowdfunding can take a few months, often with substantial upfront costs, many issuers find themselves in the position of needing to raise capital during the middle of an offering to pay salaries and keep the lights on. This type of capital raising activity could consist of sales of securities to accredited investors in offerings under Rule 506(c) of Regulation D, traditional loans from financial institutions, or loans from related parties. In the case of loans, the lender may even request that the loan be secured by whatever funds are currently in escrow in the offering under Regulation Crowdfunding.

Issuers should be aware that any mid-offering capital raising activity presents a change that will likely require an amendment to the Form C. Further, the amendment may be material, requiring each investor that has committed funds to recommit to the investment.

The SEC deems an amendment to be material if “there is a substantial likelihood that a reasonable investor would consider [the change] important in deciding whether or not to purchase the securities.” Amendments that impact the financial condition of the issuer or the intended use of proceeds are likely to be considered material. That said, what is material is based on the facts and circumstances of the particular amendment. A small investment from an outside investor of existing authorized securities of the issuer that does not change the control of the issuer may not be material, whereas a large investment that requires a new class of securities would be. Taking on debt will almost always be material, especially if it impacts the use of proceeds of the offering.

As previously noted, a material amendment will require that the issuer to reconfirm the investment with each investor that has previously committed funds. Issuers that plan ahead could have the material amendment filing coincide with a marketing push to reduce the volume of investor attrition that can be expected.

Not filing an amendment when required could have more disastrous consequences for an issuer. If an issuer is required to file an amendment covering a material change, then almost by definition the information previously provided to investors is materially misleading. While investors may not realize a material change occurred until the first annual report of the issuer, they will be able to see that the company misrepresented information if they see that significant financial activity occurred during the Regulation Crowdfunding offering that was not disclosed at the time – leading to liability for the issuer and the investment platform facilitating the offering.

Raising capital during a Regulation Crowdfunding offering may be essential for a company to stay afloat until the offering closes. However, addressing the need for an amendment to the Form C disclosing that raise is equally essential. While there may be short term pain for the company in filing a material amendment, not filing creates the potential for long-term liability.