Regulation D for Crypto like Funds, Crypto-mining, or Blockchain Businesses, can be a powerful tool.
Between 2012 and 2020, the value of Bitcoin rose by 193,639.36%.
That represents an astronomical return on investment. It is also a statistic that demonstrates why so many are currently focused on investing in cryptocurrency funds and blockchain businesses. There is clearly a lot of money to be made, as long as you understand how to invest in this new form of currency.
However, cryptocurrency is not easy to invest in. The massive rise in the value of Bitcoin has led to a single Bitcoin costing tens of thousands of dollars. As such, many investors are now considering pooling their resources into a syndicate, or cryptocurrency fund, to make investing more feasible.
This is where a private placement memorandum (PPM) may help.
With a PPM, a syndicator can offer securities in an emerging cryptocurrency or blockchain business without having to worry about registering its trades with the Securities and Exchange Commission (SEC). With the help of Regulation D of the Securities Act, your crypto fund could gain access to investors who can help you take advantage of the continued rise of many of today’s cryptocurrencies.
Of course, this brings us to some questions.
What are securities? What are private placement memorandums? What is Regulation D and how does it affect your efforts to raise funds for your crypto fund or blockchain business?
All of those questions, and more, are answered in this article.
Raising Capital for Cryptocurrency Funds and Blockchain Businesses
The high price and volatility of cryptocurrencies often make it difficult to raise capital for investing in them, especially on the public level. But there are some standardized approaches that you may consider taking when raising money for your venture:
Approach No. 1 – An Initial Coin Offering
Similar to an initial public offering, an initial coin offering (ICO) is essentially a form of platforming that benefits the creation of a new cryptocurrency. For example, an emerging blockchain business that has created its own cryptocurrency may use an ICO to attract investors. These investors spend their money on a set number of tokens, which provide access to the blockchain and cryptocurrency platform.
Perhaps the biggest challenge with ICOs is that they’re currency unregulated by the SEC. This issue is especially problematic as the SEC has determined that the virtual tokens traded in an ICO are securities and thus need to be overseen by the SEC in the same way as traditional securities.
As such, ICOs are currently a little problematic. If you’re willing to accept the risk of a likely increase in SEC oversight, you may be able to use an ICO to raise large amounts of capital from investors. If you’re not prepared for SEC involvement, you have other options available.
Approach No. 2 – An Initial Exchange Offering
In the same way that we have exchanges focused on traditional company stocks, we also have exchanges focused on cryptocurrency. Examples include Binance and KuCoin. You can use these exchanges to facilitate an initial exchange offering (IEO), which again acts similarly to an IPO.
With an IEO, you sell your tokens via your chosen exchange platform. As the token issuer, you pay a listing fee for the cryptocurrency, alongside a percentage of the number of tokens you sell during the offering.
This form of crypto fundraising is often favored because of its simplicity. An IEO participant only has to create an account on an exchange platform to conduct an IEO. That means no messing around with smart contracts. Investors can easily get involved by injecting funds into their cryptocurrency wallets, which they then use to buy the tokens provided in the IEO.
This simplicity is countered by the need to pay substantial fees to the exchange. As such, this may not be the right option for those who do not wish to give large chunks of their potential profits away to exchanges.
Approach No. 3 – Security Token Offerings
An emerging way to raise capital, a security token offering (STO) may allow you to follow SEC guidelines while still retaining the independence you value as a cryptocurrency fund or blockchain business owner.
With an STO, the security tokens you issue are supported by real-world assets. This means there’s something tangible supporting the value of your cryptocurrency or product. As they comply with SEC regulations, STOs are less risky to conduct than ICOs and IEOs.
Approach No. 4 – Going Private: a Regulation D Crypto Offer
Perhaps the biggest challenge with the three methods of raising capital discussed so far is that they all involve going public in some way. You’re launching your cryptocurrency or blockchain business, often using public exchanges to do so.
But what if you’d rather keep things private?
Perhaps you don’t believe your business is large enough to support a public offering just yet. Or, you’d rather keep the SEC out of your hair as much as you possibly can, especially when you’re building your business.
Thankfully, there are several ways you can raise money for a cryptocurrency fund of blockchain business. Venture capitalists, private equity firms, and angel investors all provide options. However, those who wish to maintain as much independence as possible may opt for the creation of an investment syndicate via a private placement memorandum. This is the same mechanisms many businesses use to raise capital.
What is a Security?
Before we can dig into any explanation of what a private placement memorandum is, we need to understand the concept of securities.
A security is any type of financial asset or instrument that you’re able to trade via an open market. In the traditional sense, stocks, shares, options, and bonds are all examples of securities. When it comes to a cryptocurrency fund or blockchain business, your digital coins and tokens could be considered examples of securities, especially if you ask the SEC.
As a business owner, you offer securities to investors in exchange for their money. There are four key types of securities that you might offer.
Type No. 1 – Equity Security
Perhaps the most familiar type of security, this involves selling an ownership interest in your business. For example, when a company offers stock, it’s selling equity in its business to those who buy the stocks.
Owners of equity security often benefit from the capital gains that come from either the sale of the associated business or the sale of their securities to other investors. Depending on the terms of the security, the security owner may also benefit from regular dividend payments. In some cases, people can hold so much equity security that they gain voting rights in the associated business.
Type No. 2 – Debt Securities
Also called fixed-income securities, debt securities act similarly to loans. As the security issuer, you’re essentially asking an investor to lend money to your business via a debt security. The investor then receives regular interest payments, based on the agreement you formed with them when offering the security. After a pre-determined period, the investor also receives the original investment back as a lump sum.
So, the benefits of this security for investors are that it provides regular income for the long-term, alongside a guarantee that they’ll be paid their initial investment back in full.
For the securities issuer, a debt security can provide access to vital funds without the need to go through the long-winded bank loan process. Furthermore, the issuer may receive access to the investor, allowing them to benefit from the investor’s knowledge and experience.
Type No. 3 – Hybrid Securities
A combination of debt and equity securities, hybrid securities offer your investors the best of both worlds.
The most common example of hybrid securities is convertible bonds. Here, the investor receives a bond, which is a form of debt security. They collect their interest as normal and have an end date in place for the bond. But they also have the option to convert that bond into an equity stake in the business at any time.
Particularly savvy investors can use hybrid securities to maximize their investments in their chosen companies. However, a syndicator may find they’re a little too complicated to use as part of a private placement memorandum.
Type No. 4 – Derivatives
With a derivative, the value of the security depends on the value of another asset or variable. For example, a derivative may be based on assets, such as currency or stocks. It may also be based on less tangible variables, such as interest rates and market indices.
Most investors use derivatives to minimize their risk while gaining access to markets and assets they’d otherwise struggle to reach.
Examples of derivatives include forwards, futures, options, and swaps.
Derivatives are unlikely to be used as part of a private placement memorandum, though you may be able to use them if you opt for an STO.
Why Hire a Lawyer?
With cryptocurrency and blockchain businesses still being somewhat new, you may believe you can make a relevant argument for not needing the help of a lawyer when trying to raise capital.
But this is not the case.
There are several reasons why you should hire a lawyer, especially if you’re considering a private placement memorandum. In this case, a syndication attorney is a must for the following reasons.
Reason No. 1 – A Background in Securities
As you may have concluded after reading about the various methods a cryptocurrency fund or blockchain business can use to raise capital, the SEC is a major issue right now. Regulation is coming and your business needs to know how to deal with it.
A strong syndication lawyer doesn’t just help you to use a PPM to gather a pool of investors. They’ll also help you to figure out which SEC guidelines you need to follow and what you need to do to ensure all of your syndication documents are valid and legal.
Your attorney can both answer these questions and ensure that your PPM is compliant with all required SEC rules and regulations.
Reason No. 2 – Compliance with Blue Sky Laws
What are blue sky laws?
They’re laws that states put in place as part of their own anti-fraud measures. They’re also not directly related to the SEC’s regulations, even though they may piggyback on them. As such, you need to consider the blue sky laws in your state on top of the more widely-known SEC regulations. Failure to do so when using PPMs or offer securities could lead to you facing civil action, even in cases where you’re following SEC regulations.
In short, you need to know your state’s laws as well as the SEC’s laws.
A good syndication attorney ensures you don’t run afoul of either.
Reason No. 3 – Creation of Paperwork
When creating your private placement memorandum, you may also be required to create several pieces of legal documentation to go along with it.
Attempting to do this on your own is problematic for a couple of reasons.
The first is that you are not a syndication lawyer, which means you don’t know exactly what your various syndication documents need to contain. This lack of knowledge can result in the creation of documents that don’t protect you or your cryptocurrency fund or blockchain business.
The second reason is that you are also not licensed to practice law. Many states consider the creation of legally binding documents as a form of practicing law. If you create such documents when you are not a lawyer, you may place yourself at risk of prosecution by the state. At the very least, the documents you create will likely be invalid as legal agreements because they were created by somebody who is not licensed.
A lot of paperwork goes into any effort to raise capital, regardless of the specific method you choose.
Hiring a relevant attorney makes creating that paperwork far easier. It also protects you from punishment for practicing law when you aren’t licensed to do so.
Your Liability for Getting PPM Wrong
One of the biggest advantages of using a private placement memorandum is that you’re able to offer securities without registering your transactions with the SEC. As a result, PPMs are not governed by many of the rules and regulations that are used for public securities trading.
Still, this does not mean that you face no liability if you fail to create your PPM correctly.
In the previous section, we mentioned blue sky laws and how many states have them to protect investors against fraudulent securities offerings. In many cases, blue sky laws piggyback from both the Securities Act and the Exchange Act. Often, they’ll impose civil liability on the issuer of a security if that issuer is found to have misrepresented or omitted key facts when making their offer.
Every state is different in terms of the types of penalties it hands out and the specific issues its laws deal with. As such, you need a syndication attorney with knowledge of the blue sky laws in your state of operation to help you create a factual and valid PPM.
Moving up from the state level, you must also consider the anti-fraud provisions the SEC has created. Again, the issue of misrepresenting or omitting facts is key here. Under Section 10(b) of the Securities Exchange Act, you’re liable if you omit or misrepresent the facts of any offer you make that is connected to securities.
In this case, recission is the main penalty you’re likely to face. Recission essentially leads to the contract you signed with an investor being declared null and void. The investor no longer has to pay the money they promised in the contract, with that burden moving back to the security issuer. What’s more, the issuer may also have to pay the investor’s legal fees and any other costs associated with the offer.
These punishments become harsher if the SEC finds that you have willfully omitted or misrepresented facts when making your offer. If the SEC can prove you’ve willfully attempted securities fraud, you can face up to 20 years in prison alongside a fine of up to $5 million.
When creating a private placement memorandum, accuracy is your key concern. You’re liable for damages even in cases where you’ve accidentally misrepresented or omitted facts. It’s for this reason that you need to work with a syndication lawyer to ensure you’re creating a valid PPM.
What is a PPM?
A private placement memorandum is a disclosure document that you use to provide investors with all of the information they need to know to decide whether they’ll invest in your business. Many compare them to business plans, though this is a somewhat inaccurate comparison.
Where a business plan is often used as a marketing document for your company, a PPM is used to provide the straight facts about an offer of securities that you’re making to an investor. The PPM will likely contain information about your company. However, its tone will typically be more formal and less marketing-centric than the tone of a business plan.
You will use a PPM if you’re trying to raise capital privately. For example, you could use a PPM to create a syndicate of investors for a cryptocurrency fund. Or, you may use PPMs to attract investment into a blockchain business, allowing you to grow the company beyond where it is currently.
A private placement memorandum is also a legal document. It will contain legal statements, along with language related to the SEC and the exemptions that you’re able to access when offering securities privately. As such, it’s vital that you work with a syndication attorney to ensure your PPM is valid and that you’re not breaking any laws around practicing law without a license.
What Types of Securities Are Offered in a PPM?
Generally speaking, you will make either a private placement equity offering or a private placement debt offering with a PPM. In other words, you either offer investors equity in your venture or you assume debt that you pay back at a later date.
Some PPM issuers may look towards the hybrid securities model, especially if they’re working closely with experienced investors. However, these securities may present too many complications for a new syndicator.
What is Included in a Private Placement Memorandum?
As mentioned, your PPM allows you to inform investors about the opportunity you’re presenting to them. This means your PPM should outline the nature of the opportunity, the terms attached to it, and any information the investor needs to know about your business.
There is no standard template to follow when creating a PPM, which means you have some flexibility in terms of how you present this information to your investors. But you will generally find that most PPMs contain the following sections.
Section No. 1 – An Introduction
Think of this section as a small one-page flyer that highlights the main bullet points that your PPM will cover. You’ll share some basic information about your blockchain business or cryptocurrency fund here, along with the key information about the opportunity you’re going to present. The introduction should contain the relevant information to help an investor immediately determine if they have an interest in your opportunity.
Section No. 2 – The Investment Summary
Something of an introduction following the main introduction, your investment summary is more focused on the offer you’re making. You’ll zoom in a little more on the offer, perhaps including additional information about your fund and what the investor receives in return for their capital.
Section No. 3 – The Risk Factors
Any investor worth their salt will examine the risks associated with an investment. In fact, many will skip to this section of your private placement memorandum before reading about the opportunity itself.
As such, it may be a wise move to confront the risks early in your PPM.
Your list of risk factors does not have to cover the general risks involved with investing. It also does not need to discuss the general risks associated with the cryptocurrency sector, as you can reasonably assume that your potential investor has done their due diligence in these areas.
Instead, you use this section to focus on risks that are specific to the opportunity you’re offering. For example, you may discuss future speculation about SEC involvement and how this may affect your fund here. The critical thing to remember when listing risk factors is that this is the area where you’re most likely to unintentionally mislead somebody. Aim for complete transparency here. Talk with your syndication attorney to ensure you’ve covered every possible risk you can think of.
Section No. 4 – Use of Proceeds
If an investor reads through the risks and then continues, the next thing they’ll want to know about is how you’ll use their money. Use this section to discuss how much you hope to raise and what you’ll spend the capital on. Itemizing every expense can be a good approach here as it shows that you’ve considered your spending down to the dollar.
Section No. 5 – Management and the Company
Assuming the investor is happy with how you intend to spend the money they’ve provided, they’ll now want to know more about you and the business. If you’re operating a blockchain business, this may be your opportunity to shed light on what the blockchain is, which can be especially useful for investors who have limited experience in the sector. Those running cryptocurrency funds may use this section to explain why they’re considering syndication and what their fund does to ensure a return in a volatile market.
You’ll also discuss your own business track record and the current financial state of your company here. Again, focus on representing the facts accurately to ensure compliance with SEC and state laws.
Section No. 6 – Offering Terms and Fees
This is the section where you start to divulge the more technical aspects of the deal you’re offering.
It’s here where you disclose information about the minimum required investment and the expected returns your investors can look forward to. If you’re making a private placement debt offering, you may discuss interest rates and term times here. Those offering equity may focus on dividends and expected capital gains, as well as how much of a controlling stake or opinion the equity gives the investor.
In terms of fees, focus only on those that are relevant to the placement offering. Fees may be charged for loans, asset management, and asset acquisition. You’ll outline how many of those fees get passed onto the securities holder, assuming any are passed on at all.
Section No. 7 – Description of Your Securities
What types of securities are you offering?
You’ll answer that question here. As mentioned, most syndicators make either a private placement debt offering or a private placement equity offering. However, it’s possible to offer both using the same PPM. You can also offer hybrid securities, depending on the complexity you wish to attach to your offering.
You basically use this section to describe the exact type of security your investors will receive.
Section No. 8 – Liquidity and Transferability
If the investor has any ability to redeem their securities for liquid assets, such as cash, or to transfer their securities to somebody else, you’ll tell them how that works in this section. Not all investment opportunities offer options to transfer or liquidate securities. If that’s the case for your opportunity, use this section to make that information clear.
Section No. 9 – Fund Location
Most PPMs last for an extended period to allow the securities issuer to build a syndicate of investors. As such, you need to define what you’ll do with any funds you collect during the early stages of the offering. Will they go into escrow? Are they immediately used to invest in cryptocurrency or to enhance your blockchain offering? You need to answer those questions here.
As a side note, some private securities offerings require you to reach a minimum number of securities sold before you can start spending the money you’ve received. Speak to your syndication attorney to discover if any of these limitations apply to your PPM.
Section No. 10 – Tax
This is a fairly simple section that defines the types of tax documents sent by the syndicator to investors each year. You’ll likely send a K1, which is a general report covering your company’s losses, income, and dividends. Your syndication lawyer can provide more details or point you in the direction of a tax attorney who can help with this section.
Section No. 11 – How to Invest
Often used as a conclusion for the main content of a private placement memorandum, this section switches the focus away from the securities issuer and towards the investor who is reading the document.
First, you’ll cover investor suitability, with a specific focus on whether the opportunity is only available to accredited investors or if it’s open to sophisticated investors. This is determined based on which Regulation D exemption you choose, which we will examine shortly.
With suitability established, you may then provide the investor with a step-by-step guide that covers what they need to do to accept your offer. This will usually contain information about the subscription and syndication documents required, in addition to information about how the investor can provide their capital to your business.
Section No. 12 – Conflicts of Interest
Typically, this final section contains a declaration to state there are no conflicts of interest that could affect the offer you’re making. Of course, this isn’t the case if there are conflicts. For example, if you’re operating a cryptocurrency fund and one of your managers also invests in another fund, this is a conflict of interest that investors want to know about. Where conflicts exist, be transparent and express them here. Again, this ensures you avoid running into the SEC’s anti-fraud laws.
Choosing an Exemption – SEC Regulation D
Regulation D, which we’ve mentioned at various points in this article, is the regulation that enables your cryptocurrency fund or blockchain business to obtain funding via a PPM. In fact, many different industries use Regulation D to raise capital.
It is a collection of rules that determine what you need to do so that you don’t have to register a securities trade with the SEC. Regulation D provides smaller companies, such as cryptocurrency and blockchain startups, with the ability to raise capital without having to go public before they’re ready to do so. However, larger companies can also use them to raise money.
To claim the exemptions offered under Regulation D, you need to create a Form D filing. This document informs the SEC about the trade, providing some basic information in the process. But it is far less detailed than a typical securities registration, thus cutting down on the amount of paperwork you need to do.
While there are several rules in Regulation D that you may need to consider, the most important for a private placement memorandum is Rule 506. Split into two parts, this rule allows you to dictate how you make your securities offering and who you’re able to make it to.
The choice between Reg D 506(b) vs 506(c) is one of the most important you’ll make when creating your PPM. That’s why it’s crucial to understand the differences between them.
Under Rule 506(b), you’re not allowed to advertise any details about the deals that you’re looking to make. For example, you cannot take out a television advert to talk about how you’re looking for investors to buy securities in your cryptocurrency fund. Any sales you make have to be to investors with whom you already have a relationship. You may also be asked to provide proof of this relationship to demonstrate that you have not attracted the investment through advertising.
Speaking of investors, you’re able to include both accredited investors and sophisticated investors when offering your PPM. There are no limits on the amount of money you can raise, either in total or from each individual investor. You also do not need to go to any great lengths to verify the status of an accredited investor. As long as you reasonably believe that the investor is accredited, you can move forward with the deal. However, you do need to provide more information when working with a sophisticated investor.
While Rule 506(c) is similar to 506(b) in many respects, such as the need to submit Form D filings, there are key differences in terms of advertising and the types of investors you can work with.
First, this rule allows you to advertise your deal directly, which also means you’re allowed to work with investors with who you do not have a pre-existing relationship with. You can advertise on practically any medium, including television, physical media, and the internet.
The compromise for this comes in the form of the investors you can work with. You’re only eligible to work with accredited investors under Rule 506(c). What’s more, you’re responsible for verifying the credentials of every investor to ensure you’re complying with the rule.
Verification is a time-consuming process that also leaves you open to liability issues if you get it wrong. For this reason, many choose to outsource the verification process to a third party. Doing this also saves time, allowing you to focus more on the opportunity you’re offering than on the paperwork surrounding it.
Prepare Your Private Placement Memorandum
A private placement memorandum, allows your cryptocurrency fund or blockchain business to offer securities without having to go down the complicated public route. For some, a PPM is the ideal way to raise capital when they don’t believe their businesses are large enough to succeed with a public offering. For others, PPM affords you the chance to raise capital without dealing with the turbulent regulatory environment that currently surrounds cryptocurrency.
It’s also important to note that a PPM is a legal document.
As such, you must work with a syndication attorney to ensure the document complies with both SEC and state regulations.
At Moschetti Law Group, we specialize in creating investor-grade PPMs that exhibit the professionalism that top-quality investors expect from the businesses they work with. Our team takes all of the hassles of creating your PPM out of your hands. What’s more, we can offer advice on how to structure your securities deals so that you’re protected in every situation.
Would you like to learn more?
Schedule your free consultation with a member of our team today to discover how the syndication attorneys at Moschetti Law Group can help you.
Tilden Moschetti, Esq., is a highly sought-after syndication attorney with nearly two decades of experience. His clientele ranges from real estate developers and startups to established businesses and private equity funds. Tilden’s expertise in syndication law comes not only from his knowledge of syndication and securities law but from real, hands-on experience as an active syndicator himself in every real estate product type and nearly all markets in the US. His knowledge and experience set him apart and established him as the Reg D legal services leader.