California Does Something Right!

Since I am so critical of California’s anti-business policies and bureaucracy, it is only fair that I notice and spread the word when they have gotten something exactly right.

So a tip of the hat to California’s legislature for passing Assembly Bill No. 667 and to Governor Jerry Brown for signing it into law. Raising money for entrepreneurs and real estate investors just got a whole lot easier in California.

Under most state laws you can’t pay a commission to someone for finding you an investor unless they are a licensed broker dealer. At the same time, most broker dealers (think Merrill Lynch or Charles Schwab) don’t want their broker’s putting investors into smaller deals. As a licensee you have all these fiduciary duties and obligations to comply with. There is too much risk investors will lose their money and blame the broker. The Charles Schwab’s of the world want no part of such aggravations. So you have this no man’s land where brokers have to be licensed to sell the deal, and because they are licensed they won’t sell the deal.

Enter California’s common sense legislation.

Within the securities world ecosphere there are people known as ‘finders’. They find money or deals and expect to be paid. If they raise $1,000,000 for your new company they want 10% (or $100,000) of what they raised. The problem is that, as mentioned, only licensed broker dealers can receive such commissions. Sometimes, with a wink and a nod, a finder will pretend to be an officer of the issuer (the company raising money) and will receive a ‘salary’ instead of a commission or they will provide ‘marketing services’ and receive an amount of money that is suspiciously close to the 10% commission, they would have received as a broker dealer.

Reason 1. “Finder” has been redefined

California’s law eliminated such machinations and gyrations. Section 25206.1 has been added to the California Corporations Code. It defines a “finder” as a natural person (not a company) who introduces accredited investors to an issuer who is seeking to raise up to $15 million in capital. An accredited investor is someone with over $1 million in net worth (exclusive of their personal residence) or one who makes over $200,000 a year (or $300,000 if they are married). So while the finder can’t introduce mom and pop investors, those aren’t the people the issuer wants to meet anyway. Even with the advent of equity crowdfunding, most offerings are geared towards accredited investors only.

Reason 2. The Finder’s role is clearly defined

The finder is limited in what they can do besides introducing the parties (which, if you are a finder, means less work for you). The finder can’t negotiate any of the terms, advise on the suitability of the offering, do any due diligence or handle any monies. In fact, the only disclosure a finder can make to a potential purchaser is the following:

• The name, address and contact information of the issuer.
• The name, type, price and aggregate amount of any securities being offered in the issuer transaction.
• The issuer’s industry, location and years in business.

If that’s all you have to do then sign me up!

Reason 3. Get in the Game by Registering with the State

Actually, that is the first step: Signing up. Before engaging in any activities the finder must file a form with the California Corporations Commissioner. They want your name and address and a $300 fee.

Importantly, for each introduction the finder must obtain a written agreement signed by the finder, the issuer, and the person introduced or referred, disclosing the following:

1. The type and amount of compensation that has been or will be paid to the finder in connection with the introduction or referral and the conditions for payment of the compensation.
2. That the finder is not providing advice to the issuer or any person introduced or referred by the finder to an issuer as to the value of the securities or as to the advisability of investing in, purchasing or selling the securities.
3. Whether the finder is also an owner, directly or indirectly, of the securities being offered or sold.
4. Any actual and potential conflict of interest in connection with the finder’s activities related to the issuer transaction.
5. That the parties to the agreement shall have the right to pursue any available remedies at law or otherwise for any breach of the agreement.
6. That person being introduced is an accredited investor and that they knowingly consent to the compensation being paid to the finder.

The finder must keep all these notices for a period of five years.

Reason 4. Registration Protects the Issuer as Well

The issuer should make certain the finder is signed up with the state and exempt from needing a broker dealer license. If the person really isn’t a finder, the investor can sue the issuer for a rescission. This means the investor can rescind their investment and get back all of the money they put in, plus interest, from the issuer. The finder may be nowhere to be found, putting the issuer at risk not only for the money they received but the commission they paid out, too. Issuers must be cautious.

But aside from such concerns, the freedom to be able to pay a finders’ fee to a finder is a positive development. More money will be raised and more jobs will be created. California actually did something right.

For more information on ways to raise money for your business consider reading my new book, co-authored with Gerri Detweiler, Finance Your Own Business.

Learn How to Get on the Fast Track to Financing

Our book Finance Your Own Business: Get On The Financing Fast Track details the power of business credit, how to get an SBA loan, the secrets of micro lenders, the benefits of crowdfunding and more.

About the Authors

Garrett Sutton, Esq., author of Start Your own Corporation, Run Your Own Corporation, Loopholes of Real Estate, The ABC’s of Getting Out of Debt, Writing Winning Business Plans and Buying and Selling a Business in the Rich Dad Advisors series, is an attorney with over twenty-five years experience in assisting individuals and businesses to determine their appropriate corporate structure, limit their liability, protect their assets and advance their financial, personal and credit success goals.

Gerri Detweiler is the author of four books, including the Ultimate Credit Handbook (named one of the top five personal finance books of the year when it was released), and a media favorite quoted in publications like USA Today, The Wall Street Journal and featured on The Today Show and CNN. A credit educator since 1987, she’s served on credit reporting agency Experian’s Consumer Advisory Council twice.

What the heck is crowdfunding? And why has the Securities and Exchange Commission (“SEC”), the government’s stock market watchdog, been so cautious about it all? Three years after the SEC was directed to come up with new crowdfunding rules, they finally delivered.

As to the first question:

Crowdfunding is derived from crowdsourcing. Wikipedia, the free encyclopedia, is an example of crowdsourcing, where the small editorial contributions from many people are leveraged into a bigger whole, a massive compendium of information. When you add money to the concept, you have crowdfunding.

There are three key players in a crowdfunding effort. First, you have the project initiator, the entrepreneurs who put forth the venture. Of course, you have the crowd, who will (hopefully) fund the project. And then you have the internet Funding Portal, which brings the two parties together.

With the passage of the Jumpstart Our Business Startups, or JOBS Act, in the spring of 2012, Congress sought to open up capital formation from smaller investors through crowdfunding. They directed the SEC to come up with new rules within a year to make the raising start up monies easier for new businesses.

Gerri Detweiler and I put the release of our book, Finance Your Own Business, on hold for a year waiting for these important new rules. The SEC, being a slow, deliberative and political agency, took their own sweet time. We could wait no longer to publish the book. Of course, in the same week the books were printed the rules were released. What else is new?

What is new with crowdfunding are some opportunities for small and new businesses to raise money beginning in the spring of 2016. Let’s answer the key questions…

What is the biggest change?

Smaller investors can now invest. Previously, only accredited investors (those with $200,000 a year incomes or a $1,000,000 net worth) could participate in a crowdfunding offering. Now, those with an annual income or net worth of less than $100,000 can invest up to 5% the lesser of their income or net worth per year, or $2,000 if that is greater. Those with higher incomes and net worth can invest up to 10% of the lesser of income or net worth. At the upper end, investors can only place a total of $100,000 in all crowdfunding offerings each year.

Even with these limits, a whole new market has just opened up.

Can I advertise the offering?

Yes. Prior to the JOBS Act, you could not use any form of public solicitation to advertise your offering. Now, for debt or equity fundings not exceeding $1 million, you can use emails, Facebook, and the like to promote your offering. Before you had to be rich and in the know. Now you just need to be on the internet. Let that sink in for a moment. (Does the word ‘caution’ come to mind?)

How do investors receive the information?

You direct them to a web based Funding Portal such as Crowdfunder, Seedinvest, AngelList or EarlyShares. There are many other Funding Portals, and more to come. Investors review your offering at one of these sites and decide. Know that you can list your offering on only one site. And know, too, that the Funding Portals are allowed to take equity in your business at the same rate as everyone else for the services they render. This may lower your out of pocket costs.

What information must be disclosed?

The strict rules on disclosure still apply. You must be candid about everything in your offering. Not only is this the law but it is the right thing to do. You must give your investors all the information they need to make a reasoned investment decision. For more information on preparing an investment document, see Finance Your Own Business.

In terms of financial information the SEC thankfully dropped the requirement of a full (and expensive!) financial audit for new issuers. If raising $100,000 or more only CPA reviewed financials are needed, with even lesser financials required for lesser raises.

Certain disclosures must also be made directly to the SEC. Be sure to work with a knowledgeable securities attorney when venturing into this area.

What if my company doesn’t raise the full amount?

Then you don’t get to keep any of it. So if you think you can raise $500,000 but $1 million is a stretch go with the smaller amount. If you don’t reach your goal then you will have to refund the investors their money and all of your printing, legal and accounting costs are your responsibility. Not only have you not raised any money but you are out of pocket for the expenses of trying to raise the money. Be prudent.

Another important consideration is that investors can change their mind up to 48 hours prior to closing. Your whole offering could be blown if one or two people back out at the end. Consider exceeding your target raise (which is permitted) so as to have a cushion at closing.

Can I sell my shares?

Not anytime soon. Like regular private placement offerings, shares must be held by the investor for at least one year. Even after a year there most likely will not be a very liquid market for the shares. That day fully arrives when the company registers with the SEC to be publically traded. Still, liquidity aside, to help a friend, to create new jobs or just to have fun rolling the dice, crowdfunding gives everyone a chance.

What else do I need to know?

“You need to be careful,” says Dave Archer, a co-founder of the Reno Angels and the president and CEO of NCET, Nevada’s technology organization. “When you raise crowdfunding money you now have a fiduciary duty to your investors. You must act in their best interest at all times.” Archer cautions that this is new and unchartered territory. “Be sure and do your homework and know exactly what you are getting into before proceeding.” Again, the counsel of a knowledgeable securities attorney will also be extremely important as you move forward.

The SEC took its sweet time developing the rules because there are lots of issues to consider here. Stock promoters and swindlers have always taken advantage of the investing public. Despite the best efforts of the regulators, this will happen again, now on a website near you. But you’ve got to weigh (as the SEC finally did) the inevitable downsides against the significant crowdfunding benefits of capital formation and job creation.

Will the next Google arise from an equity crowdfunding effort? Who can know? But if it does, I sure hope I am in it.

Let’s say you need help financing your new business. You’ve put $10,000 of your own money in, and maybe your parents added another $5,000 – yet you find that it still won’t be enough. You run the numbers, and discover you need another $5,000 to pay for this and that over the next three months before your customers can float the business.

What to do?

A bank loan could take some time to obtain, but you need financing now. What’s another option? Many people turn to a business credit card.

A 2014 survey of small business owners by the Federal Reserve Banks of New York, Atlanta, Cleveland and Philadelphia found that credit cards were the third most popular type of funding, with 19% citing it as a primary source of funding.

Business credit cards can allow you to rack up serious travel or cash-back rewards, and they can give you fast access to credit when you really need it. But like riding a horse, with fast and rewarding comes the need to pull in the reins. You’ve got to be in control.

They’re a Different Animal

Sure, a business credit card looks just like a personal one, and you can swipe (or now “dip”) it like one. But when it comes to federal protections they can be quite different. Things like protection from universal default, interest rate increases at any time and for no reason, and floating due dates don’t apply to business cards like they do to personal ones. Though, some business credit card issuers have extended some of these protections to the cards they offer to their cardholders.

So unless you are confident you won’t carry a balance on your card, and will be organized enough to always pay on time, you’ll want to make sure you read the fine print.

You May Be Stuck With the Tab

What happens if you give a card to an employee and they use it to take a trip to Vegas? You may be out of luck. Charges made by an employee who was authorized to use the card may not be considered fraudulent. Just take a look at the fine print on Visa’s Zero Liability policy: “Financial institutions may exclude from the Zero Liability policy a transaction made by a person authorized to transact business on the account and/or a transaction made by a cardholder that exceeds the authority given by the account owner.”

This isn’t all that different from personal credit cards, where you can be held responsible for charges if you give your kid the card to use and they spend more than you told them they could spend. But business owners who don’t keep close tabs on what their employees spend on these cards could be in for an expensive surprise.

There May Be More at Risk Than You Know

Because corporate credit cards are relatively easy to get if you have good credit, it can be easy to overspend. After all, there is no banker asking you why you want to borrow, or how you plan to spend the money. That’s not necessarily a bad thing; it can give you a lot of flexibility, after all. As I talk about in my book Finance Your Own Business, most of these cards require a personal guarantee, which means if your business runs into tough times and defaults, the issuer can go after your personal funds or certain assets to try to collect.

So despite these potential drawbacks, why would you choose a business card over a personal one? There’s a very good reason: These cards can allow you to keep your business and personal credit separate. Most of these cards are not reported on your personal credit reports unless you fall behind or default, though at least one major issuer reports all business credit card activity on the owner’s personal credit reports. (You can see how business credit is potentially affecting your personal credit by getting your free credit report summary on Nav.) This means that if you need to make a large purchase, use your card heavily to earn rewards, or carry a balance from time to time, that activity won’t hurt your personal credit scores. Which is good, because you really should be able to live outside your business.

A couple that I’ll call Jake and Marcia purchased a coffee shop. The business was really Marcia’s dream, not his, but she was persistent and he reluctantly agreed to try to help out.

Things went badly from the start and within less than 18 months they were forced to shut it down. But that wasn’t the worst of it. Because they had obtained a loan that required a personal guarantee to purchase the business, they were facing the possibility of losing the home where they raised their children. Needless to say, their relationship was also quickly going south, with Jake accusing his wife of putting their entire future at risk.

What is a personal guarantee and what does it mean? And what about your personal credit? Does it affect that, too? As a corporate attorney working with small-business owners all over the world, I’ve heard a lot of questions, misconceptions — and some horror stories, like Jake and Marcia’s — about how personal guarantees work.

Basically, a personal guarantee allows a lender to try to collect from what you own personally if you default on a loan and your business is unable to repay it. It allows a lender to reach beyond the income and assets of the business to collect if necessary.

Should You or Shouldn’t You?

The newer your business, the more likely it is you will be required to provide a personal guarantee. It provides additional protection for the lender, and if your business doesn’t have a strong track record, it’s no surprise the lender will insist on one.

Entrepreneurs are often optimistic and willing to do whatever it takes to get the funding they need. But if you are going to sign a PG, make sure you fully understand the risks. If you have a spouse or partner, they need to be on board as well. (Sometimes they may be required to sign the loan documents, too, especially in community property states or where equity in jointly held property serves as collateral.)

If all goes well, and you pay the loan back, then there’s no problem. But if you run into financial difficulties, you need to understand that the lender may try to get repaid through your personal bank accounts or other assets (to the extent allowed by law).

Keep in mind that what types of property are available to creditors who get a judgment depends on state law. A few states prohibit wage garnishment for most types of debts, and others have strong homestead laws that may protect equity in a home (Texas and Florida are two examples).

Is Your Credit at Risk?

Signing a personal guarantee doesn’t automatically impact your personal credit. With the exception of some business credit cards, most loans made to a business are not typically reported on the owner’s personal credit reports — unless he or she doesn’t pay the loan back and it goes to collections. A personal guarantee doesn’t usually change that. But if you sign a personal guarantee and you don’t repay the loan, it’s likely it will wind up on your credit as a collection account, or even a judgment, and will hurt your credit scores.

This is one of many good reasons to regularly check your credit reports and credit scores. You can get a free annual credit report from each of the major credit reporting agencies once a year through AnnualCreditReport.com. You can also get your credit scores for free from many sources, including Credit.com, to watch for important changes. Creditera offers a free business and personal credit score summary and score. No credit card required.

One way to avoid personal guarantees is to build strong business credit ratings, which I explain in my new book, Finance Your Own Business, and to demonstrate to the lender that your business can support the loan through sales and revenue. These guarantees may be negotiable. If you’re not there yet, tread carefully and borrow as little as possible. The less you borrow, the less is at risk if things don’t work out.

Learn More About Business Lines of Credit

Our upcoming book Finance Your Own Business: Get On The Financing Fast Track details the power of business credit, how to get an SBA loan, the secrets of micro lenders, the benefits of crowdfunding and more.

Fill out the form on this page and we will let you know when the new book is released and offer early bird discounts. Plus you’ll get a free guide today – The Levels of Business Credit. (And don’t worry: we know you’re busy so we won’t flood you with email.)

About the Authors

Garrett Sutton, Esq., author of Start Your own Corporation, Run Your Own Corporation, Loopholes of Real Estate, The ABC’s of Getting Out of Debt, Writing Winning Business Plans and Buying and Selling a Business in the Rich Dad Advisors series, is an attorney with over twenty-five years experience in assisting individuals and businesses to determine their appropriate corporate structure, limit their liability, protect their assets and advance their financial, personal and credit success goals.

Gerri Detweiler is the author of four books, including the Ultimate Credit Handbook (named one of the top five personal finance books of the year when it was released), and a media favorite quoted in publications like USA Today, The Wall Street Journal and featured on The Today Show and CNN. A credit educator since 1987, she’s served on credit reporting agency Experian’s Consumer Advisory Council twice.