Credit Cards & Crowdfunding – Some Considerations
The industry, at long last, has a credit card processor willing to service equity and debt crowdfunding. As portals, brokers and other people jump to do this, I want to take a moment to discuss a few things.
WHO: the credit card company only wants to sign “platforms”, as the underwriting process for a single small issuer is just too much and not worth their time. This means brokers, funding portals, and platforms who bring on numerous offerings per year. NOTE THAT THE PLATFORM IS THE “MERCHANT”, not the issuer (critical point, as I’ll discuss below).
FUNDS LANDING: Unless you are a trust company, bank or $250,000 net-cap broker-dealer you cannot touch the money that investors send. This means that your escrow relationship will need to accommodate you, as the merchant, delivering funds from investors to the escrow account. This will be enormously complicated for the escrow agent as they will have to be able to sort through the daily single-batch deposits to determine how much is from which investors and ensure those funds are accounted for, reconciled and reported.
RISK: there is significant risk for everyone involved, including the platform, the escrow agent and of course the credit card company. The card company will protect itself by pricing their fees at the risk, and by retaining a deposit for the duration of the risk period (which is 180 days). The escrow agent’s risk is that the chargeback account is likely the landing account (still tbd), in which case the card company would hit that particular bank account for chargebacks as far out as 6 months, which could result in a negative balance and thus hit the escrow agent’s capital (as funds would have been disbursed to the issuer, and likely already spent). The platform risk is obvious, as it is the “merchant” and thus ultimately bears all risk for all transactions, 100%.
DEPOSIT/HOLDBACK: tricky issue. Platforms would prefer that the credit card company hit the various transactions for a rolling 180 day deposit. However, regulators may take a dim view of that as it would mean, in effect, an investor sending, say, $500 to escrow would actually only get $475 (or whatever) delivered to the escrow account (which is then the amount the escrow agent would reflect on its books), and remember that the credit card company is not an escrow agent nor a party to the escrow agreement, so if they take any funds from the investors principal those are not considered in escrow. Regulations require all investor funds to be sent to escrow…not “most of” investor funds to be sent to escrow. Thus, I’m not sure how to work around this problem except for the portal (as the merchant) to put up, in advance, a very large deposit with the credit card company so they don’t take anything out of individual investment amounts.
BROKER/PORTAL COMP: broker-dealers and funding portals face a variety of regulations about how much compensation they can take on an offering. At times FINRA has been known to count things that, to most people, is obviously not broker-compensation but to the regulators, for whatever reason, they say it is. This has included things like legal fees, due diligence reimbursements, escrow fees, consulting fees, and other items. So, will FINRA view the fees a portal or broker-dealer may charge issuers (and/or investors) to recover costs of credit card processing as “broker comp”? That’s a very large question. If they do then it’ll likely affect how much they can earn as it will reduce variable comp against the cap.
BROKER NET-CAPITAL CALCULATIONS: brokers are subject to stringent net capital rules with a seemingly endless list of “haircuts” they have to take in performing their net-cap calculations. So, if a broker-dealer is the “merchant”, and distributes any funds to the issuer prior to the 180 day risk period expiring, what will be the required haircut against net-cap to offset this risk? And do they have to carry the risk on their balance sheets? This, I think, needs to be clarified before any broker can become a merchant and process credit card transactions for investors.
THIRD PARTY MERCHANTS: some people may simply open the merchant account in a different, non-FINRA-member entity. The thinking being that if the parent/holding company of the portal is the merchant instead of the portal itself then the potential fees and net-cap issues would not come into play. That might work, however keep in mind that this third-party entity, like the portal, isn’t the issuer of securities, it is acting as a payment facilitator and taking the risks of the transactions. Only regulated entities can act as payment processors, including trust companies, banks, $250K net-cap broker-dealers, and state chartered payment processors (e.g. PayPal, Stripe, et al). I believe that your third-party entity would need to get registered, obviously you should rely on your attorney for guidance.
OFFERING TYPES: credit cards are explicitly permitted under Reg CF (even though those reg’s don’t touch on, and provide no safe harbor for the broker/portal-comp or net-cap issues). But what about Reg A? Or Reg D? Well, I think this depends upon whether a broker-dealer is or isn’t involved in the offering. If it’s a direct-to-crowd offering by an issuer then they can likely accept investments via credit cards (check with your attorney, of course). But if a broker is involved, they are subject to regulations that can easily be interpreted as disallowing the use of credit cards by investors in Reg A or D securities; each broker’s CCO will need to evaluate this and make a decision for the firm.
TECHNOLOGY: don’t underestimate the engineering skills that portals and escrow agents are going to need to handle this business. The API’s of the credit card processor are excellent, and extensive, and writing into them to permit transactions, append transactions with offering codes, break down batch files and report by investor, and other things is going to take time. Naturally FundAmerica is committed to doing this for our escrow partner, Prime Trust in order to make things easy on our portal, broker and platform customers.
CONCLUSION: credit cards have arrived, and offerings can now be funded with simplicity and ease that goes far beyond ACH. However, it costs more (generally 3% – 5% plus $0.35) than ACH ($0.50/transaction regardless of size), and may have some tricky regulatory issues to navigate. But this industry will do that, and we’ll figure it out.
About the Author: Scott Purcell is the CEO of FundAmerica, a fintech services provider to the emerging equity and debt crowdfunding industry. His firm provides escrow, payment processing, and compliance technology for numerous broker-dealers, investment advisers, portals and others who make a business of online capital formation pursuant to rules now in effect thanks to the JOBS Act. FASTransfer is the only tech-driven SEC registered transfer agent focused on the crowd-industry. He is a founding Board member of the Crowdfunding Intermediary Regulatory Association (CFIRA) and the author of the book “The Definitive Guide to Equity and Debt Crowdfunding” as well as the “Industry Best Practices for Funding Portals”.