Syndication and crowdfunding are terms that have been used interchangeably within the last decade, and their concepts and meaning have become increasingly blurred. However, whereas syndication focuses on funding relationships and structure between the funder and funded, crowdfunding is a method of finding investors (or backers) with the cornerstone philosophy of ‘strength in numbers’. This article attempts to define each term, gives examples of each, and seeks to clarify each concept.
What is Syndication?
Syndication is the grouping of investors into a transaction. The relationship between the funders and funded become important, and thus the legal structure of the transaction, become very important. Consider the relationships between players in syndicates across different industries:
Banking (Loan) syndication: Traditional loan syndication is the aggregation of multiple lenders generally with a direct relationship with the borrower and often direct interests in the collateral, notwithstanding the fact that they might have been organized by a lead bank. Note the related concept of loan participation, however, which tends to be more analogous to real estate and venture capital syndication (described below) with regard to the relationship between funders and the funded. In a participation relationship, participants (lenders) are not direct creditors of the borrower. Rather, a lead lender negotiates one loan and sells undivided interest in rights under the loan to participants (other lenders). There is no debtor-creditor relationship between a participant and a borrower, and participants generally must rely on the actions of the lead lender to collect.
Real estate syndication: Instead of contributing his or her money to acquire or manage real estate, a ‘sponsor’ sells interests in entities which own real property to investors. Typically, the sponsor identifies the real estate opportunity, takes on the administrative reigns as ‘manager’, controls most decision-making, and contributes mostly sweat equity in lieu of or to supplement monetary equity. Investor members, who typically invest based on the track record of the sponsor and risk/reward ratio of the opportunity, rely on the sponsor to make the real estate lucrative (whether through construction, development, leasing, repurposing, etc.), but do have certain voting rights. The sponsor is compensated via fees and a profit-sharing arrangement of usually 30-40% to ensure that incentives are aligned.
Venture capital syndication: Instead of taking on a whole round oneself, a lead investor shares in their deal with other investors. In Angellist angel syndicates, for example, a lead investor finds and diligences the investment opportunity, negotiates the investment terms and keeps backers informed about the progress of the investment. Backers link up to experienced investors with successful track records of ‘picking the right ones’, commit to investing on the same terms as the lead, and pay a carry of between 5-20% carry per deal to the lead (and 5% to Angellist). By linking up, backers increase the total investment amount, gain major investment rights, and access more deals. SyndicateRoom provides a variation of this structure: a nominee legally owns the investment, keeps share certificates on investors’ behalf, provides updates and reports, and administers the investment when certain events occur, such as dividend payments or an exit. Investors are beneficial owners, retain full economic rights, typically vote through the nominee, and pays the nominee a carry of 2.5%.
What is the Definition of Crowdfunding?
Crowdfunding is the raising of capital from the crowd. It refers to the mass advertising of a project or offering, usually to those outside of one’s immediate personal network, and focuses on the idea of strength in numbers. The term was first introduced by Michael Sullivan on August 12, 2006, in describing fundavlog:
“Many things are important factors, but funding from the ‘crowd’ is the base of which all else depends on and is built on. So, Crowdfunding is an accurate term to help me explain this core element of fundavlog.”
It’s not defined by any particular set of laws
Crowdfunding is also not defined as offerings under any particular set of regulations. On one hand, crowdfunding is a global phenomenon, and not limited to laws under the JOBS Act. Further, there are entire categories of crowdfunding that do not fall under any sort of securities law, such as donation-based (GoFundMe) or rewards-based (Kickstarter) campaigns.
It’s not about being online
I used to describe crowdfunding as ‘online syndication’, but was recently convinced otherwise. Although crowdfunding was popularized by online portals such as Kickstarter and Kiva, crowdfunding campaigns need not use an online portal. A company with a significant following or consumer base might decide instead to add an ‘Invest Now’ button on its website, and that would still be considered crowdfunding. Crowdfunding also need not advertise online (i.e. all those Facebook and Twitter ads that never seem to stop following me). A company could simply disseminate information about its offering on its web page (with proper disclosures). And the transaction need not be done online—a company could have fancy videos on a beautiful website to lure folks in, and then handle the logistics of the transaction offline (which happens with many investments through SDIRAs).
In fact—although I know experts will disagree on this point—a crowdfunding campaign could have no online component, and still be a considered crowdfunding. Consider, for example, that a substantial percentage of Rule 506(c) filings had no online component in their offering, but rather used other methods, such as direct mail or public speech (i.e. non-curated pitch contests) to appeal to the crowd.
It tends to be about advertising (kind of)
From a U.S. perspective, the defining feature of the new JOBS Act regulations is the ability to advertise, or in SEC speak, ‘generally solicit’. However, this doesn’t mean there are no restrictions around how an issuer advertises or from who an issuer can ultimately accept investments. Title II allows unrestricted advertising but only accredited investors. Title III allows limited advertising, but does not restrict investor type. Title IV allows unrestricted advertising and investor type, but requires a qualification process with the SEC. Donation and rewards-based crowdfunding have virtually no restrictions around advertising or investor type.
Still, there are exceptions to this general rule. Several online crowdfunding platforms that sell securities primarily offer Rule 506(b) offerings in a non-Citizens VC compliant fashion. Some attorneys insist that, subject to certain conditions, an investor previously solicited under a Rule 506(c) offering may be accepted into subsequent Rule 506(b) offerings, creating an indirect funnel towards Rule 506(b) offerings. Still other attorneys have called these technical readings “bastardly interpretations” of the law. Nevertheless, Rule 506(b) offerings still involve a crowd, although the advertising may be done prior to the offering or may be indirect (about a portal instead of about specific offerings). The SEC’s view on these interpretations is still unclear. One cannot say that the use of Rule 506(b) is or isn’t indicative of crowdfunding—that harkens back to confusing a law with a method.
How Does Syndication Compare to Crowdfunding?
It doesn’t. After having debated each concept’s definition with industry experts and attorneys, one of the more elegant, all-encompassing explanations is the following, as explained by Jor Law of VerifyInvestor.com:
“Syndication [or Participation] refers to the type of funding relationship between the funded and its funders, including the relationship between multiple funders. Crowdfunding, by contrast, is a method of finding funders, who are generally unknown or outside of one’s personal network.”
Crowdfunding is sometimes, but not always, syndication, and vice versa. Crowdfunding is just funding from the crowd, and is a tool that can be used to syndicate deals.
Traditionally, syndications are instances in which a financier leads a financing event but does not want to completely finance the deal itself, and thus shared it with partners so that the deal could be done. Crowdfunding is a method of funding and focuses on how someone finds those funders. Typically companies don’t syndicate; financiers do.
Ready for a brainteaser? The following are all true statements:
- You can crowdfund directly (not via a portal) without any syndication;
- You can crowdfund through a portal without any syndication;
- You can get funded through a syndicator who has their own very close, very private network and does not have to crowdfunding their deal (i.e., major banks that regularly do deals together);
- You can get funded through a syndicator who crowdfunds to find their syndicate (through a portal or not);
Explains Jor, “crowdfunding essentially allowed the expansion of how syndicates were formed. The purest sense of syndication was close, direct relationships between a few parties. Even before crowdfunding really took off, some people formed private networks to help build syndicates. Now the syndicates don’t even have to be private networks.”
Consider, for example, Crowdcube’s model or Title III investments. Crowdcube is crowdfunding without syndication. Crowdcube is an online portal in the UK that enables direct investment and ownership in a business without any middleman, in contrast with its UK competitor Seedrs, which uses the nominee model previously described. Here’s a good article breaking down the pros and cons of their structures. Similarly, due to regulatory limitations, Title III legislation effectively prohibits syndication at the platform level (though groups on investors could theoretically syndicate off-portal). Have you been wondering about all the hoopla over the Fix Crowdfunding Act? This is why. The Fix Crowdfunding Act would allow special purpose vehicles (or SPVs) to aggregate many investors into one more cost-efficient and less administratively-burdensome vehicle. The pros and cons of SPVs are beyond the scope of this article, but you get the point.
The lines between the concept of syndication and crowdfunding have always been blurred, and the level of overlap or ambiguity between each varies from industry to industry. With the “crowd” now in the picture, these two terms and their interrelationship will undoubtedly continue to evolve.
Special thanks to Jor Law for spending the entire weekend fiercely debating the finer nerdy points of this article, and HT to Gene Trowbridge, Jillian Sidoti, Mark Roderick, and Georgia Quinn for their feedback and contributions.
Amy Wan, Esq., CIPP/US is a Partner with CrowdfundingLawyers.net where she practices crowdfunding law. Formerly, she was General Counsel at Patch of Land, a real estate marketplace lending platform. While there, Amy pioneered the industry’s first payment dependent note that is secured pursuant to an indenture trustee and designed to be bankruptcy remote, and advised the company on its Series A funding round. In recognition her work at Patch, she was named as a Finalist for the Corporate Counsel of the Year Award 2015 by LA Business Journal. Amy also brings extensive experience in legal innovation and rethinking the delivery of legal services. She is the founder and co-organized of Legal Hackers LA, and was named one of the one of ten women to watch in legal technology by the American Bar Association Journal in 2014. Prior to joining Patch of Land, Amy worked in enforcement and compliance at the U.S. Department of Commerce, where she represented the United States at the WTO and participated in free trade agreement negotiations on regulatory coherence and technical barriers to trade. Amy also spent time at the U.S. Department of State and U.S. Department of Transportation as a Presidential Management Fellow. She holds an LL.M. in Public International Law from the London School of Economics and Political Science, a JD from the University of Southern California Gould School of Law, and a BA in Biological Sciences from the University of Southern California.