crowd-financing for p3s.docx
TRANSCRIPT
Crowd-financing for Public-Private Partnerships in the U.S. 1
How would it work? 2
3
4
Morteza Farajian, Ph.D. 5
Office of Transportation Public-Private Partnerships 6
600 E. Main St., Suite 2120, Richmond, VA 23219 7
Tel: 804-786-0470; Email: [email protected] 8
9
Brian Ross, MSCEE, MBA, LEED AP 10
InfraShares 11
2713 Belmont Canyon Road, Belmont CA 94002 12
Tel: 415-312-2224; Email: [email protected] 13
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Word count: 5,911 words text + 4 tables/figures x 250 words (each) = 6,911 words 18
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Submission date: July 31, 201525
Farajian, Ross 2
ABSTRACT 1
In January 2015, President Obama introduced a $302 billion proposal known as the Grow America Act 2
to help federal agencies find new ways to increase infrastructure investments by at least 35% in an 3
attempt to partially resolve the significant funding need for the aging infrastructure in the U.S. 4
Public-private partnership (P3) model remains a tool that can facilitate private investment. However, 5
the current P3 model does not allow for broad based public equity investment in P3 projects. The 6
Jumpstart Our Business Startups (JOBS) Act in 2012 has led to a rapidly changing legislative and 7
regulatory environment, which provides for the ability of new ventures to raise equity and debt 8
investment. This new form of investment crowdfunding, or crowd-financing, provides flexibility 9
for start-ups to raise low cost capital from supporters of their project or business. This flexibility 10
can also be utilized in P3 projects providing the opportunity to engage small institutional and 11
individual investors as direct equity participants. This crowd-financing enhanced P3 model creates 12
value beyond just the financing benefits. Due to the novelty of the approach and potential impact 13
to taxpayers, a comprehensive look at the approach is needed. This paper introduces an implication 14
framework for the P3 crowd-financing model and builds on a previous paper that provided a policy 15
review on the model using a SWOT analysis. This paper also highlights similarities between 16
crowd-financing models being implemented in the real estate industry and applications to P3s, and 17
then describes the current regulatory framework for crowd-financing. An outline of how 18
crowd-financing would be implemented for P3s is provided, including discussions of investment 19
type, SEC exemptions, and crowd-financing platform interaction. 20
21
22
23
Keywords: Public-Private Partnership, Crowd-financing P3 Model, Investment Crowdfunding, 24
Direct Equity Investors, 25
26
Farajian, Ross 3
Introduction 1
2
The need to address aging infrastructure due to growing capacity demands and decreasing 3
economic competiveness is greater than ever in the United States. In fact, this need is becoming a 4
critical issue for the nation and evident in an overall grade of D+ given to American infrastructure 5
by the American Society of Civil Engineers (ASCE) (1). The question is how the needed new 6
infrastructure development and the aging infrastructure maintenance should be funded particularly 7
given U.S. government budgetary constraints and “shortages in lending capacity and more 8
stringent regulation in the banking system” (2). This question has been the core of numerous 9
academic and non-academic studies. In January 2015, President Obama introduced a $302 billion 10
proposal known as the Grow America Act to help federal agencies find new ways to increase 11
infrastructure investments by at least 35% (3). The 2015 Grow America Act, the 2014 Build America 12
Investment initiative and the 2012 Jumpstart Our Business Startups (JOBs) Act all can pave the road 13
to increase private investment in the U.S. infrastructure. 14
15
One of the tools that has been used worldwide, as well as in the U.S., to facilitate private sector 16
investment in the infrastructure is an innovative form of project delivery model which is called 17
Public-Private Partnership (P3). Over the past two decades, P3s in the U.S. have evolved 18
drastically, expanding to over thirty three U.S. states, District of Columbia and one U.S. territory 19
with various P3 approaches and enabling legislations (4). In general, most of the P3 approaches 20
have similar elements in their financial package: public funds, debt and potentially equity. Debt is 21
usually repaid through project revenues which typically come from user fees or availability 22
payments. Different forms of bonds such as Private Activity Bonds (PABs) and Qualified Public 23
Infrastructure Bonds (QPIBs), provide the opportunity for individual or institutional investors to invest 24
in the U.S. infrastructure at the debt level. 25
26
Similar to debt, equity is usually repaid through project revenues if sufficient revenue is available 27
after debt service payments. Therefore, investing at the equity level is riskier than investing at the 28
debt level, and as a result is rewarded at a higher rate of return. While the current P3 model 29
provides the opportunity for individual investors to invest in P3 projects at debt level, it provides 30
little or no opportunity for individual investors to have a direct equity investment in those projects. 31
Therefore, the current P3 model can be easily criticized since the direct equity opportunity is 32
primarily limited to large infrastructure funds and developers who usually enjoy a high rate of 33
return on their equity. It might be true that equity investment in P3 projects is risky and therefore 34
should be rewarded with a higher rate of return; however, this high rate of return can be justified 35
only if it is determined by the market based on a true interaction between supply and demand. An 36
individual investor can easily criticize the high rate of returns on equity investment in P3 projects 37
by stating that he/she would be willing to take similar risks at a lower return rate compared to 38
investment funds. The only way that this claim can be validated and the criticism can be addressed 39
is providing the equity investment opportunity to such investors. 40
41
Farajian et al. (2015) discuss policy implications of a new P3 model that uses the crowdfunding 42
concept to provide individual investors the opportunity to invest equity in P3 projects (5). Under 43
this new P3 model, part of the equity investment for a P3 project is raised from individual investors 44
(the crowd), particularly the ones in the same region or state, through a competitive process and an 45
intermediary online platform. This new form of investment crowdfunding, or crowd-financing, 46
provides flexibilities that can be utilized in delivery of P3 projects. Although Farajian et al. 47
acknowledge potential financial benefits may be gained through this new approach as a result of 48
Farajian, Ross 4
higher competition at equity level and potential lower cost of capital for equity investments, they 1
mainly focus on policy benefits such as enhanced transparency, providing equal investment 2
opportunities to local stakeholders and users of the facility, and enhanced local stakeholder 3
support. In particular, this new model provides the opportunity to extend the partnership to 4
potential users of the project or people who are impacted by the project and better align their 5
interests with the interests of the public agency and the P3 developer. Figure 1 summarizes the 6
strengths, weaknesses, opportunities and threats of this new P3 approach. 7
8
Figure 1: SWOT Analysis Summary 9
10 Source: Farajian, et al (2015) (5) 11
12
This paper is taking the discussion of the P3 crowd-financing model from the policy level to the 13
application level and intends to address the question that how this concept can be implemented in 14
practice. In particular, this paper discusses (1) precedents in real estate development for a 15
crowd-financed P3 model, (2) available options based on the JOBS Act, SEC regulations and State 16
legislations, and (3) a process to utilize the crowd-financing model in P3 procurement and post 17
procurement. 18
19
Background and Comparison to Current Applications in Real Estate 20
21
The 2012 JOBS Act made significant changes to the ways that new companies can raise capital. 22
Specifically, the JOBS Act lifted the ban on general solicitation thereby allowing, under certain 23
conditions, new companies to sell equity shares and debt instruments (collectively referred to as 24
securities) to the general public via the internet without the onerous process of registering the 25
offering with the SEC as an IPO. The ability to raise small amounts of investment from many 26
more individual investors, referred to in this paper as crowd-financing (as opposed to 27
crowd-funding which refers to raising money through donations), is typically facilitated by online 28
Equal investment opportunity Induced complexity
Return on equity Lack of track record and market confidence
Enhanced stakeholder support Administrative and accounting challenges
Increased transparency Third-party confidential information
Social equality
Strengths Weaknesses
Opportunities Threats
Prioritization Business failure
Idea exchange Fraud
Possible misconceptions
Internal in Origin
Dis
ad
van
tag
es
Ad
van
tag
es
External in Origin
Farajian, Ross 5
platforms that cater to specific industries such as information technology, health products, or real 1
estate development. Small investors who are interested in specific projects can now invest directly 2
in projects they have not been able to previously because such investment opportunities were 3
limited, statutorily and practically, to institutional investors with large sums of investment capital. 4
5
The changes implemented in the JOBS Act apply only to new business ventures, or “start-ups”. 6
Because the Special Purpose Vehicles (SPV) established by the Development Company, equity 7
sponsors, design/build firm, and O&M partners to undertake the P3 is technically a new venture, it 8
is able to take advantage of the regulations established by the JOBS Act. While crowdfunding has 9
received the most recent attention with regard to new venture capital and start-up businesses, the 10
mechanism is also gaining popularity as a tool in civic projects and real estate development 11
investments. This evolution in the use of crowdfunding demonstrates the potential of 12
crowd-financing for P3 projects (5). 13
14
Crowd-financing for a P3 would generally follow the successful model established by the 15
commercial real estate industry for crowdfunding investment in real estate development projects. 16
Websites such as Fundrise.com, Realtyshares.com, and Realtymogul.com exemplify the various 17
regulatory frameworks, security structures, fees, and revenue models employed for crowdfunding 18
investment in real estate, but at a fundamental level the process consists of a developer offering 19
investment in a SPV established to undertake a new real estate development project that will 20
generate returns for the investors. 21
22
Similarly in a P3 project, the P3 developer sets up a SPV and investors purchase debt or equity 23
shares in the SPV. The SPV then makes debt service payments or equity returns depending on the 24
success of the project. The key differences between a typical infrastructure P3 project and a real 25
estate development project are the associated development risks (design, construction, O&M), the 26
size of projects, the duration of projects, the types of customers (the public and public agencies), 27
and the role of public agencies in selection, oversight, and financing of projects. Just as there are 28
numerous real estate crowd-financing platforms that specialize in specific project types (retail, 29
apartments, single family residences, etc.), there is a need for crowd-financing platforms that cater 30
to the unique aspects of infrastructure as an asset class (6). 31
32
Another key difference between crowd-financing for real estate and large transportation P3s is the 33
role of debt. As discussed earlier, the debt financing in a typical transportation P3 project is 34
usually provided through various government loan programs such as the Transportation 35
Infrastructure Finance and Innovation Act (TIFIA), tax-exempt project revenue bonds such as 36
PABs, or other bonds that are offered competitively in the bond market. This reduces the need for 37
debt crowd-financing for transportation P3 projects; therefore, this paper focuses on the role of 38
equity crowd-financing used by the P3 SPV. However, if necessary or desirable, the SPV could 39
issue debt securities via crowd-financing platforms, which is common in the real estate investment 40
crowdfunding industry. Debt crowd-financing may also be appropriate for P3s in other 41
infrastructure sectors such as water/waste-water, telecoms and social infrastructure where public 42
debt facilitation is not as advantageous. 43
44
Another key comparison to crowd-financing for commercial real estate is the role of pension 45
funds. While pension funds typically have a portion of their assets allocated to commercial real 46
estate, individuals with interest in a pension fund are not able to select specific projects in their 47
Farajian, Ross 6
community that they want their specific funds to be invested in; they are subject to the investment 1
decisions of the fund managers. As with pension fund investment in infrastructure, the wishes of 2
the individual participants are not a consideration in the fund’s investment decision and therefore 3
investments through pension funds do not represent the same level of benefits that a 4
crowd-financing model can offer. For instance, pension funds do not provide the same level of 5
public engagement and support that can be gained through crowd-financing of direct equity 6
investment from individual investors who may be the users of the project or live close to the 7
project. 8
9
Furthermore, pension funds do not provide the same level of transparency and ongoing 10
engagement that investors will receive as direct equity participants through crowd-financing. 11
Also, the competitive crowd-financing process provides a great opportunity to make the rate of 12
return on equity investment more competitive by offering it to qualified individuals in the same 13
way that bonds are offered in the bond market. Finally, the returns offered to investors through 14
pension funds may be mitigated by management fees and limited project selection due to the 15
Employee Retirement Income Security Act of 1974 (ERISA) restrictions. 16
17
However, while inclusion of pension funds as equity participants in a P3 does not provide the same 18
level of public engagement or economic impact as crowd-financing equity from individuals, 19
pension funds do play a critical role in private investment in public infrastructure and P3s. 20
Because pension funds often desire the long-term, stable, inflation hedged returns of infrastructure 21
assets, they are a natural fit as equity sponsors of P3s and frequent investors in infrastructure funds 22
that participate in P3s. Unfortunately, because the investment thresholds for direct investment in 23
P3s and infrastructure funds can be quite high, typically over $1 million, many smaller pension 24
funds are unable to participate. Crowd-financing for P3s, and potentially infrastructure funds, will 25
allow smaller, local funds to participate alongside individuals and large institutional investors, 26
providing more competitive and resilient sources of equity. 27
28
Initiating Crowd-financing for a P3 29
30
In real estate development crowdfunding, the crowdfunding campaign is initiated by the real estate 31
developer. However, in a P3, the crowd-financing process could be initiated by either the P3 32
developer or the public agency sponsor. P3 developer partners are typically selected by the public 33
agency partner through a competitive RFQ/RFP process. The public agency may include a 34
requirement or preference for some portion of the capital to be raised through crowd-financing in 35
the RFQ/RFP documents. If the evaluation is based on a minimum price that as long as all 36
requirements are met, the lowest bid is selected, a minimum amount to be crowd-financed can be 37
required by the public agency in the procurement document. Under the best value evaluation 38
approach in which a combination of technical and financial scores is used to select the proposal, 39
the public agency can develop scoring criteria for the value placed on the type, or amount, of 40
crowdfunded capital offered to the public. Similar to how points are awarded to innovative design, 41
points could be awarded for innovative financing structures that include community investment. 42
As an example, the City of Oakland recently released a Request for Proposals for the 43
redevelopment of the Henry J. Kaiser Convention Center that included the following language (7): 44
45
“Community-based Financing Tools: The City is interested in exploring the viability of new 46
community-based financing models that allow Oakland residents of all income and wealth levels 47
Farajian, Ross 7
to participate in the profits generated by becoming investors in the project. To the degree possible, 1
and to the degree it is feasible in combination with other financing mechanisms, respondents 2
should consider using community-based financing tools such as community development IPOs or 3
other innovative community financing tools and platforms.” 4
5
In general, less prescriptive requirements allow the developers to become more innovative and 6
compete in terms of public benefit or cost reduction. Theoretically, crowd-financing could provide 7
a lower cost of capital, so developers that propose the largest offering could also potentially 8
provide the best value for money (this needs to be explored further). However, if the P3 developer 9
wishes to limit crowd-financing participation due to lack of overall financial benefits in particular 10
cases but the public agency still believes crowd-financing provides non-financial benefits to the 11
public, a policy decision can be made to mandate a minimum amount of equity to be 12
crowd-financed. Similarly, the public agency can mandate a ceiling on the maximum amount of 13
equity that can be crowd-financed. It is unlikely that equity crowd-financing will replace entirely 14
traditional P3 equity sources such as private sponsor equity (developer/EPC partner), insurance 15
companies, pension funds, and infra funds, but putting a ceiling on the percentage of equity that 16
can be raised through crowd-financing ensures the developer still has enough equity stake “skin in 17
the game” incentivizing its performance. This is necessary to ensure the P3 developer is 18
incentivized to utilize its resources in the most efficient way to increase performance and mitigate 19
the risk of default or bankruptcy. Ultimately, rating agencies would also consider this element as 20
one of their evaluation criteria while providing a rating on debt. 21
22
The crowd-financing process could also be executed as an auction for particular projects, allowing 23
for investors to bid on securities and letting the market establish the risk weighted returns 24
appropriate for the project instead of a limited number of institutional equity sponsors (8). On the 25
other hand, the public agency may decide to define more restrictive terms of the offering to 26
mitigate the potential political risk of riskier crowd-financing offerings. 27
28
Alternatively, the P3 developer may include crowd-financing as part of their proposal without any 29
specific requirement from the public agency; particularly in unsolicited proposals. The P3 30
developer may recognize the benefit of public engagement that crowdfunding offers and highlight 31
it as part of their unsolicited proposal to increase public engagement and transparency in hopes of 32
reducing the chance of political resistance associated with unsolicited proposals. 33
34
In all these scenarios, the P3 developer (and possibly the public agency) may engage in a “testing 35
the waters” campaign by providing preliminary information via the crowdfunding platform and 36
soliciting non-binding indications of investment interest from the public. Strong indications of 37
interest may signal strong public support for the project, as well as financial viability. Investors 38
who indicate interest could be contacted prior to the general public once the actual offering is 39
executed. However, “testing the waters” campaigns need to adhere to strict SEC regulations to 40
avoid market tampering (see discussion of Regulation A+ offerings below). 41
42
Regardless of the amount to be offered via crowd-financing, the P3 developer needs to retain 43
responsibility for obtaining the necessary rating and securing financing for the project. The risk on 44
assumptions related to rate of return will stay with the P3 developer although some benchmarking 45
protections can be provided by the public agency to mitigate risks associated with market 46
conditions similar to risk protections provided on interest assumed in debt financing. If the P3 47
Farajian, Ross 8
developer is unsuccessful in raising the planned crowd-financed amount, either it can increase the 1
internal rate of return on crowd-financed portion of the equity to attract more investors or back-fill 2
the gap. In either case since the P3 developer has the responsibility to deliver the proposed 3
financial package, the weighted average cost of equity should stay the same. This means the P3 4
developer will need to reduce the internal rate of return on the other portion of equity which is not 5
crowd-financed. 6
7
Figure 2 summarizes the above discussion and represents a preliminary framework on how equity 8
crowdfunded P3 model can be implemented. 9
10
Figure 2: A Preliminary Framework for Equity Crowd-financed P3 Model (Source: Authors) 11
12 Source: Created by the authors 13
14
The type of capital raised through crowd-financing is very flexible and can be any type of security 15
ranging from equity to debt. However, as discussed above, this paper focuses on the role of 16
crowd-financed equity for transportation P3s. Equity financing involves not just the sale of 17
common equity stock, but also the sale of other equity or quasi-equity instruments such as 18
preferred stock, and convertible preferred stock: 19
Common Stock: A security that represents ownership in a corporation. Holders of common 20
stock exercise control by electing a board of directors and voting on corporate policy. 21
Common stockholders are on the bottom of the priority ladder for ownership structure. In 22
the event of liquidation, common shareholders have rights to a company's assets only after 23
bondholders, preferred shareholders and other debtholders have been paid in full. 24
Procurement Documents
Define minimum threshhold for Crowd-financed equity if the public agency believes
equity crowd-financing brings non-financial value
Define maximum threshhold to maintain P3 developer's
skin in the game
Impose more restrictive terms of offering in case public agency wishes to
control the level of risk for individual investors
Evaluation
In a best price evaluation, only
minimum and maximum threshholds should be
met
In a best value evaluation, points will
be given for equity crowd-financing, and potentially internal
rate of return at offering, based on evaluation criteria defined in the RFP
Financial Close
A crowdfunding platform will be used for equity-
crowdfinancing
If offering is unsuccessful, the P3 developer can
increase the internal rate of return to attract more
investors
The P3 developer will ultimately be responsibile to back-fill any financing gaps
as a result of an unsuccessful offering at no cost to the public agency
Farajian, Ross 9
Preferred Stock: A class of ownership in a corporation that has a higher claim on the assets 1
and earnings than common stock. Preferred stock generally has a dividend that must be 2
paid out before dividends to common stockholders (preferred return) and the shares usually 3
do not have voting rights. The precise details as to the structure of preferred stock is 4
specific to each corporation. However, the best way to think of preferred stock is as a 5
financial instrument that has characteristics of both debt (fixed dividends) and equity 6
(potential appreciation). Also known as "preferred shares". 7
Convertible Preferred Stock: Preferred stock that includes an option for the holder to 8
convert the preferred shares into a fixed number of common shares, usually any time after 9
a predetermined date. 10
The type of equity offered could depend on several factors including: investor demand, 11
developer’s determination of the most cost efficient structure, and possibly on the desires of the 12
public agency as outlined in the RFP. However, given that the P3 developer will want to limit the 13
crowd investors involvement in operations (voting rights), and that the public agency will most 14
likely want to shield community investors from severe underperformance of the project 15
(construction risk, ramp-up risk, economic downturn, T&R shortfalls, etc.), preferred stock is the 16
most likely security to be offered. However, preferred stock will naturally offer lower equity 17
returns than common stock. 18
19
The P3 developer will also be responsible for providing the offering documentation required by the 20
SEC filing exemption being used (e.g. 506(c), Regulation A+, Rule 147, etc. as discussed below). 21
The SEC filing exemption will depend on the capital needs of the developer, the level of 22
community investment required by the public agency, and the nature of the project. The SEC has 23
finalized rule-making on Title II and Title IV of the JOBS Act, enabling Regulation D 506(c) and 24
Regulation A+ offerings. Many states have also enacted “intrastate” crowdfunding regulations 25
which operate under the Rule 147 intrastate offering exemption. 26
27
Crowdfunding Regulations and Types of Offering Registration Exemptions 28
29
Regulation 506(c) 30
31
For Regulation D 506(c) general solicitation offerings enabled by the 2012 JOBS Act, the primary 32
benefit is that the amount of capital that can be raised is unlimited (9). 506(c) offerings are the 33
main SEC crowdfunding exemption currently used by commercial real estate crowdfunding 34
platforms, with multiple projects raising over $50 million dollars (10). In addition to being exempt 35
from SEC registration, 506(c) offerings are exempt from state securities registration as well (Blue 36
Sky exemption). Because 506(c) offerings are the most common, there are numerous service 37
providers that facilitate the legal process for low fees. 38
39
Drawbacks to the use of 506(c) offerings include a limit of 2000 investors, and the investors must 40
be accredited (11). This limits participation to investors that have a net worth over $1 million, or 41
made over $200,000 per year in gross income in both of the prior two years (9). An accredited 42
investor may also be an entity such as a bank, partnership, corporation, nonprofit or trust, when the 43
entity satisfies certain criteria. Also, the securities sold through 506(c) offerings are restricted 44
from being resold for one year, except under special circumstances, which make them highly 45
Farajian, Ross 10
illiquid. 1
2
Because of the opportunity for large capital raises, but the restriction to accredited investors, 3
506(c) offerings are best suited for large regional mega-projects that may serve multiple states 4
(power generation, toll roads, oil & gas, etc.). These projects will typically require larger capital 5
raises and will have a risk/return profile more suitable for accredited investors. 6
7
Regulation A+ 8
9
Regulation A+ exempt offering rules were finalized by the SEC in June 2015 and are currently 10
allowed for implementation. Reg A+ offerings are split into two tiers of offering with the ability to 11
raise up to $20 million under tier 1 offerings and $50 million for tier 2 offerings (12). While the 12
amount that can be raised is limited, unlike 506(c) offerings, Regulation A+ offerings are open to 13
both accredited and unaccredited investors; with certain restriction on unaccredited investors for 14
tier 2 offerings. Another benefit of Regulation A+ offerings is that the securities sold are 15
un-restricted, meaning they can be sold at will by the investors; this adds liquidity to the securities 16
making them more valuable to short-term investors. Regulation A+ also allows for “test the 17
waters” campaigns that allow developers to gauge interest in a potential offering prior to any filing 18
with the SEC. 19
20
Because Regulation A+ offerings are open to all investors, the SEC requires that tier 1 offerings 21
are qualified within each state where securities will be sold. Because each state has different 22
securities regulations (Blue Sky Laws), this requirement makes it impractical for Regulation A+ 23
tier 1 offerings to be sold in more than just a few targeted states. Unlike 506(c) offerings, most 24
Regulation A+ offerings will require that investors are provided annual reviewed or audited 25
financial statements by the P3 SPV. While most intrastate offering regulations (discussed below) 26
also allow for accredited and unaccredited investors, intrastate offerings typically require the 27
offeror to be located in the state of the offering and have much lower limits for amounts that can be 28
raised. Another benefit of regulation A+ offerings is that they can be combined with 506(c) 29
offerings. 30
31
Rule 147 - Intrastate Crowdfunding 32
33
Not wanting to wait for full the SEC to finalize Title III of the JOBS Act, several states have passed 34
intrastate crowdfunding laws to allow for businesses that operate solely in their state to raise 35
crowdfunded capital from any local (residents of the state) investors (13). States active in 36
transportation P3s such as Florida, Texas, Georgia, Colorado and Indiana have all passed intrastate 37
crowdfunding legislation, while many other states are in the process of passing legislation or 38
investing (see Figure 3 below). 39
40
41
42
43
44
45
46
47
Farajian, Ross 11
Figure 3: State by State Map of Intrastate Crowdfunding Exemptions 1
2 Source: Crowdfund Insider (13) 3
4
The majority of the proposed bills continue the precedent of setting the overall offering cap at 5
$2,000,000 (provided they deliver independently audited financials, otherwise $1,000,000). 6
However, a few of the states (i.e. Illinois and Minnesota) propose to allow for significantly higher 7
offering caps, and certain of the states (i.e. New Mexico and North Carolina, and South Carolina) 8
have not included a cap at all. Moreover, many of the newly proposed bills specifically require the 9
offering caps to be reviewed and increased every five (5) years to reflect changes in the Consumer 10
Price Index (CPI). This option is best for small projects that will serve specific communities 11
within a state (wastewater treatment plant, fire-station, school) selling to an investor demographic 12
with a buy/hold mindset that can easily digest the nature of the project. 13
14
Each type of offering discussed above has unique characteristics, limitations, advantages and 15
disadvantages of each type of offering. It also suggests that each one of the offerings, and therefore 16
may deliver better value for certain projects or certain policy goals. Table 1 summarizes the 17
discussions in this section and provides additional information on specifics of each type of offering 18
and what projects may benefit the most from that type of offering. 19
20
21
22
23
24
25
26
27
28
Farajian, Ross 12
1
Table 1: Summary of Offering Exemptions 2
3
4 5
Source: Created by the authors 6
7
8
9
10
Reg A – Tier 1 Reg A – Tier 2 Reg D: Rule 506 ( c ) Intrastate (Typical)
Maximum Offering
$20,000,000 $50,000,000 Unlimited $2,000,000
Offeree Types All, including non-
‐accredited
investor
All, including non‐‐‐
accredited investor
Accredited Investors Only
All ‐‐‐ Unaccredited
Individual
Investment Limits
None All offerings: 5% of income
or net worth below $100k,
10% above $100k, $100k
max
None $2,000 minimum; 5% of
income or net worth below
$100k, 10% above $100k,
$100k max
Investor Verification
N/A Self‐‐‐Certification Heightened Accredited
Verification; Financial
Infrmation Required
Self‐‐‐Certification
Advertising /
General Solicitation
Unrestricted Unrestricted Unrestricted Limited to investors within state
Pre-‐filing /
Testing the
Waters
Testing the waters allowed
with no pre‐‐‐filing; must
file solicitation materials
with first offering
statement; offering circular
must be filed 48 hours
prior to first sale
Testing the waters allowed
with no pre‐‐‐filing; must
file solicitation materials
with first offering
statement; offering circular
must be filed 48 hours
prior to first sale
No filing requirements
(yet)
Pre‐‐‐filing with state
required before any offer
(no testing the waters)
Closing Speed Slow ‐‐‐ SEC and State
Qualification Required
Slow ‐‐‐ SEC Approval
Required
Fast ‐‐‐ NO SEC
Involvement
Fast ‐‐‐ NO SEC Involvement
Offering Documents
Robust -‐ SEC Qualification
and State Approval
Robust ‐‐‐ SEC Approval No Specific Requirements Robust, State Filing Required
Financials Disclosure
Reviewed Financials Audited Financials No Specific Requirements None under $100k; Reviewed
$100k ‐‐‐ $500k, Audited
above $500k
Ongoing
Disclosure/Filing
None Annual, Semi‐‐‐Annual,
Current Reports including
audited financials
None Annual Disclosure &
Financials
Transfer Restriction
None None 1 Year 1 Year or to Issuer or
Accredited
Shareholder Limit None with conditions None with conditions 2,000 accredited
investors
Unlimited
Intermediary None Required None Required None Required Funding Portal or Broker‐‐‐
Dealer Required; Internet
Portal Required
State Pre‐‐‐
emption
No; Coordinated Review Yes Yes; but expensive blue
sky filing fees
Yes
Investor Education
Req.
None None None Tests Required
Best for Small to medium sized projects
serving 1 state that will benefit
from all levels of public
engagement
Medium to large sized projects
that will benefit from all levels
of public engagement
Regional Mega-projects with
high capital needs and
targeting affluent individuals
and small institutional
investors
Small community projects with
need for broad-based community
engagement and targeted
economic impact
Farajian, Ross 13
1
The Crowdfunding Campaign and Internet Platform Function 2
3
In terms of timing, the crowdfunding campaign will begin once the P3 project has been awarded 4
and the P3 terms are agreed to (commercial close). Then the private developer works with a 5
crowdfunding platform, such as www.infrashares.com, that specializes in crowdfunding 6
investment for P3s to develop and run the crowdfunding campaign (14) The length of the 7
campaign is determined by the financial close schedule, but will need to be long enough for the 8
developer to promote the project and for investors to evaluate and make an investment decision. 9
10
Retail investor traffic is driven to the crowdfunding platform through the use of public agency 11
outreach, social media, traditional media, search engine optimization (SEO, google AdWords) and 12
complimentary sites such as other investment crowdfunding sites targeting other industries. A 13
teaser summary is posted on the site that can be viewed by potential investors that includes 14
summary commercial terms and a video describing the project. Investors visiting the site can 15
browse by project type, geography, security type, IRR, etc. to find an offering that fits their 16
investment objectives. The site will also offer comparison and analysis tools to help investors 17
determine which projects are right for them. If an investor is interested in a specific project, then 18
they request access to the full offering materials such as offering statements, financial models, 19
concession agreements, credit rating agency reviews, etc. 20
21
If, after reviewing the offering documents and performing any other due diligence, they decide to 22
invest, they make a pledge to invest upon successful completion of the campaign. Campaigns are 23
considered successful if they reach the funding goal determined by the P3 developer. However, 24
the crowdfunding platform may retain the option to backfill any shortfall with its own funds. As 25
discussed earlier, since the P3 developer financing plan shouldn’t be structured to be dependent on 26
the crowd-financing campaign, an unsuccessful campaign does not, in anyway, jeopardize 27
reaching financial close. Under this scenario the P3 developer should readily have access to equity 28
which should backfill the gap at no additional cost to the public agency (under certain 29
circumstances the public agency may choose to develop a risk sharing mechanism). 30
31
In order to make management of the crowd-financed equity investors as easy as possible for the P3 32
developers, the crowdfunding platform forms a discrete project fund LLC for each offering to act 33
as intermediary between the P3 developer and the crowd investors. The project fund LLC acts on 34
behalf of the crowd investors when dealing with the P3 developers in issues such as voting rights, 35
management and consent, if granted. If a board seat is warranted, the platform management will 36
represent the LLC. In general, the crowd investors will be passive investors in the project fund 37
LLC, but the details of this relationship will vary by project. All disclosures, reports, financial 38
statements issued by the P3 developer are distributed through the platform project fund LLC to 39
investors. Third party escrow/ACH services (as required by the SEC) are used to facilitate the 40
collection of investment monies and disbursement of returns. This structure removes P3 41
developers concerns regarding management of multitudes of individual investors. 42
43
In order to facilitate this structure, the P3 developer enters into a private placement agreement with 44
the project fund LLC, whereupon success of the crowdfunding campaign, securities of the P3 45
operating company are purchased from the P3 developer by the project fund LLC. The project 46
fund LLC then subsequently issues securities of its ownership to the crowd investors through a 47
Farajian, Ross 14
506c, Regulation A+ or intrastate offering. The project fund LLC securities are backed by the 1
performance of the P3 project. This is the structure used by many of the commercial real estate 2
crowdfunding sites1. 3
4
In addition to mitigating P3 developer concern over crowd investor management, the project fund 5
LLC structure allows the P3 developer to avoid any SEC registration or navigation of 6
crowdfunding regulation. SEC compliance is left to the experts at the platform who can leverage 7
technology and industry acumen to manage the mechanics of the fund as efficiently as possible. 8
Because of the rapid growth of the crowdfunding industry, there has been a proliferation of 9
white-label providers that offer SEC filing, accreditation, escrow, payment distribution, document 10
management, signature, and Customer Relationship manager (CRM) services. These vendors are 11
offering commodity services that allow the platform to drive operational expenses very low 12
relative to what a P3 developer would have to expend on their own. 13
14
Post Financial Close 15
16
Following investment and financial close of the P3, the crowdfunding platform will act as an 17
ongoing engagement tool for the investors. The platform will distribute all financial statements, 18
disclosures and construction/O&M updates issued by the SPV. The platform will also facilitate all 19
disbursements of returns to investors and allow investors to track the performance of their 20
individual investments or portfolio of projects. Any secondary market for existing securities will 21
also be facilitated by the platform allowing investors to buy and sell securities as their individual 22
liquidity needs require. This ongoing interaction between investors and the P3 project provides 23
high levels of transparency and public oversight, making sure the developers incentives are 24
aligned with crowd-financed investors over the long-term. 25
26
Summary of Discussions and Future Research Need 27
28
The goal of the crowd-financed P3 model is to facilitate involvement of the public, especially local 29
communities, as a major partner in the current P3 model. In addition, aligning the interest of P3 30
developer, public agency and the crowd-financed equity investors who may be the users of the 31
project or local stakeholders impacted by the project can act as catalyst to facilitate delivery of the 32
project. This engagement provides the opportunity to use the interests and power of the crowd to 33
bring down the investment barrier under the current P3 model and create opportunities for 34
additional transparency and enhanced public engagement in the policy decisions. 35
36
This paper explains how the crowd-financed P3 model can be implemented in practice. The 37
lessons from utilizing crowdfunding in civic projects and commercial real estate can be used to 38
design an implementation framework for the crowd-financed P3 model. Based on policy goals, 39
project characteristics and market conditions different provisions can be added to procurement 40
documents to define the rules around this implementation framework. Those provisions should 41
instruct the P3 developers on how crowdfunding can be used in their financial proposals. The 42
detail of those provisions and potential risk sharing mechanisms that can be utilized under the 43
crowd-financed P3 model to achieve certain policy objectives can be the subject of future research 44
studies. 45
1 See Fundrise “Project Dependent Notes”:
https://fundrise.desk.com/customer/portal/articles/1596433-what-is-a-project-payment-dependent-note-.
Farajian, Ross 15
1
In summary, the benefits of the crow-financed P3 model and its readiness to be implemented make 2
it an attractive topic both for public agencies and P3 developers. However, additional research is 3
still needed to further study the implication of the crowd-financed P3 model, particularly to 4
provide more information on popularity of the crowd-financed P3 model among individual 5
investors and their appetite for infrastructure investing. Also, additional data on rate of the return 6
that those individual investors may demand and a comparison against what investment funds or 7
institutional investors demand will better enable decision makers to evaluate financial benefits of 8
the crowd-financed P3 model. 9
10
References: 11
12
1. American Society of Civil Engineers. (2013). Report Card for America’s Infrastructure 13
2. McKinsey Global Institute. (2013). Infrastructure productivity: How to save $1 trillion a year. 14
Mckinsey and Company 15
3. Dynan, K. (2015, January 16). Build America Investment Initiative- Expanding Opportunities to 16
Invest in America's Infrastructure. Retrieved on July 20, 2015 from U.S. Department of the 17
Treasury: 18
http://www.treasury.gov/connect/blog/Pages/Build-America-Investment-Initiative---Expanding-O19
pportunities-to-Invest-in-America%E2%80%99s-Infrastructure.aspx 20
4. Federal Highway Administration (2015). State P3 Legislation. Retrieved on July 20, 2015 from 21
http://www.fhwa.dot.gov/ipd/p3/state_legislation/ 22
5. Farajian, M., Lauzon, A., Cui,Q. (2015) An Introduction to a Crowdfunded Public-Private 23
Partnership Model in the U.S.: A Policy Review on Crowdfund Investing.Transportation Research 24
Record Journal 25
6. Ross, B. (2015, January 27). Opportunities for Crowdfunding in the P3 Industry. Retrieved July 27, 26
2015, from InfraShares: www.infrashares.com 27
7. City of Oakland (2014, September 22). Request for Proposals. Retrieved July 27, 2015, from 28
http://www2.oaklandnet.com/oakca1/groups/ceda/documents/webcontent/oak049322.pdf 29
8. Masscatalyst. (2015). Price Discovery with our Auction Market Platform. Retrieved on July 26, 30
2015 from https://www.masscatalyst.com/how-it-works/auction 31
9. U.S. Securities and Exchange Commission. (2013, September 22). Eliminating the Prohibition 32
Against General Solicitation and General Advertising in Rule 506 and Rule 144A Offering. 33
Retrieved on July 27, 2015 from 34
https://www.sec.gov/info/smallbus/secg/general-solicitation-small-entity-compliance-guide.htm 35
10. Drake, D. (2014, November 4). Five Realty Crowdfunding Projects Raising $50M Or More. 36
Retrieved on July 26, 2015 from 37
http://www.forbes.com/sites/groupthink/2014/11/04/five-realty-crowdfunding-projects-raising-5038
m-or-more/ 39
11. Levine, M. L., & Feigin, P. A. (2014). Crowdfunding Provisions under the New Rule 506(c): New 40
Opportunities for Real Estate Capital Formation. The CPA Journal, 46-51. 41
12. Bergman, M. H. (2014). SEC Proposes rules to update regulation A. Insights; the Corporate & 42
Securities Law Advisor, 32-35. 43
13. Zeoli, A. (2015, May 7). State of the States: An Update On Interstate Crowdfunding.Retrieved on 44
July 27, 2015 from 45
http://www.crowdfundinsider.com/2015/05/67394-state-of-the-states-an-update-on-intrastate-cro46
wdfunding-2/ 47
14. Cho, A. (2015, April 20). Entrepreneurs Hope To Bring Crowdfunding To P3 Projects. Engineering 48
News-Record, pp. 22-23. 49