Can an LLC Serve as a Crowdfunding Vehicle for a Corporation?

Crowdfunding doesn’t screw up the issuer’s cap table. Nevertheless, because many issuers and investors think it does, the SEC adopted 17 CFR §270.3a-9 earlier this year. This allows Reg CF issuers to use a “crowdfunding vehicle” to issue securities to investors while adding only one entry to its cap table.

The use of SPVs to own securities is common in the Title II (Rule 506(c)) world and the world of securities generally. Accordingly, we form a separate entity, typically a limited liability company, to own securities of the “main” company. Indeed, a variation of the SPV structure is required in securitized real estate financing.

But that’s not what the SEC has in mind with crowdfunding vehicles in Title III. The SEC has in mind an entity that is a mirror image; you might say an alter-ego of the issuer. For example, the crowdfunding vehicle:

• Can have no purpose other than owning securities of the issuer;
• Must have the same fiscal year-end as the issuer;
• May not borrow money;
• Must be reimbursed for all its expenses only by the issuer; and
• Must “Maintain a one-to-one relationship between the number, denomination, type, and rights of crowdfunding issuer securities it owns and the number, denomination, type, and rights of its securities outstanding.”

What does that last requirement mean? To me, it sounds as if the “rights” associates with the issuer’s securities must be the same as the “rights” associated with the crowdfunding vehicle’s securities.

The “rights” associated with securities are defined in part by contract, which we can control, but in part by state law. Corporate laws vary widely from state to state, and even within a state, the laws of corporations are often very different than the laws of limited liability companies. This is intentional: limited liability company statutes were written to be different than the corresponding corporate statutes. For example, LLC statutes typically give members of an LLC far greater freedom of contract while corporate laws, for historical reasons, take a more paternalistic view.

Now, suppose the issuer in a Reg CF offering is a Delaware corporation. Absent guidance to the contrary from the SEC, I think that for the “rights” to be the same, the crowdfunding vehicle must also be a Delaware corporation, not a Delaware limited liability company. Similarly, if the issuer is a Wyoming limited liability company, the crowdfunding vehicle couldn’t be a Delaware limited liability company. If the issuer is a Wyoming limited liability company, then the crowdfunding vehicle would have to be a Wyoming limited liability company. Even then, only if the Operating Agreement of the crowdfunding vehicle is identical to the Operating Agreement of the issuer, giving security-holders identical rights.

That’s all well and good except for the tax issue. If the issuer and the crowdfunding vehicle are both C corporations, then dividends paid by the issuer to the crowdfunding vehicle will be subject, in part, to double tax.

Maybe the SEC will issue guidance smoothing the edges of the “one-to-one relationship” rule, so to speak. Or maybe Congress will amend section 243 of the Internal Revenue Code to give issuers a 100% deduction for dividends paid to a crowdfunding vehicle. Until then, issuers that are corporations should either resign themselves to double tax or not use a crowdfunding vehicle, which they don’t need anyway.

Source: https://crowdfundingattorney.com/2021/07/23/can-an-llc-serve-as-a-crowdfunding-vehicle-for-a-corporation/