A number of solar and cleantech companies have been raising money through the internet using an approach called crowd-funding. Some are doing this directly. Others are taking advantage of independent crowdfunding platforms that have matched varied developers with potential cleantech investors. Is this a good way to raise money? How does it work? What has been the experience of companies that have tried it?

A group talked about these and other questions during a roundtable discussion organized by Infocast in January. The following is an edited transcript. The speakers are Bruce Ledesma, chief operating officer of Solar Mosaic and former executive vice president and general counsel of SunPower Corporation, Tim Newell, vice president of financial products at SolarCity and, before that, founder and CEO of a financial technology company called Common Assets that was acquired by SolarCity, and Jon Norling, an advisor to GridShare, an internet funding portal for crowdfunding investments in cleantech and renewable energy. The moderator is Keith Martin with Chadbourne in Washington.

MR. MARTIN: Bruce Ledesma, what is crowdfunding?

MR. LEDESMA: Crowdfunding refers to the process of raising money over the internet for a new business or product.

It started with donations- or rewards-based crowdfunding, meaning that the people offering money get nothing in return— they make donations — or they receive a free product or gift — a reward. Kickstarter popularized this concept. The model has been enormously successful. Millions of dollars have been raised.

Our focus today is on something different. It is on what I would call equity- or debt-based crowdfunding. A company issues debt or equity securities to the public in exchange for money. This version comes in a few different flavors.

One flavor is a company may try to raise money for working capital. An example of a platform used for this purpose is Angel’s List. Young companies can secure angel or series A-level financing from the public for their own balance sheet use.

Another flavor is what my company, Mosaic, does. We issue debt to the public and make the proceeds available to businesses or consumers who want to buy solar systems. Mosaic focused in the past on commercial projects but, last year, we pivoted to making loans to homeowners who want to install solar. To the extent we are sourcing our capital for these homeowner loans from the crowd, we are engaged in what is known as “peer-to-peer lending.” There are lots of high-profile companies in this space outside of solar. The Lending Club is probably the most prominent and was the largest initial public offering in California last year.

MR. NEWELL: Crowdfunding is not a new phenomenon.

I would define it as use of the internet to enable smaller investors to participate in investments that were only available in the past to large financial institutions. Its roots were in the 1980s and early 1990s with the emergence of on-line brokerages that gave smaller investors access to initial public offerings for the first time. Since then, there has been a steady progression of financial products that offer such investors direct access to everything from foreign exchange trading to mutual funds and ETFs. The story of the last 15 to 20 years has been steady removal of intermediaries through whom smaller investors had to go in favor of allowing direct investment.

At SolarCity, we issue bonds directly to investors using our own platform, but there are many other ways you can do it.

MR. MARTIN: So, Tim Newell, crowdfunding is a natural evolution. The internet is displacing brokers.

MR. NEWELL: Correct. A lot of the attention currently is on fixed-income and debt investments — that is what peer-to-peer and small business lending are about — with a smaller share of capital going to equity investments.

Back-to-Back Loans

MR. MARTIN: Bruce Ledesma, you said that Mosaic is using crowdfunding to engage in peer-to-peer lending, but I am confused about whether Mosaic borrows and relends or merely acts as a go-between to allow customers who want to buy rooftop solar systems to borrow the money to do so directly through crowdfunding.

MR. LEDESMA: We connect the borrowers to the crowd lenders, and we do that through our platform. Technically, Mosaic issues notes to the crowd, but the crowd is linked to specific, underlying borrowers.

MR. MARTIN: Back-to-back lending, but the crowd has a specific customer?

MR. LEDESMA: Exactly. The crowd lender has default risk associated with a particular project or individual homeowner or borrower. The payment obligations from Mosaic to the crowd are contingent upon the underlying linked borrower making its payments.

MR. MARTIN: How large are the loans?

MR. LEDESMA: We provide loans ranging between $10,000 and $100,000 to residential customers. The average loan is about $29,000.

MR. MARTIN: Is there also a commercial range?

MR. LEDESMA: We have moved away from the commercial business, but the loans we made in the past were between $250,000 and $2 to $3 million.

MR. MARTIN: How much have you borrowed in total today?

MR. LEDESMA: On the commercial side, we funded about $8.5 million during the two years that we ran that program. We just launched on the residential side and, in the last two quarters, we have signed agreements for just over $10 million. We have not crowdfunded those loans yet. They are in the queue, but we have also brought institutional capital into the mix to supplement the crowd. We are feeding the institutional demand for the time being while we ramp up our residential program and we see how those loans perform. We expect to start moving them over to the crowd later this year.

MR. MARTIN: Two more questions for you and then I have a series of questions for Tim Newell. How long does it take from the point you decide you want to borrow from the crowd to when the deal is struck? Is it a day, a week, a month?

MR. LEDESMA: The process should be continuous. We post residential opportunities and watch the uptake rates, but, in general, the loans should be taken up almost immediately after posting. That was our experience with commercial loans.

MR. MARTIN: What interest rate, upfront fee and tenor does the homeowner get on these loans?

MR. LEDESMA: We have different loan products with different rates. Our flagship tenor is 20 years, and the rate is either 4.99% or 5.99%, but rates can vary depending on the creditworthiness of the borrower. We have another product that will be available soon that is a 12-year loan. We are still hammering out the details on the interest rate.

MR. MARTIN: That is the pricing on offer between Mosaic and the customer, correct?

MR. LEDESMA: Yes.

MR. MARTIN: This is a back-to-back borrowing. I imagine you borrow more cheaply from the crowd, and the difference is your margin?

MR. LEDESMA: Yes. We are paid an origination fee by the consumer like most consumer lenders receive, and then we provide a return to the crowd whose amount depends on the product and some other structuring considerations. The crowd return would be somewhere in the range of 4% to 11%. The higher returns are for loans to borrowers with lower FICO scores. The interest rates I quoted earlier are for the most creditworthy borrowers.

Solar Bonds

MR. MARTIN: Tim Newell, you are using crowdfunding to raise debt rather than equity for SolarCity. How much have you managed to raise to date?

MR. NEWELL: We are raising debt using our own crowdfunding platform, but we are doing something different than Mosaic in that we are issuing solar bonds to raise corporate-level debt for SolarCity directly rather than financing individual projects or individual homeowners. SolarCity uses the money to install solar systems that we own. We are aggregating tens of thousands of projects and issuing bonds whose interest payments come from SolarCity and the monthly solar payments we receive from our customers.

We launched our solar bonds platform in the fourth quarter of 2014. We have not said publicly yet how much capital we have raised through our direct platform, but what I can say is that we have had thousands of people register on the site and have issued millions of dollars in solar bonds.

MR. MARTIN: What is the term of the solar bonds? Twenty years?

MR. NEWELL: The initial bonds that we made available had varying tenors. We offered different series of bonds with one-, two-, three- and seven-year terms. The interest rates ranged from 2% to 4%.

MR. MARTIN: Why does SolarCity bother with this? Lyndon Rive, your CEO, told us last fall that SolarCity needs to raise $3 billion in 2015. This is just a drop in the bucket.

MR. NEWELL: It is a great question.

We have raised capital for some time now from a series of large institutional and corporate investors like Goldman Sachs, Google, Bank of America Merrill Lynch and others. We will continue doing that.

There are two reasons why we are also going to investors directly through our solar bonds platform.

First, the number of banks and other financial institutions that participate in renewable energy is growing rapidly, but it is still an emerging investment sector and is a very small percentage of the overall capital markets. When you are looking ahead to having to raise billions of dollars a year to finance solar installations, it is important to open the door to a wider range of investors. We established our own platform to bring in a broad range of investors — not only individuals, but also small and medium-sized institutional investors — to widen the market, to make our capital raising efforts more resilient over any kind of economic situation and, over time, to bring us the lowest cost of capital and the least risk in raising that capital.

The second reason is that, while solar energy has had huge growth, the transition from fossil fuel to clean energy will remain a bumpy process that will require continuing public policy support. The more people who feel they have a stake in the solar economy, the better.

MR. MARTIN: Did I understand each of you correctly? Bruce Ledesma, it sounded like each crowd loan is linked to a specific customer so that the crowd lender takes credit risk of that single customer. Tim Newell, it sounded like SolarCity is doing non-recourse borrowings through solar bonds, but putting a portfolio behind each bond. Is that correct?

MR. NEWELL: No, that’s not correct on our part. We are issuing corporate debt. The payments on the debt are made out of the customer revenue we receive from large portfolios of solar systems, but the debt is backed by SolarCity.

MR. MARTIN: Okay. Bruce Ledesma, did I describe Mosaic’s structure correctly?

MR. LEDESMA: Yes. An investor will often allocate its investment across more than one borrower by funding a percentage of each loan and diversify in that manner, but, yes, the loans are non-recourse and the lenders are taking the customer credit risk.

MR. MARTIN: And each of you is doing this directly and not going through an independent platform?

MR. LEDESMA: Correct for Mosaic.

MR. NEWELL: For SolarCity, we use our own solar bond platform.

MR. MARTIN: Jon Norling you are working with an internet funding portal, so I assume it is a platform for crowdfunding. You heard about the two models that SolarCity and Mosaic are pursuing. What other models have you seen used successfully to raise money for renewable energy or cleantech companies?

MR. NORLING: I don’t think these companies have been getting a lot of traction to date raising true investments from the crowd. The market is still in its infancy and needs to be proven. Equity crowdfunding is allowed today only in a limited number of jurisdictions.

Going back to your first question, I see crowdfunding as way potentially to raise a lot of small investments from many people where the investment decisions are influenced by the crowd. People see others joining a crowdfunding campaign. This builds momentum, and that momentum helps the issuer reach its goal.

Five Paths to Market

MR. MARTIN: Let’s focus on the legal underpinning for crowd-funding. First, are we talking about unaccredited investors or accredited investors or both? Is there a legal barrier to trying to raise money from both?

MR. LEDESMA: There are multiple paths to use of crowdfunding nationally. One path is to register the offering with the US Securities and Exchange Commission, which is what SolarCity has done, for example. It is an expensive and burdensome process to register a debt offering if you are not already a public company. It is really not a viable option, so everyone else needs to look for an exemption from the registration requirement and, today under the Jobs Act, there are three potential paths. Only one of these is in use, and two are still in the rulemaking process at the SEC.

The potential paths are title 2, title 3 and title 4 of the Jobs Act. Title 2 probably received the least amount of media attention, but is active today and is the closest model to free-form, unregulated capitalism in that it allows companies to blast the airwaves and market offerings publicly with no maximum cap on the dollar amount raised. There is no prospectus to file with the SEC, but there is one major catch and that is that only accredited investors can qualify and there are some fairly intensive verification procedures required where you must check people’s tax returns or paycheck stubs and make other intrusive inquiries.

MR. MARTIN: What is an accredited investor? How much income must he have?

MR. LEDESMA: He must have at least $200,000 annual income or $1 million in net worth. Accredited investors represent about 7% of the US population.

The other two titles require SEC rulemaking before they become available and the SEC does not seem overly excited about them.

Title 3 has received the most media attention. It would allow offerings to the general public and not just to accredited investors, and it allows general advertising, but it is limited to $1 million per 12-month period, so it is really aimed at young companies trying to get seed funding as opposed to project financing or peer-to-peer lending. It is not a viable path for Mosaic because of the $1 million cap per year.

Title 4 would also allow the general public to invest. It permits general advertising and it raises the cap to $50 million per 12 months. We are very interested in seeing how that one unfolds, but it has been taking some time and the rules are not final.

MR. MARTIN: Jon Norling, you are a lawyer also. Is there anything you want to add to what Bruce Ledesma just said?

MR. NORLING: We have been following the rulemakings closely and have been preparing for the title 3 equity crowdfunding rules to be finalized. It looks like they will be delayed for another year. Our offerings today are primarily Regulation D offerings to accredited investors.

MR. MARTIN: That is what Bruce Ledesma called title 2?

MR. NORLING: Yes.

MR. NORLING: The investors are limited. You are not getting the true crowd. Accredited investors have a lot of options for where to put their money, so it is tougher to get traction on a crowdfunding website if the audience is limited to accredited investors.

MR. MARTIN: Tim Newell, I assume SolarCity is also using what Bruce Ledesma called title 2.

MR. NEWELL: SolarCity is a public company, and the crowd-funding options that were talked about either are not appropriate for us as a public company or do not give us what we want in terms of offering investment opportunities to the broadest number of investors. That is why we took the path of using a fully-registered offering. If you are not going to take the path we chose, then you have basically five options. You could do a Regulation D offering like Bruce talked about or a Regulation A offering. Both of those are available today and....

MR. MARTIN: Stop there for a second. I am not sure our audience is following this. Regulation D is an offering to accredited investors with no limit?

MR. NEWELL: Correct. There is no limit on the number of investors or the amount you can raise with a Regulation D offering as long as all the investors are accredited. The choice is whether you are going to limit yourself to private discussions or do a general solicitation.

MR. MARTIN: What is Regulation A?

MR. NEWELL: Regulation A offerings are a form of registered offering. Under Regulation A, you can approach any investor — not just accredited investors — but there is a limit currently of $5 million on the amount you can raise. That is what has been proposed to go to $50 million.

MR. MARTIN: So Regulation D is what Bruce Ledesma called title 2, and Regulation A is what he called title 3.

MR. NEWELL: There are three other ways you can do this as well. One is to go through a business development company. That is essentially putting together a public shell, raising capital and then using that capital to make investments. You can also go through a version of a venture capital firm. And, finally, you can make an intrastate offering where you are only taking investments from investors within the state and qualifying on the basis of a state’s laws. Therefore, Regulation D, Regulation A, BDC’s, venture funds and intrastate offerings are your choices if you are not going to do a fully-registered offering.

MR. MARTIN: Let me come back to the states. That is a good list. I take it then that SolarCity did not need the Jobs Act to do what it is doing with its solar bonds?

MR. NEWELL: The Jobs Act is an important step forward. It is just not relevant to us. We want as broad an offering as possible, and the restrictions that are inherent in the Jobs Act would not allow that.

MR. MARTIN: Is there a filing with the SEC that describes your solar bonds?

MR. NEWELL: Yes. We filed a shelf registration with the SEC last October for $200 million in debt, and we are currently issuing solar bonds under that registration. You can go to the SEC website and get all the details there. You can also find the prospectus on our solar bonds website.

MR. MARTIN: Let me ask one more legal question and then move to practical issues. The SEC delay has let 13 states adopt their own rules for crowdfunding by businesses in state from state residents. Jon Norling, in which states does investment-type crowdfunding have traction due to state rules?

MR. NORLING: Wisconsin, Michigan and Colorado have started some active crowdfunding campaigns, although they are limited to investors in those states. We have seen an interesting intersection in Michigan and Colorado between community solar and crowdfunding. For example, Colorado has community solar legislation, and the state crowdfunding rules present an opportunity to crowdfund community solar projects.

MR. MARTIN: So if I am a Colorado business, I can raise money through crowdfunding in Colorado from Colorado residents without the federal restrictions. What does it take to be a Colorado business? Must my business be headquartered in Colorado or is it enough to be doing projects in Colorado?

MR. NORLING: You need to be a state-registered business. All of the states require a resident to be authorized and organized to conduct business in the state. At least one state — I forget which — allows foreign registration of a limited liability company, and some require that at least 80% of the capital be used in that state.

MR. LEDESMA: Sticking with the general theme of different approaches to an offering, if you are a public company that has already gone through the arduous IPO process, as SolarCity has, then registering a solar bond offering is a simpler exercise on something called an S-3. The rest of us in the private company world trying to do crowdfunding must find another path. The Jobs Act only provides a path currently for offerings to accredited investors. Tim Newell mentioned a few other avenues. One is an intrastate offering.

Mosaic has decided to pursue such an offering in California; we are a California-based company. We have created a California-domiciled entity to issue notes to the crowd. We have secured a permit in California to crowdfund up to $100 million and it should work fine, but of course we have to stay within California.

Practical Considerations

MR. MARTIN: Let’s move to some practical issues. How should a company that wants to use an outside platform select one? Platforms seem a little like Amazon for retailers; they offer a large audience.

MR. NORLING: Time to give a plug for GridShare. GridShare is a platform. We think the primary criteria for selecting platforms should be a broad base of potential investors who are registered with the site and who are excited about cleantech offerings, not only making venture-type investments but also investing in operating renewable energy projects either through debt or being part of the sponsor equity.

MR. MARTIN: Is there data that someone can look at to evaluate your platform?

MR. NORLING: It is www.gridshare.com. You will find various venture offerings on the site; for example, a company is looking to raise money to tap hydrogen from animal waste. Another wants to raise money to plant thousands and thousands of hectares of jatropha for making biofuels.

MR. MARTIN: If someone wants to use a particular platform, how can he determine how large an audience it has?

MR. NORLING: I am not aware of any data on audience size. It is an interesting point, though, and one that we will try to figure out how to address on ours.

MR. LEDESMA: Let me add to what Jon Norling said about how to select a platform. I would focus on the track record: how long the platform has been around and whether there is a history of successfully-placed investments. That data should be displayed on the platform. There should also be a clear answer to what happens if the company that is managing the platform disappears. Typically, you would expect to see an arrangement with a backup servicing company that would continue to service the payment streams from the borrowers to the lenders. Information about it and any risks should be disclosed in the prospectus describing the platform.

MR. MARTIN: Tim Newell, you have been in this business for a while. If you were just starting out looking for a platform, what Google search would you do?

MR. NEWELL: I would not start with a Google search. I would first understand strategically what am I trying to achieve by using this method of raising capital: why use crowdfunding instead of other more traditional forms of financing? Many people think crowdfunding is a route to raising capital at lower cost or more quickly. I would be very careful about making either assumption.

Crowdfunding has the greatest potential for companies that have a strategic reason for doing it; for example, a company has a community-based project and wants to use this mechanism to bring in community investments.

Start there, and then ask yourself, “Is Regulation A right for me, where I reach general investors but in a smaller offering?” “Is Regulation D right for me where I focus solely on accredited investors?” No matter which platform you choose, you are still going to use one of these methods to reach an audience of potential investors. There are not that many choices.

MR. MARTIN: Those are excellent questions. Jon Norling, when someone uses your platform, has he in effect selected one of the routes that Tim Newell just mentioned and, if so, which one?

MR. NORLING: He has. It is either a Regulation A or Regulation D offering at this point, although we are now starting to get traction in some states that allow intrastate offerings.

MR. MARTIN: What percentage of money raised should one expect to pay in fees?

MR. NORLING: I know that the SEC just came out with a 15% figure all-in, with some of that being from the costs of audits and some of the other requirements for companies seeking to raise more than $500,000 in an offering. I think the fees ultimately will be in line with what you see for fees charged by investment banks and financial advisors, although we think, as an internet portal, that we can come in below that. You will still have transaction fees to paper the deal with lawyers. Our goal at GridShare is to have an all-in fee in the single digits that will include the accounting, the legal work and the costs for hosting the offering on the platform.

MR. MARTIN: Let me probe there. An investment bank does a lot of work. It does a road show. It prepares a lot of documents — a prospectus of some sort —and it digs deeply into the company when preparing the prospectus. What does a platform do aside from providing an audience?

MR. NORLING: Let’s look at the SEC proposed regulations and what the platform is allowed to do. The platform can assist the issuer with the preparation of investment documents — the prospectus, a kind of pitch book — but the SEC was very clear that anything more than that in terms of doing due diligence and advising on risks is considered providing investment advice which crowdfunding portals are prohibited from doing unless the portal is a registered broker-dealer. GridShare is not a registered broker-dealer, so it cannot provide investment advice. This has led to the use of third-party service providers who work on behalf of the issuer and provide some due diligence materials and some sort of ranking for the project to help guide investment decisions.

MR. MARTIN: Is there a stigma against companies using crowdfunding? I was at a roundtable discussion in Washington last fall. Two small solar and energy efficiency companies said that they will not use it for fear of such a stigma.

MR. LEDESMA: That sounds like what will eventually be antiquated thinking, certainly around Silicon Valley, which is an innovative, disruptive culture. I suspect the fear is companies that use crowdfunding will be viewed as having failed at securing venture money from their own angel network so now they are turning to strangers. If you are talking about the peer-to-peer lending space, there is absolutely no stigma. Lending Club moved $4 billion in loan volume last year and was the biggest IPO out of California. I think that speaks for itself. A number of successful companies are moving billions of dollars through peer-to-peer platforms that are wildly popular.

MR. NEWELL: The use of the internet to raise money is relatively new, and the negative perception that often accompanies anything new often has its roots in those participants in the marketplace who may have the most to lose by the development of a broader market. What you are seeing is the use of technology to broaden a marketplace by allowing investors to have direct access in ways they did not have before. It does not mean that there won’t be institutional investors participating in these financings. In fact, if you look at models like Lending Club, the crowd includes individual investors, hedge funds and banks —including very large banks — as investors. That is how peer-to-peer platforms tend to develop. The choice is whether to invest with the crowd or along an institutional path. Many institutional investors want to do all of the above, and technology is now offering a way to do that. If this follows the same pattern as every other part of the financial sector, then all of the major financial players in the market will adopt this approach over time because it expands the market.

MR. MARTIN: Bruce Ledesma, you described three titles of the Jobs Act and said that the SEC has been slow to issue final regulations allowing two of them to be used. Until that happens, the use of crowdfunding is limited to raising money from accredited investors.

MR. LEDESMA: Or the intrastate exemption that we are using in California, for example, to reach a broad potential investor base, but composed entirely of California residents.

MR. MARTIN: The SEC final rules are expected when? Late 2015? Early 2016?

MR. LEDESMA: I believe late 2015.

MR. NORLING: The latest we have heard is October 2015.

MR. MARTIN: The SEC is proposing that anyone raising more than $500,000 must post audited financials. The SEC is concerned about fraud. Critics say compliance with the proposed SEC rules would add about 15% to the cost of any offering. Are the critics referring to other things besides audit costs when they complain about the burdensome proposed rules?

MR. LEDESMA: There are significant other costs involved with this Regulation At approach that might be viewed as a mini-IPO or S-1 type exercise. It is somewhere between a fully-exempt and relatively-inexpensive offering and a full-blown million dollar IPO process. Someone has to draft some version of a registration statement that entails legal costs. There are the audit costs. There are disclosure and risks and insurance that go with that package, so the costs add up. The countervailing point is that when you move to raise tens of millions of dollars from unsophisticated investors, there must be some level of regulated disclosure, and there is a cost associated with that path, albeit a lighter cost than a full registration. It is reasonable for the SEC to require some process, but if the process becomes too expensive, then it no longer is viable.

MR. MARTIN: Jon Norling, have any other equally burdensome things been proposed besides posting audited financials?

MR. NORLING: The SEC had a pretty detailed breakdown of what it views as the probable costs. The main items are audit costs, the transaction costs for lawyers to paper the transaction and the fees charged by the portal. The costs are expected to be 15% on average, but for smaller raises of under $100,000, the estimate was that as much as 25% of the funds would go to transaction costs, which I think would make small offerings under crowdfunding really untenable, even though, at that level, you would not have the audit costs.

It is unclear whether the auditor would have to be registered with the Public Company Accounting Oversight Board, the PCAOB, which can raise the costs of audits, or whether the auditor can be the company’s local CPA. For a small start-up company, there is not much to audit.

It should be noted that the SEC requirement to audit is in sharp contrast to the 13 states that have adopted crowdfunding regulations. No audits are required in most states other than where a company is seeking to raise more than $1 million. Then audited financials are required. An audit is not triggered at the $500,000 level as in the SEC proposed regulations. Maybe the SEC will increase its own trigger to closer to $1 million.