This Offering Circular relates to the offer and sale of series of interests, as described below, to be issued by RSE Innovation, LLC (the “Company,” “RSE Innovation,” “we,” “us,” or “our”). Interests in both of the series identified below were originally offered for sale under Offering Statement 1. Such series interests will continue to be offered and sold under Offering Statement 1 until Offering Statement 2, of which this Offering Circular forms a part, is qualified, at which time they will be offered for sale under Offering Statement 2.
(1) Dalmore Group, LLC (when acting in connection with initial offerings of interests, the “BOR”) acts as a broker of record and is entitled to a Brokerage Fee, as described in “Offering Summary” – “Use of Proceeds.” The BOR’s role and compensation are described in greater detail under “Plan of Distribution and Subscription Procedure – Broker” and “– Fees and Expenses.” With respect to trading on the PPEX ATS (as defined below), Dalmore Group, LLC (when acting in connection with secondary market transactions of interests, the “Executing Broker”) also acts as executing broker in connection with secondary transactions in interests between investors (as described in “Description of the Business – Liquidity Platform”).
(3) No underwriter has been engaged in connection with the Offering (as defined below) and neither the BOR, nor any other entity, receives a finder’s fee or any underwriting or placement agent discounts or commissions in relation to any Offering of Interests (as defined below). We intend to distribute all membership interests in any series of the Company principally through the Platform (as defined below) and any successor platform used by the Company for the offer and sale of interests, as described in greater detail under “Plan of Distribution and Subscription Procedure” and “Description of the Business – Liquidity Platform.” The Manager pays the Offering Expenses (as defined below) on behalf of each Series
(4) The BOR has agreed to accept a flat-rate Brokerage Fee of $25,000 with respect to the Series #STEGO Offering in light of the large number of interests being issued to the Asset Seller.
(5) The amount set forth herein reflects the per unit amounts that would be applicable in the event that the maximum amount of Series #STEGO membership interests are sold. In the event that the minimum amount of Series #STEGO membership interests are sold, the per unit amounts would be 0.23% in fees payable to the BOR and $68.59 in proceeds owed to the Company.
14
not involving the PPEX ATS, but there is no guarantee that any other manner of secondary trading will be available or successful.
Accordingly, you may have no liquidity for your Interests, particularly if the Underlying Asset in respect of that Interest is never sold. Even if a public or private market does develop for a Series, the price at which you are able to sell your Interests might be below the amount you paid for them. In addition, we may elect for certain Series Interests not to trade in secondary transactions on the PPEX ATS; for instance, we intend not to allow Interests in Series #MANTLE319 or Series #STEGO to trade on the PPEX ATS, and therefore there will be no liquidity via this method of trading for holders of Interests in Series #MANTLE319 or Series #STEGO unless the Manager determines to allow such Interests to trade on the PPEX ATS at a later date. Series for which we intend not to allow secondary trading on the PPEX ATS are noted on the Master Series Table in Appendix A.
Furthermore, secondary trades in Interests of Series that are taxed as partnerships, such as Series #STEGO, could jeopardize that tax status if the trades would result in the Series being treated as a publicly traded partnership for tax purposes. See “Tax Consequences for Series Taxed as Partnerships” for more information. Therefore, in accordance with its discretion under Section 4.2(a) of the Operating Agreement to withhold consent to transfers of Interests, and in furtherance of the provisions of Section 4.2(b)(iv) of the Operating Agreement prohibiting (subject to the Manager’s waiver) transfers of Interests that would subject the related Series to additional tax liability, the Manager will analyze whether any proposed secondary trading of such Interests would result in the related Series being treated as a publicly traded partnership, and if so, the Manager will not consent to such trades. Therefore Investors in any such Series will have limited opportunities for liquidity in their investment, and possibly none at all, until the Underlying Asset of the Series is sold. Series for which we intend not to elect to be taxed as a corporation are noted on the Master Series Table in Appendix A.
There may be state law restrictions on an Investor’s ability to sell the Interests.
Each state has its own securities laws, often called “Blue Sky” laws, which (1) limit sales of securities to a state’s residents unless the securities are registered in that state or qualify for an exemption from registration and (2) govern the reporting requirements for brokers and dealers doing business directly or indirectly in the state. Before a security is sold in a state, there must be a registration in place to cover the transaction, or it must be exempt from registration. Also, the broker or dealer must be registered in that state. We do not know whether our securities will be registered, or exempt, under the laws of any states. A determination regarding registration will be made by the broker-dealers, if any, who agree to serve as the market-makers for our Interests. There may be significant state Blue Sky law restrictions on the ability of Investors to sell, and on purchasers to buy, our Interests. In addition, Tier 2 of Regulation A limits qualified resales of our Interests to 30% of the aggregate Offering price of a particular Offering. Investors should consider the resale market for our securities to be limited. Investors may be unable to resell their securities, or they may be unable to resell them without the significant expense of state registration or qualification, or opinions to our satisfaction that no such registration or qualification is required.
We do not have a significant operating history and, as a result, there is a limited amount of information about us on which to base an investment decision.
Our short operating history may hinder our ability to successfully meet our objectives and makes it difficult for potential investors to evaluate our business or prospective operations. Revenues are generated at the Company or the Series level for certain Underlying Assets anticipated to generate revenue streams. For other Underlying Assets, no revenue models have been demonstrated at the Company or Series level, and we do not expect either the Company or these Series to generate any revenues in respect of such Underlying Assets for some time.
We have devoted substantially all of our efforts to establishing our business and principal operations, which commenced in 2020. We will update the appropriate disclosure at such time as revenue models have been developed. See the “Management’s Discussion and Analysis” section for additional information. No guarantee can be given that the Company or any Series will achieve its or their investment objectives, the value of any Underlying Asset will increase, or any Underlying Asset will be successfully monetized.
15
There can be no guarantee that the Company will reach its funding target from potential Investors with respect to any Series or future proposed Series of Interests.
Due to the start-up nature of the Company and the Manager, there can be no guarantee that the Company will reach its funding target from potential Investors with respect to any Series or future proposed Series of Interests. In the event the Company does not reach a funding target, it may not be able to achieve its investment objectives by acquiring additional Underlying Assets through the issuance of further Series of Interests and monetizing them to generate distributions for Investors. In addition, if the Company is unable to raise funding for additional Series of Interests, this may impact any Investors already holding Interests as they will not see the benefits which may arise from economies of scale following the acquisition by other Series of Interests of additional Underlying Assets and other monetization opportunities (e.g., hosting events with the collection of Innovation Assets).
We do not expect to generate significant revenues at the Company or Series level for some time, and we rely on RSE Markets to fund our operations.
While our domain name Underlying Assets have generated some revenues to date through a domain parking arrangement, we do not expect to generate significant revenues or cash flow at the Company or Series level for some time, and it is possible that no profits will be realized by Investors unless and until an Underlying Asset is sold at a price high enough to provide sufficient funds to effectuate a distribution after paying the applicable costs, fees and expenses, or the Investors sell their Interests. Until such time as the Company or a Series generates sufficient revenue, we will be nearly completely reliant on RSE Markets, through the Asset Manager (if Rally Holdings) and the Manager, to fund our operations.
Although we believe RSE Markets has sufficient capital resources and sources of liquidity to perform its obligations for the foreseeable future, there can be no assurance that RSE Markets will be able to maintain sufficient capital to satisfy its obligations in future periods. RSE Markets’ capital resources and sources of liquidity will be relied upon by the Company and each listed Series and our auditors in determining our likely ability to continue as a going concern. RSE Markets’ current liquid capital resources and sources of liquidity have been determined to be insufficient to satisfy its operational requirements, including the obligations with respect to the Company and each listed Series, for at least one year, and the Company and each listed Series have concluded that substantial doubt exists about their ability to continue as a going concern, which may have a material adverse effect on the value of our Interests.
There is substantial doubt about our ability to continue as a going concern.
The Company’s and each listed Series’ ability to continue as a going concern is dependent upon its ability to generate future profitable operations and/or obtain the necessary financing to meet its obligations and repay its liabilities arising from normal business operations when they become due.
There are few businesses that have pursued a strategy or investment objective similar to the Company’s.
One business that is affiliated with the Company, RSE Collection, LLC (which succeeded by merger to the business of RSE Archive, LLC, a former series limited liability company and affiliate of the Company, on December 31, 2024), has pursued a similar strategy in an overlapping asset class. The Company and the Interests may not gain or maintain market acceptance from potential Investors, potential Asset Sellers or service providers within the Asset Class’ industry, including insurance companies, storage facilities or maintenance partners. This could result in an inability of the Asset Manager to operate the Underlying Assets profitably or generate any Contractual Revenues. This could impact the issuance of further Series of Interests and additional Underlying Assets being acquired by the Company or a Series. This would further inhibit market acceptance of the Company, and if the Company or a Series does not acquire any additional Underlying Assets, Investors would not receive any benefits which may arise from economies of scale (such as reduction in storage costs as a large number of Underlying Assets are stored at the same facility, group discounts on insurance, the ability to monetize Underlying Assets through Museums and certain monetization opportunities that would require the Company or a Series to own a substantial number of Underlying Assets).
The Offering amounts exceed the purchase price of the Underlying Asset.
16
The size of each Offering will exceed the purchase price of the related Underlying Asset as of the date of such Offering (as the net proceeds of the Offering in excess of the purchase price of the Underlying Asset will be used to pay fees, costs and expenses incurred in making the Offering and acquiring the Underlying Asset). If an Underlying Asset were to be sold and there had not been substantial appreciation of the value of the Underlying Asset prior to such sale, there may not be sufficient proceeds from the sale of the Underlying Asset to repay Investors the amount of their initial investment (after first paying off any liabilities on the Underlying Asset at the time of the sale, including, but not limited to, any outstanding Operating Expenses Reimbursement Obligation) or any additional profits in excess of that amount.
Excess Operating Expenses could materially and adversely affect the value of Interests and result in dilution to Investors.
Operating Expenses related to a particular Series incurred post-Closing shall be the responsibility of the Series. However, if the Operating Expenses of a particular Series exceed the amount of revenues generated from the Underlying Asset of such Series, the Manager or the Asset Manager may (a) pay such Operating Expenses and not seek reimbursement, (b) loan the amount of the Operating Expenses to the particular Series, on which the Manager or the Asset Manager may impose a reasonable rate of interest, and be entitled to Operating Expenses Reimbursement Obligations, or (c) cause additional Interests to be issued in such Series in order to cover such additional amounts.
In connection with the allocation of Operating Expenses to the various Series, the Manager will periodically (and no less than semiannually) review Series’ ability to pay their Operating Expenses. Based on that review, the Manager will determine the method by which such Operating Expenses will be paid, including whether any Operating Expenses Reimbursement Obligations will be incurred. Amounts outstanding under any Operating Expenses Reimbursement Obligations incurred by a Series will be repaid from the Free Cash Flow or Capital Proceeds generated by the applicable Series and could reduce the amount of any future distributions payable to Investors in that Series. If additional Interests are issued in a particular Series, this would dilute the current value of the Interests of that Series held by existing Investors and the amount of any future distributions payable to such existing Investors. Further, any additional issuance of Interests of a Series could result in dilution of the holders of that Series.
We are reliant on the Manager, Rally Holdings and RSE Markets, including the officers of RSE Markets, as well as on the Asset Manager for each Series, including the personnel of such Asset Manager. Our business and operations could be adversely affected if the Manager or Asset Manager loses key personnel or RSE Markets loses officers.
The successful operation of the Company (and, therefore, the success of the Interests) is in part dependent on the ability of the Manager and Rally Holdings to source and acquire the Underlying Assets and to maintain the Platform, and on the Asset Manager for each Series (whether Rally Holdings, DomainX, or another person) to manage the Underlying Assets. As the Manager and Rally Holdings have been in existence only since March 2021 and October 2020, respectively, and are early-stage startup companies, they have no significant operating history. Further, while Rally Holdings is also the Asset Manager for series of RSE Collection, LLC, a series limited liability company with a similar business model in the collectible and memorabilia asset class, and thus has some similar management experience, its experience is limited, and it has limited experience selecting or managing assets in the Asset Class. DomainX has been in existence since 2020, and though it has operated in the business of domain name brokerage, sales, investment, monetization, and management since then, there can be no guarantee that it will achieve positive results of operations for the Company or the Series for which it serves as Asset Manager.
In addition, the success of the Company (and, therefore, the Interests) is highly dependent on the expertise and performance of the Manager, the Asset Manager for each Series (whether Rally Holdings, DomainX, or another person), RSE Markets and their respective teams; the expert networks provided by the Asset Manager of each Series; and other investment professionals (which may include third parties) to source, acquire and manage the Underlying Assets. There can be no assurance that these individuals will continue to be associated with the Manager, an Asset Manager, or RSE Markets. The loss of the services of one or more of these individuals could have a material and adverse effect on the Underlying Assets and, in particular, their ongoing management and use to support the investment of the Interest Holders.
17
Furthermore, there are a number of key factors that will potentially impact the Company’s operating results going forward, including the ability of Rally Holdings to:
·continue to source high quality Innovation Assets at reasonable prices to securitize through the Platform;
·market the Platform and the Offerings in individual Series of the Company and attract Investors to the Platform to acquire the Interests issued by Series of the Company;
·find and retain operating partners to support the regulatory and technology infrastructure necessary to operate the Platform;
·continue to develop the Platform and provide the information and technology infrastructure to support the issuance of Interests in Series of the Company; and
·find operating partners to manage the collection of Underlying Assets at a decreasing marginal cost per asset.
Finally, the success of the Company and the value of the Interests is dependent on there being a critical mass of demand from the market for the Interests and the Company’s ability to acquire a number of Underlying Assets in multiple Series of Interests so that the Investors can benefit from economies of scale which may arise from holding more than one Underlying Asset (e.g., a reduction in transport costs if a large number of Underlying Assets are transported at the same time). Certain Underlying Assets, such as the Underlying Asset of Series #MANTLE319, are currently unique among the Asset Class and therefore do not currently benefit from economy of scale effects, which may reduce the potential return to Investors in such Series. In the event that the Company is unable to source additional Underlying Assets due to, for example, competition for such Underlying Assets or lack of Underlying Assets available in the marketplace, then this could materially impact the success of the Company and each Series by hindering its ability to acquire additional Underlying Assets through the issuance of further Series of Interests.
If the Company’s series limited liability company structure is not respected, then Investors may have to share any liabilities of the Company with all Investors and not just those who hold the same Series of Interests as them.
The Company is structured as a Delaware series limited liability company that issues a separate Series of Interests for each Underlying Asset. Each Series of Interests will merely be a separate Series and not a separate legal entity. Under the Delaware Limited Liability Company Act (the “LLC Act”), if certain conditions (as set forth in Section 18-215(b) of the LLC Act) are met, the liability of Investors holding one Series of Interests is segregated from the liability of Investors holding another Series of Interests and the assets of one Series of Interests are not available to satisfy the liabilities of other Series of Interests. Although this limitation of liability is recognized by the courts of Delaware, there is no guarantee that if challenged in the courts of another U.S. State or a foreign jurisdiction, such courts will uphold a similar interpretation of Delaware corporation law, and in the past certain jurisdictions have not honored such interpretation. If the Company’s series limited liability company structure is not respected, then Investors may have to share any liabilities of the Company with all Investors and not just those who hold the same Series of Interests as them. Furthermore, while we intend to continue to maintain separate and distinct records for each Series of Interests and account for them separately and otherwise meet the requirements of the LLC Act, it is possible a court could conclude that the methods used did not satisfy Section 18-215(b) of the LLC Act and thus potentially expose the assets of a Series to the liabilities of another Series of Interests. The consequence of this is that Investors may have to bear higher than anticipated expenses which would adversely affect the value of their Interests or the likelihood of any distributions being made by a particular Series to its Investors. In addition, we are not aware of any court case that has tested the limitations on inter-series liability provided by Section 18-215(b) in federal bankruptcy courts and it is possible that a bankruptcy court could determine that the assets of one Series of Interests should be applied to meet the liabilities of the other Series of Interests or the liabilities of the Company generally where the assets of such other Series of Interests or of the Company generally are insufficient to meet our liabilities.
For the avoidance of doubt, as of the date of this Offering Circular, the Series highlighted in gray in the Master Series Table in Appendix A have not commenced operations, are not capitalized and have no assets or liabilities, and no such Series will commence operations, be capitalized or have assets and liabilities until such time as a Closing related to such Series has occurred.
18
If any fees, costs and expenses of the Company are not allocable to a specific Series of Interests, they will be borne proportionately across all of the Series of Interests (which may include future Series of Interests to be issued). Although the Manager will allocate fees, costs and expenses acting reasonably and in accordance with its allocation policy (see “Description of the Business – Allocations of Expenses” section), there may be situations where it is difficult to allocate fees, costs and expenses to a specific Series of Interests and, therefore, there is a risk that a Series of Interests may bear a proportion of the fees, costs and expenses for a service or product for which another Series of Interests received a disproportionately high benefit.
We maintain physical, technical, and administrative security measures designed to protect our systems against cyber-attacks and unauthorized disclosure of sensitive data. If these efforts are not successful, our business and operations could be disrupted, our operating results and reputation could be harmed, and the value of the Interests could be materially and adversely affected.
The highly automated nature of the Platform, through which potential Investors may acquire Interests, and the PPEX ATS, through which potential Investors may transfer Interests in certain Series, may make them attractive targets to cyber threat actors. The Platform and the PPEX ATS process certain confidential information about Investors, the Asset Sellers, and the Underlying Assets. While we maintain commercially reasonable measures to protect this confidential information and our information systems, security incidents involving the Platform, the PPEX ATS, the Company, the Asset Manager, the Manager, or any of their respective service providers remain a risk. And because we do not operate the PPEX ATS, we do not control the measures taken to protect the PPEX ATS from cyber threats. Unauthorized access to or disclosure or acquisition of confidential information, whether accidental or intentional, can lead to harm such as identity theft and fraud. Security incidents could also expose the Company to liability related to the loss of confidential information, such as time-consuming and expensive litigation and negative publicity, regulatory investigations and penalties, as well as the degradation of the proprietary nature of the trade secrets of the Asset Manager, the Manager, and the Company. If security measures are breached because of third-party action, employee error, malfeasance, or otherwise, or if design flaws in the Platform or the PPEX ATS software are exposed and exploited, the relationships between the Company, Investors, users, third-party vendors and the Asset Sellers could be severely damaged, and the Company, the Asset Manager, or the Manager could incur significant liability. Security incidents can also disrupt business operations, diverting attention from utilization of the Underlying Assets and causing a material negative impact on the value of Interests or the potential for distributions to be made on the Interests.
Because techniques and malware used to sabotage or obtain unauthorized access to systems change frequently and may not be captured by existing security tools and software, the Company, the third-party hosting service used by the Platform or the PPEX ATS, and other third-party service providers may be unable to prevent all cyber-attacks. In addition, federal regulators and many federal and state laws and regulations require companies to notify individuals of data security breaches involving their personal data. These mandatory disclosures regarding a security breach can be costly to implement and often lead to negative publicity, which may cause Investors, the Asset Sellers, or service providers within the industry, including insurance companies, to lose confidence in the effectiveness of the secure nature of the Platform or the PPEX ATS. Any security breach, whether actual or perceived, would harm the reputation of the Asset Manager, the Manager, the Company, the Platform and the PPEX ATS, and the Company could lose Investors and the Asset Sellers as a result thereof. This would impair the ability of the Company to achieve its objectives of acquiring additional Underlying Assets through the issuance of further Series of Interests.
System limitations or failures could harm our business and may cause the Asset Manager or Manager to intervene into activity on our Platform.
Our business depends in large part on the integrity and performance of the technology, computer and communications systems supporting the business. If new systems fail to operate as intended or our existing systems cannot expand to cope with increased demand or otherwise fail to perform, we could experience unanticipated disruptions in service, slower response times and delays in the introduction of new products and services. These consequences could result in service outages of the Platform, resulting in decreased customer satisfaction and regulatory sanctions and adverse effects on primary issuances or secondary transactions.
The Platform has experienced systems failures and delays in the past and could experience future systems failures and delays. In such cases Rally Holdings has and may in the future (along with the Manager) take corrective
19
actions as it reasonably believes are in the best interests of Investors or potential Investors. For example, our technology system has in certain instances over-counted the number of subscriptions made in an initial Offering, when volume of subscriptions has rapidly increased. In these cases, Rally Holdings has confirmed with the Investors to remove the duplicate subscriptions and, rather than opening the Offering back up for additional Investors, has purchased the Interests underlying such duplicate subscriptions for its own account on the same terms as all other Investors would purchase such Interests.
If subscription or trading volumes in the future increase unexpectedly or other unanticipated events occur, we may need to expand and upgrade our technology, transaction processing systems and network infrastructure. We do not know whether we will be able to accurately project the rate, timing or cost of any volume increases, or expand and upgrade our systems and infrastructure to accommodate any increases in a timely manner.
While we have programs in place to identify and minimize our exposure to vulnerabilities and to share corrective measures with our business partners, we cannot guarantee that such events will not occur in the future. Any system issue that causes an interruption in services, including the Platform and the PPEX ATS, decreases the responsiveness of our services or otherwise affects our services could impair our reputation, damage our brand name and negatively impact our business, financial condition and operating results.
Privacy regulation is an evolving area and compliance with applicable privacy regulations may increase our operating costs or adversely impact our ability to service our clients.
Because we store, process and use data, some of which contains personal information, we are subject to complex and evolving federal, state and foreign laws and regulations regarding privacy, data protection and other matters. While we believe we are currently in compliance with applicable laws and regulations, many of these laws and regulations are subject to change and uncertain interpretation, and could result in investigations, claims, changes to our business practices, increased cost of operations and declines in user growth, retention or engagement, any of which could seriously harm our business.
The Platform and the PPEX ATS are highly technical and may be at a risk to malfunction.
Our Platform and the PPEX ATS are complex systems composed of many interoperating components and incorporates software that is highly complex. Our business is dependent upon Rally Holdings’ and NCPS’s ability to prevent system interruption on the Platform and the PPEX ATS. The Platform’s software, including open source software that is incorporated into the Platform’s code, and the software supporting the PPEX ATS may now or in the future contain undetected errors, bugs, or vulnerabilities. Some errors in the Platform’s software code may only be discovered after the code has been released. Bugs in the Platform’s software, third-party software including open source software that is incorporated into our code, misconfigurations of the Platform’s systems, and unintended interactions between systems could cause downtime that would impact the availability of our service to Platform users. We have from time to time found defects or errors in our system and may discover additional defects in the future that could result in Platform unavailability or system disruption. In addition, we have experienced outages on the Platform due to circumstances within our control, such as outages due to software limitations. We rely on Amazon Web Services, Inc. (“AWS”) data centers for the operation of the Platform. If the AWS data centers fail, Platform users may experience down time. If sustained or repeated, any of these outages could reduce the attractiveness of the Platform to users. In addition, our release of new software in the past has inadvertently caused, and may in the future cause, interruptions in the availability or functionality of the Platform. Any errors, bugs, or vulnerabilities discovered in our code or systems after release could result in an interruption in the availability of the Platform or a negative experience for users and Investors and could also result in negative publicity and unfavorable media coverage, damage to our reputation, loss of users, loss of revenue or liability for damages, regulatory inquiries, or other proceedings, any of which could adversely affect our business and financial results. The PPEX ATS operated by NCPS also faces risks similar to those described above.
There can be no guarantee that any liquidity mechanism for secondary sales of Interests will develop on the PPEX ATS in the manner described, that registered broker-dealers will desire to facilitate liquidity in the Interests for a level of fees that would be acceptable to Investors or at all, that such secondary trading will occur with high frequency if at all, that a market-clearing price (e.g., a price at which there is overlap between bid and ask prices)
20
will be established when an investor is seeking to buy or sell Interests in a secondary transaction or that any buy or sell orders will be filled.
We anticipate that liquidity will be limited until sufficient interest has been generated on the Platform, which may never occur (see “Description of the Business – Liquidity Platform” for additional information). It is anticipated that secondary trading will occur on a recurring basis through the PPEX ATS, although there can be no assurance that any offers to buy and sell will match, and there is no guarantee that an Investor will be able to sell Interests at a desired price or at all. The frequency and duration of the periods of time during which the PPEX ATS will immediately match offers to buy and sell Interests in secondary transactions will be determined by NCPS in its capacity as operator of the PPEX ATS. In addition, we may elect for certain Series Interests not to trade in secondary transactions on the PPEX ATS; for instance, we intend not to allow Interests in Series #MANTLE319 or Series #STEGO to trade on the PPEX ATS, and therefore there will be no liquidity for holders of Interests in Series #MANTLE319 or Series #STEGO unless the Manager determines to allow such Interests to trade on the PPEX ATS at a later date. Series for which we intend not to allow secondary trading on the PPEX ATS are noted on the Master Series Table in Appendix A. For the avoidance of doubt, no secondary trading will occur on the Platform, though the Platform is the means by which Investors input and receive information relating to secondary trading (see “Description of the Business – Liquidity Platform” for additional information).
There can be no guarantee that the Manager will continue to pay for commissions due to the Executing Broker in connection with secondary trading effectuated on the PPEX ATS.
With respect to secondary trading via the PPEX ATS operated by NCPS, the Manager, at its sole discretion, may from time-to-time cover the commission owed to the Executing Broker in respect of executed transfers of Interests, but there is no assurance that this practice will continue permanently, and Investors may subsequently be required to pay such commission in order to participate in secondary market transactions on the PPEX ATS operated by NCPS (see “Description of the Business – Liquidity Platform” for additional information).
The PPEX ATS is the primary venue for secondary trading of Series Interests.
To the extent that a trading market for our Interests develops, your ability to trade Series Interests in secondary transactions will be limited by the operability and availability of the PPEX ATS, which is the primary venue for secondary trading of Interests. The PPEX ATS may become inoperative (see “The Platform and the PPEX ATS are highly technical and may be at a risk to malfunction.” for more detail), or it may become inaccessible to us if NCPS ceases to operate the PPEX ATS or to offer its functionality to us. In either case, the PPEX ATS would no longer be available as a venue for secondary trading. Though the PPEX ATS is not an exclusive venue for secondary trading of Interests, alternative means of effectuating secondary trading may be limited in availability or may be more burdensome for Investors. Without the PPEX ATS, your ability to resell our Interests could be limited or eliminated, which could delay, or prevent entirely, any return on your invested capital. See “There is currently no active trading market for our securities. An active market in which Investors can resell their Interests may not develop or be sustainable.” for more details. For the avoidance of doubt, the Company has no present intention to establish any additional venue for secondary trading of Series Interests.
Abuse of our advertising or social platforms may harm our reputation or user engagement.
The Asset Manager provides content or posts ads about the Company and Series through various social media platforms that may be influenced by third parties. Our reputation or user engagement may be negatively affected by activity that is hostile or inappropriate to other people, by users impersonating other people or organizations, by disseminating information about us or to us that may be viewed as misleading or intended to manipulate the opinions of our users, or by the use of Rally Holdings’ products or services, including the Platform, that violates our terms of service or otherwise for objectionable or illegal ends. Preventing these actions may require us to make substantial investments in people and technology and these investments may not be successful, adversely affecting our business.
21
If we are unable to protect our intellectual property rights, our competitive position could be harmed, or we could be required to incur significant expenses to enforce our rights.
Our ability to compete effectively is dependent in part upon our ability to protect our proprietary technology. We rely on trademarks, trade secret laws and confidentiality procedures to protect our intellectual property rights. There can be no assurance these protections will be available in all cases or will be adequate to prevent our competitors from copying, reverse engineering or otherwise obtaining and using our technology, proprietary rights or products. To prevent substantial unauthorized use of our intellectual property rights, it may be necessary to prosecute actions for infringement and/or misappropriation of our proprietary rights against third parties. Any such action could result in significant costs and diversion of our resources and management’s attention, and there can be no assurance we will be successful in such action. If we are unable to protect our intellectual property, it could have a material adverse effect on our business and on the value of the Interests.
Actual or threatened epidemics, pandemics, outbreaks or other public health crises may adversely affect our business.
Our business could be materially and adversely affected by the risks, or the public perception of the risks, related to an epidemic, pandemic, outbreak or other public health crisis, such as the COVID-19 pandemic. The risk, or public perception of the risk, of a pandemic or media coverage of infectious diseases could adversely affect the value of the Underlying Assets and our Investors or prospective Investors financial condition, resulting in reduced demand for the Offerings and the Asset Class generally. Moreover, an epidemic, pandemic, outbreak or other public health crisis, such as COVID-19, could cause employees of the Asset Manager, on whom we rely to manage the logistics of our business, to avoid any in-person involvement, which would adversely affect our ability to adequately staff and manage our businesses. “Shelter-in-place” or other such orders by governmental entities could also disrupt our operations, if employees who cannot perform their responsibilities from home, are not able to report to work. Risks related to an epidemic, pandemic or other health crisis, such as COVID-19, could also lead to the complete or partial closure of one or more of our facilities or operations of our sourcing partners for the Underlying Assets.
Any adverse changes in the Asset Manager’s or an Operating Partner’s financial health or our relationship with the Asset Manager or its affiliates could hinder our operating performance and the return on your investment.
The Asset Manager (whether Rally Holdings, DomainX, or another entity) and the Operating Partner will utilize their personnel to perform services for us. Our ability to achieve our investment objectives and to pay distributions to our Investors is dependent upon the performance of the Asset Manager and its affiliates, any Operating Partner and its affiliates, as well as their Innovation Asset professionals in the identification and acquisition of investments, the management of our assets and operation of our day-to-day activities. Any adverse changes in the Asset Manager’s or the Operating Partner’s financial condition or our relationship with the Asset Manager or Operating Partner could hinder their ability to successfully manage our operations and our Innovation Assets.
We may be negatively impacted by volatility in the political and economic environment, and a period of sustained inflation across the markets in which we operate could result in higher operating costs.
Trade, monetary and fiscal policies, and political and economic conditions may substantially change, and credit markets may experience periods of constriction and variability. These conditions may impact our business. Further, elevated inflation may negatively impact our business and increase our costs. Sustained inflation across the markets in which we operate could negatively affect any attempts to mitigate the increases to our costs. In addition, the effects of inflation on consumers’ budgets could result in the reduction of potential Investors’ spending and investing habits. If RSE Markets, Rally Holdings, the Manager or we are unable to take actions to effectively mitigate the effect of the resulting higher costs, their and/or our financial position could be negatively impacted.
Risks Relating to the Offerings
We are offering our Interests pursuant to Tier 2 of Regulation A, and we cannot be certain if the reduced disclosure requirements applicable to Tier 2 issuers will make our Interests less attractive to Investors as compared to a traditional initial public offering.
22
As a Tier 2 issuer, we are subject to scaled disclosure and reporting requirements which may make an investment in our Interests less attractive to Investors who are accustomed to enhanced disclosure and more frequent financial reporting. The differences between disclosures for Tier 2 issuers versus those for emerging growth companies include, without limitation, needing to file only semiannual reports as opposed to quarterly reports and far fewer circumstances where a current disclosure would be required. In addition, given the relative lack of regulatory precedent regarding the recent amendments to Regulation A, there is some regulatory uncertainty in regard to how the Commission or the individual state securities regulators will regulate both the offer and sale of our securities, as well as any ongoing compliance to which we may be subject. For example, a number of states have yet to determine the types of filings and amount of fees that are required for such an Offering. If our scaled disclosure and reporting requirements, or regulatory uncertainty regarding Regulation A, reduces the attractiveness of the Interests, we may be unable to raise the funds necessary to fund future Offerings, which could impair our ability to develop a diversified portfolio of Underlying Assets and create economies of scale, which may adversely affect the value of the Interests or the ability to make distributions to Investors.
We are required to periodically assess our internal control over financial reporting. If there are deficiencies in our internal controls, we may not be able to report our financial condition or results of operations accurately or timely, which may result in a loss of investor confidence in our financial reports, significant expenses to remediate any internal control deficiencies, and ultimately have an adverse effect on our business or financial condition.
As a Tier 2 issuer, we will not need to provide a report on the effectiveness of our internal controls over financial reporting, and we will be exempt from the auditor attestation requirements concerning any such report so long as we are a Tier 2 issuer. We are in the process of evaluating whether our internal control procedures are effective and therefore there is a greater likelihood of undiscovered errors in our internal controls or reported financial statements as compared to issuers that have conducted such evaluations. If we fail to achieve and maintain an effective internal control environment, we could suffer material misstatements in our financial statements and fail to meet our reporting obligations, which would likely cause investors to lose confidence in our reported financial information. Additionally, ineffective internal control over financial reporting could expose us to increased risk of fraud or misuse of corporate assets and subject us to potential regulatory investigations, civil or criminal sanctions and class action litigation.
If either the Manager or Rally Holdings is required to register as a broker-dealer, the Manager or Rally Holdings may be required to cease operations and any Series of Interests offered and sold without such proper registration may be subject to a right of rescission.
Because the length of an Innovation Asset’s popularity is uncertain, we must estimate the popularity of the Innovation Asset in the future. Due to the inherent uncertainty in predicting the future, it is difficult to estimate with precision the projected future Contractual Revenues associated with the Underlying Asset. These estimations are based on future events that may or may not occur. Additionally, future events change based on a number of factors that are difficult or impossible to control. As a result, it is difficult to predict an accurate return on investment or rate of return of an investment in any Underlying Asset, and our competitive position, results of operations, financial condition and cash flows could be materially adversely impacted if we receive less revenue from Underlying Assets than estimated. The Company will not provide updates with projected future Contractual Revenues after an Offering.
Risks Relating to the Underlying Assets
The value of the Underlying Assets and, consequently, the value of an Investor’s Interests can go down as well as up.
Valuations are not guarantees of realizable price of an Underlying Asset and do not necessarily correlate to the price at which the Interests may be sold on the PPEX ATS operated by NCPS. The value of the Underlying Assets may be materially affected by a number of factors outside the control of the Company, including any volatility in the economic markets and the future relevance of the Related Entity or the Related Asset.
An economic downturn and adverse economic conditions may harm the potential Contractual Revenues for the Underlying Assets.
Economic downturns and adverse economic conditions may negatively affect the Contractual Revenues from the Underlying Assets. For example, an economic downturn could result in a decrease of disposable income that consumers have available to purchase Innovation Assets or utilize their services. In addition, an economic downturn could decrease potential Contractual Revenues from third parties that use the underlying Innovation Assets in other creative endeavors.
We may be dependent on our Operating Partners for the collection of Contractual Revenues.
We may be reliant on the Operating Partners to audit and collect Contractual Revenues on our behalf. If the Operating Partners are unable to collect all Contractual Revenues that are due to the Series or there is a dispute in amounts owed, we may have limited recourse against them. We may have limited ability to change Operating Partners if we are not satisfied with their level of service.
27
Third party liability may attach to an Underlying Asset and thereby reach the Series related thereto.
Each Series assumes all of the ownership risks attached to its Underlying Asset, including third party liability risks. Therefore, a Series may be liable to a third party for any loss or damages incurred by such third party in connection with the Series’ Underlying Asset. This would be a loss to the Series and, in turn, adversely affect the value of the Series and would negatively impact the ability of the Series to make distributions.
The Company may not insure, or fully insure, Underlying Assets, and any uninsured losses relating to such Underlying Assets would result in a material and adverse impact on the valuation of the Series related to such damaged Underlying Assets.
The Company may not carry insurance for any Underlying Assets, and even if it does carry insurance, insurance of any Underlying Asset may not cover all losses, and there are certain types of losses that may be uninsurable or not economically insurable. For instance, the Underlying Asset of Series #STEGO is unlikely to be insurable until excavation of the fossil is complete and the extent of the remains is determined. Under such circumstances, any insurance proceeds received might not be adequate to restore a Series’ economic position with respect to its affected Underlying Asset. Furthermore, the Series related to such affected Underlying Assets would bear the expense of the payment of any deductible. Any uninsured loss could result in both loss of cash flow from, and a decrease in value of, the affected Underlying Asset and, consequently, the Series that relates to such Underlying Asset.
An Underlying Asset may be lost or damaged by causes beyond the Company’s control while being transported or when in storage or on display. Insurance may not cover all losses, and there can be no guarantee that insurance proceeds will be sufficient to pay the full market value of an Underlying Asset which has been damaged or lost which will result in a material and adverse effect in the value of the related Interests.
Any Underlying Asset may be lost or damaged by causes beyond the Company’s control when in storage or on display. Any damage to an Underlying Asset or other liability incurred as a result of participation in these programs, including personal injury to participants, could adversely impact the value of the Underlying Asset or adversely increase the liabilities or Operating Expenses of its related Series of Interests. Further, when an Underlying Asset has been purchased, it will be necessary to transport it to the Asset Manager’s preferred storage location. An Underlying Asset may be lost or damaged in transit, and transportation, insurance or other expenses may be higher than anticipated due to the locations of particular events.
Although we intend for the Underlying Assets to be insured at replacement cost (subject to policy terms and conditions), in the event of any claims against such insurance policies, there can be no guarantee that any losses or costs will be reimbursed, that an Underlying Asset can be replaced on a like-for-like basis or that any insurance proceeds would be sufficient to pay the full market value (after paying for any outstanding liabilities including, but not limited to, any outstanding balances under Operating Expenses Reimbursement Obligations), if any, of the Interests. Insurance of any Underlying Asset may not cover all losses. There are certain types of losses, generally of a catastrophic nature, such as earthquakes, floods, hurricanes, terrorism or acts of war that may be uninsurable or not economically insurable. Inflation, environmental considerations and other factors, including terrorism or acts of war, also might make insurance proceeds insufficient to repair or replace an asset if it is damaged or destroyed. Under such circumstances, the insurance proceeds received might not be adequate to restore a Series’ economic position with respect to its affected Underlying Asset. Furthermore, the Series related to such affected Underlying Assets would bear the expense of the payment of any deductible. Any uninsured loss could result in both loss of cash flow from, and a decrease in value of, the affected Underlying Asset and, consequently, the Series that relates to such Underlying Asset.
We may be forced to sell Underlying Assets at inopportune times, or we may be unable to sell Underlying Assets at opportune times, resulting in lower returns available to Investors.
The Company may be forced to cause its various Series to sell one or more of the Underlying Assets (e.g., upon the bankruptcy of the Manager) and such a sale may occur at an inopportune time or at a lower value than when the Underlying Assets were first acquired or at a lower price than the aggregate of costs, fees and expenses used to purchase the Underlying Assets. In addition, there may be liabilities related to the Underlying Assets, including, but
28
not limited to, Operating Expenses Reimbursement Obligations on the balance sheet of any Series at the time of a forced sale, which would be paid off prior to Investors receiving any distributions from a sale. In such circumstances, the Capital Proceeds from any Underlying Asset and, therefore, the return available to Investors of the applicable Series may be lower than could have been obtained if the Series held the Underlying Asset and sold it at a later date.
Further, with respect to Series for which DomainX serves as Asset Manager (such as Series #URL5 and Series #URL6), the terms of the applicable Asset Management Agreements provide that DomainX must approve any sale, transfer or conveyance of such Series’ Underlying Assets. These Series may be unable to obtain such approval from DomainX in a timely fashion or at all for Underlying Asset sales that the Company or Manager otherwise believe to be advisable. This could prevent these Series from realizing potentially advantageous returns for Investors.
Investors may not receive distributions or a return of capital.
The revenue of certain Series is expected to be derived primarily from the use of its Underlying Asset (known as “Contractual Revenues”), as described in “Description of the Business – Business of the Company.” In the event that the revenue generated in any given year does not cover the Operating Expenses of the applicable Series, the Manager or the Asset Manager may (a) pay such Operating Expenses and not seek reimbursement, (b) provide a loan to the Series in the form of an Operating Expenses Reimbursement Obligation, on which the Manager or the Asset Manager may impose a reasonable rate of interest, and/or (c) cause additional Interests to be issued in the applicable Series in order to cover such additional amounts.
Any amount paid to the Manager or the Asset Manager in satisfaction of an Operating Expenses Reimbursement Obligation would not be available to Investors as a distribution. In the event additional Interests in a Series are issued, Investors in such Series would be diluted and would receive a smaller portion of distributions from future Free Cash Flows, if any. Furthermore, if a Series or the Company is dissolved, there is no guarantee that the proceeds from liquidation will be sufficient to repay the Investors their initial investment or the market value, if any, of the Interests at the time of liquidation. See “Potentially high storage, maintenance and insurance costs for the Underlying Assets may have a material adverse effect on the value of the Interests of the related Series” for further details on the risks of escalating costs and expenses of the Underlying Assets.
Environmental damage could impact the value of an Underlying Asset which would result in a material and adverse effect in the value of the related Interests.
Improper storage may lead to the full or partial destruction of an Underlying Asset. For instance, fossils can be damaged or destroyed by exposure to water or moisture. Additionally, some defects may not be initially visible or apparent and may only become visible at a later date, at which point the value of the Underlying Asset and in turn the Series may be impacted.
Certain Underlying Assets in the Asset Class demand specific requirements for proper long-term storage that take into account temperature, humidity, movement and exposure to sunlight. See “Description of the Business – Facilities” for additional information.
Potentially high insurance, storage and maintenance costs, if required, for the Underlying Assets may have a material adverse effect on the value of the Interests of the related Series.
In order to protect and care for the Underlying Assets, the Manager must ensure adequate storage facilities, insurance coverage, and, if required, maintenance work. The cost of care may vary from year to year depending on the amount of maintenance performed on a particular Underlying Asset, changes in the insurance rates for covering the Underlying Assets and changes in the cost of storage for the Underlying Assets, and if required, the amount of maintenance performed. It is anticipated that as the Company and its affiliates acquire more Underlying Assets, either directly or through additional Series, the Manager and Rally holdings may be able to negotiate a discount on the costs of storage, insurance and maintenance due to economies of scale. These reductions are dependent on the Company and its affiliates acquiring, either directly or through additional Series, a number of Underlying Assets and service providers being willing to negotiate volume discounts and, therefore, are not guaranteed. These reductions may not benefit all Series equally, as certain Underlying Assets—such as the Underlying Asset of Series #MANTLE319—
29
may be unique among the Asset Class and the assets held by the Company’s affiliates, limiting the Manager’s and Rally Holdings’ opportunity to negotiate for volume discounts from service providers in respect of such Underlying Assets until the Company and its affiliates have acquired a large enough number of similar Underlying Assets.
If costs turn out to be higher than expected, this would impact the value of the Interests related to an Underlying Asset, the amount of distributions made to Investors holding the Interests, potential proceeds from a sale of the Underlying Asset (if ever), and any Capital Proceeds returned to Investors after paying for any outstanding liabilities, including, but not limited to, any outstanding balances under Operating Expenses Reimbursement Obligations. See “Investors may not receive distributions or a return of capital” for further details of the impact of these costs on returns to Investors.
The involvement of the Underlying Assets in litigation could adversely affect our business.
Our ability to receive Contractual Revenues from Underlying Assets is highly dependent upon the Innovation Assets of the Underlying Assets. In addition, we may be involved in litigation with the appointed Operating Partners who are managing an Underlying Asset. The litigation may be due to the Operating Partners not fulfilling their duties, such as assisting with generating Contractual Revenues, maintaining the Underlying Assets, as applicable. These actions can be time consuming and expensive. We cannot assure you that we will not be subject to expenses and losses that may adversely affect our operating results and Contractual Revenue.
Neither the Asset Sellers, the Related Entities, nor any third-party Asset Managers owe any fiduciary duties to us or our stockholders, and they have no obligation to enhance the value of the Underlying Assets or disclose information to our stockholders.
Events surrounding the Related Entities, including personal or business relationships, could have an impact on the Underlying Assets. The Related Entities have no obligation to disclose any such events. Although the Asset Seller will be contractually obligated to disclose all material facts to us, we cannot guarantee that the Asset Seller will comply with such disclosure requirements or that we can independently verify or uncover material events. In addition, the Asset Seller, the Related Entities, and any third-party Asset Managers (such as DomainX) have no obligation to enhance the value of the Underlying Assets. For example, the Related Entity may cease operations, which may have the effect of decreasing future Contractual Revenues on the Underlying Assets. Furthermore, neither the Asset Seller, the Related Entity, nor any third-party Asset Manager (such as DomainX) owes any fiduciary duties to us or our stockholders. Our stockholders will have no recourse directly against the Asset Sellers, the Related Entities, or any third-party Asset Manager, either under the agreement to purchase the Underlying Assets or under state or federal securities laws.
Each Series will own an Underlying Asset, and it will be difficult or impossible for the Series to ensure the Underlying Assets are operated in the Series’ best interest. The Series will not have the full ability to direct the operations of the Underlying Assets.
Some of the Underlying Assets’ future revenue might be derived from Contractual Revenues. The Series will have limited or no authority regarding the promotion, exploitation or enforcement of the Innovation Assets. Our strategy of having others operate certain Innovation Assets, including situations in which we appoint third-party Asset Managers of Underlying Assets, as we have done for Series #URL5 and Series #URL6, puts us generally at risk to the decisions of others regarding operating decisions. Although we will attempt to secure contractual rights that will permit us to protect our interests to a degree, there can be no assurance that such rights will always be available or sufficient.
The Operating Partners may refuse or fail to make payments to us under the Underlying Assets.
Free Cash Flow generated under a Series may depend largely on Operating Partners making Contractual Revenue payments to each Series. An Operating Partner may dispute amounts to which the Series believe they are entitled to, or may be unwilling or unable to make payments to which the Series is entitled, including for reasons discussed elsewhere in these risk factors. In either event, the Series may become involved in a dispute with the Operating Partners regarding the payment of such amounts, including possible litigation. Disputes of this nature could harm the relationship between the Company and the Operating Partners and could be costly and time-consuming for
30
us to pursue. Failure of the Operating Partners to make Contractual Revenue payments to us for any reason may adversely affect our business and in particular the value of each Underlying Asset.
In addition, if an Operating Partner who may be obligated to make payments to each Series were to become the subject of a proceeding under the United States Bankruptcy Code or a similar proceeding or arrangement under another state, federal or foreign law, our rights and interests under the Underlying Assets or otherwise may be prejudiced or impaired, perhaps significantly so. In such circumstances, we may be precluded, stayed or otherwise limited in enforcing some or all of our rights under the Underlying Assets or otherwise and realizing the economic and other benefits contemplated therein.
Contractual Revenues may decrease due to factors outside our control, including operational decisions and other risks faced by the Operating Partners or Related Entities.
The Series’ ability to receive Contractual Revenues from the Underlying Assets may depend in part on the operational success of any Operating Partners, Related Entities, or third-party Asset Managers. Actions taken by any Operating Partners, Related Entities, or third-party Asset Managers may have the result of decreasing the Contractual Revenues under the Underlying Assets. Our financial results are indirectly subject to hazards and risks normally associated with the continued success of Innovation Assets. For example, the Operating Partners may determine to pull certain Innovation Assets from certain distributions in an attempt to bargain for higher revenues. If this occurs and higher Contractual Revenues are not received, the Contractual Revenues under the Underlying Assets may be adversely affected.
Underlying Assets of certain Series of the Company are managed by a third-party Asset Manager.
Certain Series of the Company, namely Series #URL5 and Series #URL6, have appointed DomainX as a third-party Asset Manager of their respective Underlying Assets. As Asset Manager, DomainX will have sole authority and complete discretion over the care, custody, maintenance and management of these Underlying Assets and to take any action that it deems necessary or desirable in connection therewith. We cannot assure Investors that any third-party Asset Manager’s efforts to manage the Underlying Assets will be successful in protecting or enhancing Underlying Asset value.
An investor must rely on the Company to pursue remedies against the Operating Partners or third-party Asset Managers in the event of any default.
If any Operating Partners or third-party Asset Managers default on their payment obligations, if any, under the Underlying Assets, there can be no assurances that the Company will have adequate resources, if any, to satisfy any obligations to us under the Underlying Assets. It may be necessary, therefore, for us to pursue remedies against the Operating Partners or third-party Asset Managers. These Operating Partners may assert that the assignment of Underlying Assets by the Asset Seller did not create an obligation on their part to pay any Contractual Revenues to us. Moreover, Contractual Revenues under the Underlying Assets may be an obligation of any Operating Partners or third-party Asset Managers to us, not obligations to the Interest Holders. The Interest Holders will have no recourse directly against any Operating Partner or any third-party Asset Managers.
Related Entities in the past received, and we expect that in the future they will continue to receive, media coverage. The popularity of a Related Entity’s Related Assets is contingent upon a number of factors, including the general public’s view of the Related Entity or the Related Assets. Unfavorable publicity regarding the Related Entity or Related Assets could negatively affect the value of the Underlying Assets. Any negative publicity could damage the Related Entity’s reputation and lead to a decline in popularity, which would decrease the value of the Underlying Assets.
Contractual Revenues may decrease due to factors outside our control, such as an injury, illness, medical condition or death of the Related Entity, or due to other factors such as public scandal or other reputational harm. In any
31
such event, we do not maintain any insurance against such an event, and it is likely that the Contractual Revenue associated with the Underlying Assets may decrease.
Our focus for the foreseeable future is to source Underlying Assets associated with high-profile Innovation Assets. There is a risk that an Innovation Asset’s popularity will be short-lived. If the Related Entity or Related Asset associated with any Underlying Asset that a Series may acquire has a sustained decrease in popularity, the Contractual Revenue that would otherwise be received would likely be less than we anticipate, and it is likely that such Underlying Assets would not return to their prior levels or may cease completely.
We believe that our ability to receive Contractual Revenues from Underlying Assets depends in part on the Related Entity’s reputation and ability to be viewed favorably by the public. Prior to purchasing Underlying Assets, we assess the reputation of the Related Entity through our independent assessments. However, there can be no assurance that our review process will uncover all facts and characteristics that could adversely affect the reputation of a Related Entity or the value of Underlying Assets, or that our assessment of reputational risk is accurate. Even if our review process provides us with an accurate assessment of a Related Entity as of the date of our review, there can be no assurance that they may not suffer reputational damage in the future, whether as a result of future behavior or otherwise.
Rules regarding the ownership and administration of Domains are created by an independent body know as ICANN and administered by sub bodies known as Registries and Registrars. They are the authorities in the space and all Domain action must go through them.
The rules governing the ownership and operation of the Underlying Assets are controlled entirely by “ICANN” (the Internet Corporation for Assigned Names and Numbers), a multi-stakeholder, private sector, not-for-profit corporation formed in 1998 for the express purposes of overseeing a number of Internet related tasks, including regulating, among other things, Internet domains (“Domains”), Domain Registrars (defined below) and the rules of ownership. Changes in the rules around registration, ownership, sale or leasing of Domains could negatively impact the value of the Underlying Assets. ICANN can, in its sole discretion, choose to add additional “gTLDs” (general Top-Level Domains), which would create the potential to dilute the value of our Domains. ICANN may, in its discretion, increase the carrying cost of Domain renewal above its current nominal rate.
After a Domain is registered with a registrar (the “Registrar”), that Domain is in turn registered by the Registrar with a registry (the “Registry”). Should the Registrar or Registry change its rules or carrying costs, in its own discretion or due to ICANN action, regarding the registration, ownership, operation, sale or lease of Domains, the value of the Underlying Assets could be materially and negatively impacted. Should the Underlying Assets cease to exist, or should we be required to change our Registrar, our ability to alter our registration, sell or lease the Underlying Assets with necessary expediency may be adversely affected.
We may use the services of a Webhosting Company (the Webhost) in connection with a Domain. Should our account with the Webhost fall victim to hacking or other malicious activity, the content on the site could be altered in a way that could adversely affect the value of the Domain.
Governmental and regulatory policies or claims concerning the Domain registration system and the Internet in general, and industry reactions to those policies or claims, may cause instability in the industry and adversely impact our business if we acquire Domain names as Underlying Assets.
ICANN manages the Domain Name System’s (“DNS”) allocation of IP addresses, accreditation of Registrars and registries, and the definition and coordination of policy development for all of these functions. ICANN has been subject to strict scrutiny by the public and governments around the world, as well as multi-governmental organizations such as the United Nations, with many of those bodies becoming increasingly interested in Internet governance. Any instability in the Domain name registration system may materially and adversely impact the value of Domain names which we may acquire as Underlying Assets.
Owning or making a Domain available to be leased can introduce new considerations for Investors.
32
We may utilize services to maintain the security and credentials of a Domain. Should our account with the service provider be compromised, our ownership or control of the Domain could be in jeopardy, materially and adversely affecting the value of the Underlying Asset.
Should the Manager fail to submit our payment or administrative forms in a timely manner, the Series may lose the rights to the Underlying Asset. We may need to treat the name as a trademark and defend it to make sure the reverse does not happen to us.
Domain names are often selected to match a trademark owned by a business. In the past, when disputes have arisen between a Domain owner who is holding a Domain and a trademark owner who wishes to purchase the Domain, ICANN has ruled, in some cases, in favor of the trademark holder. As such, we must take proper care to ensure that the Underlying Asset has no potential trademark infringement on another asset or that such overlap does not arise.
The value of the Underlying Asset is, in part, based on the public perception of it as ‘high quality.’ Should any malicious party hijack, spoof or otherwise alter the content of the Underlying Asset, this could adversely affect its value.
One of the potential revenue streams for the Underlying Assets is via leasing the Domain name rights to a third party. Should the third party use the Domain in a way that is at odds with public perception, the value of the Underlying Asset could be materially and adversely affected. Additionally, should the third party conduct illegal activity via the Domain in any relevant jurisdiction, our rights to the Underlying Asset could be at risk entirely.
With respect to the Underlying Asset of Series #MANTLE319, disruptions in the financial markets or deteriorating economic conditions could adversely impact the Underlying Asset, which could hinder our ability to implement our business strategy and the Manager’s or the Operating Partner’s ability to collect potential Contractual Revenues for the Underlying Asset.
The success of our business is significantly related to general economic conditions and, accordingly, our business could be harmed by an economic slowdown and downturn in Innovation Asset values, in particular with respect to the Underlying Asset of Series #MANTLE319. Periods of economic slowdown or recession, significantly rising interest rates, declining employment levels, decreasing demand for Innovation Assets, declining Innovation Asset values, or the public perception that any of these events may occur, may result in a general decline in acquisition, disposition and leasing activity, as well as a general decline in the value of certain Innovation Assets and in rents, which in turn could reduce the value of our Interests.
During an economic downturn, it may also take longer for us to dispose of Innovation Asset investments or the selling prices may be lower than originally anticipated. As a result, the carrying value of our Innovation Asset investments may become impaired and we could record losses as a result of such impairment or we could experience reduced profitability related to declines in Innovation Asset values or rents. Further, as a result of our target leverage, our exposure to adverse general economic conditions will be heightened.
All the conditions described above could adversely impact our business performance and profitability, which could result in our failure to make distributions to our Investors and could decrease the value of an investment in us. In addition, in an extreme deterioration of our business, we could have insufficient liquidity to meet our debt service obligations when they come due in future years. If we fail to meet our payment or other obligations under secured loans, the lenders will be entitled to proceed against the collateral granted to them to secure the debt owed.
There are risks associated with reliance on third-party appraisers and inspectors.
With respect to Series #MANTLE319, we attempted to discern the accurate market value of the Underlying Asset by having it appraised by a reputable firm at the time of purchase. In the event of a significantly inflated estimate of the market value results in losses, we may have recourse for reimbursement from the appraiser, although there can be no guarantee of our ability to collect or the appraiser’s ability to pay. Furthermore, appraisers sometimes overestimate the value of properties, potentially resulting in losses, and such mistakes may not be uncovered until years later when new evidence surfaces or additional appraisals are performed. The Company may not have recourse,
33
if such an event occurs, and the value of the Underlying Asset will likely decline. If the appraiser overestimated the value of the Underlying Asset at the time of purchase, it may subsequently be impaired to the market value.
Similarly, if the inspection of the Underlying Asset by a reputable firm did not uncover all damage or issues with the Underlying Asset, the cost of maintenance or repairs may have a material adverse effect on the value of the Underlying Asset. In such case, we may seek recourse against the inspector, but there can be no guarantee of the Company’s ability to collect or the inspector’s ability to pay.
We may be subject to unknown or contingent liabilities related to Innovation Assets that we acquire for which we may have limited or no recourse against the Asset Sellers.
Some Underlying Assets may be subject to unknown or contingent liabilities for which we may have limited or no recourse against the Asset Seller. Such liabilities might include liabilities for clean-up or remediation of environmental conditions, claims of vendors or other persons dealing with the acquired asset, tax liabilities and other liabilities whether incurred in the ordinary course of business or otherwise. Even if such liabilities are due to breaches of any representations or warranties made by the Asset Seller, there is no guarantee that we will recover any amounts with respect to losses due to breaches by the Asset Sellers. In addition, the total amount of costs and expenses that we may incur with respect to such liabilities may exceed our expectations and adversely affect our business, financial condition, results of operations and cash flow.
The Asset Manager or the Operating Partner may be unable to create the demand for tours of the Underlying Asset of Series #MANTLE319, which could adversely affect the Series’ ability to generate Contractual Revenues.
If there is no demand or interest from the general public in attending tours of the Underlying Asset of Series #MANTLE319 due to its historical significance, the ability of the Series to generate Contractual Revenues would be negatively impacted. In the case where information is discovered negatively impacting the reputation of a cultural figure associated with the Underlying Asset, this may have an impact on revenue-generating activities. Other factors that can potentially impact the tours of this Underlying Asset include local health and safety protocols, limiting the number of attendees for tours, surrounding tourist attractions, and the current cultural relevance of the Underlying Asset.
Property taxes, if applicable, could increase due to property tax rate changes or reassessment, which could impact our cash flow.
Series #MANTLE319 will be required to pay state and local taxes on its property. The real property taxes may increase as property tax rates change or as the Underlying Asset is assessed or reassessed by taxing authorities. If the property taxes we pay increase, our financial condition, results of operations, cash flow, the value of our Interests and our ability to satisfy our principal and interest obligations and to make distributions to our Investors could be adversely affected.
Refurbishment processes or an inability to source original parts may adversely affect the value of the Underlying Assets.
There may be situations in the future that require the Company to undertake refurbishments of an Underlying Asset (e.g., due to natural wear and tear). Where it does so, it will be dependent on the performance of third-party contractors and sub-contractors and may be exposed to the risks that a project will not be completed within budget, within the agreed timeframe or to the agreed specifications. While the Company will seek to mitigate its exposure, any failure on the part of a contractor to perform its obligations could adversely impact the value of any Underlying Assets and therefore, the value of the Interests related to such Underlying Assets.
Underlying Assets may not be held long term.
The Company intends to cause each Series to hold its respective Underlying Asset for an extended period but may receive offers to purchase the Series’ Underlying Asset in its entirety or decide to list the asset for sale at auction. If the Manager, with the advice of the Advisory Board, deems the sale or auction listing to be generally
34
beneficial to the majority of Series’ Interest Holders, the Underlying Asset may be liquidated, with proceeds of the sale distributed to its Series’ Interest Holders. Even though the Manager and the Advisory Board deem the sale to be generally beneficial to the majority of Series’ Interest Holders, there might be unique circumstances where not all Series’ Interest Holders align with the Manager and Advisory Board’s decision.
With respect to Series #STEGO, Wyoming Dinosaur Discovery, LLC, GeoDecor, Inc., and Tom Lindgren (collectively, the “Lindgren Group”) retain a contractual right to approve the venue and price at which the Asset may be resold, which approval may not be unreasonably withheld. If the Lindgren Group reasonably withholds approval of a sale that the Manager deems to be beneficial, then the Company may be unable to sell the Underlying Asset when it would otherwise do so.
The Underlying Asset for Series #STEGO is subject to ongoing excavation, and subscriptions to purchase Series Interests are irrevocable by the purchaser. The remaining excavation efforts and the post-excavation process to clean, stabilize, and mount this Underlying Asset for display could result in damage to the Underlying Asset for Series #STEGO, harming its value and diminishing any potential return for Investors in Series #STEGO.
The excavation of the Underlying Asset of Series #STEGO is ongoing, and no guarantee can be made as to the final results of the excavation process. Many steps in the process could damage components of the Underlying Asset, including initial removal from the Earth, packaging and unpacking for transport, shipping, and handling of the components of the Underlying Asset. Likewise, the components of the Underlying Asset may be damaged in the course of preparing it for presentation, including cleaning, stabilizing, and mounting the Underlying Asset. Any damage to the Underlying Asset could have a material adverse effect on the value of the Underlying Asset, which may prevent Series #STEGO from being able to monetize the Underlying Asset or to ultimately sell the Underlying Asset at a profit.
In accordance with the terms of the Company’s form of Subscription Agreement, subscriptions to purchase Series Interests are irrevocable by the potential Investor, even in the event of damage to the Underlying Asset before the Closing of the Offering. If the Underlying Asset is damaged after a potential Investor has subscribed to purchase Interests in the Series but before the Offering has closed, the potential Investor should not expect to receive a refund of the amount tendered with the subscription agreement (unless the Series Offering is terminated without a Closing). In such case, any potential return on investment with respect to Series #STEGO may be materially reduced.
Risks Relating to Ownership of our Interests
Investors’ limited voting rights restrict their ability to affect the operations of the Company or a Series.
The Manager has a unilateral ability to amend the Operating Agreement and the allocation policy in certain circumstances without the consent of the Investors. The Investors only have limited voting rights in respect of the Series of Interests. Investors will therefore be subject to any amendments the Manager makes (if any) to the Operating Agreement and allocation policy and also any decision it takes in respect of the Company and the applicable Series, upon which the Investors do not get a right to vote. Investors may not necessarily agree with such amendments or decisions and such amendments or decisions may not be in the best interests of all of the Investors as a whole but only a limited number.
Furthermore, the Manager can only be removed as Manager of the Company and each Series in very limited circumstances, namely, following a non-appealable judgment of a court of competent jurisdiction that the Manager committed fraud in connection with the Company or a Series of Interests. Investors would therefore not be able to remove the Manager merely because they did not agree, for example, with how the Manager was operating an Underlying Asset.
Your limited voting rights in the Company will vary over time depending upon the number of Interests held by the Manager or its affiliates and the number of Interests, if any, for which our Interest Holders have irrevocably elected to further limit or eliminate their voting rights.
Interests beneficially owned by the Manager or its affiliates shall have no voting rights for so long as they are beneficially owned by the Manager or its affiliates. In addition, Investors may irrevocably elect to limit or eliminate
35
their voting rights such that they may vote only a portion of their Interests in a Series (as applicable to each such Investor, a “Vote Limit”). In the Operating Agreement, such an Interest Holder is referred to as a “Vote Limited Record Holder”. Vote Limited Record Holders retain no voting rights with respect to Interests in a Series that they own in excess of the applicable Vote Limit. Any election by an Investor to become a Vote Limited Record Holder would effectively increase the voting power held by our other Interest Holders with respect to matters submitted for Interest Holder vote that are determined by reference to the number of votes cast, or entitled to be cast, on such matter. Conversely, if the Manager or its affiliates or a Vote Limited Record Holder were to sell its Interests to a non-affiliate, the purchaser of such Interests would not be subject to the seller’s Vote Limit and would have full voting rights with respect to such Interests, which would reduce the voting power held by other Interest Holders. A large change in the outstanding voting power of the Company could result in an Interest Holder gaining or losing “affiliate” status, which could have securities law implications since securities held by affiliates, which are deemed “control” securities, are not freely tradeable under federal securities laws.
Certain Interest Holders have elected to limit their voting rights in this fashion in the past. The Transfer Agent keeps records concerning the number of Vote Limited Record Holders of each Series and the Vote Limit applicable thereto. The Transfer Agent also keeps records of the transfers of Interests, and the Manager will analyze any transfer by a Vote Limited Record Holder to determine whether the transferee is an affiliate of the transferring Vote Limited Record Holder. But we cannot predict whether any Interest Holder will elect to become a Vote Limited Record Holder, how many Interests may be affected by any such election or when or if the Manager or its affiliates or any Vote Limited Record Holder will sell any of its Interests in the future. Accordingly, while Interest Holders can determine the minimum voting rights they will hold, which is equal to their percentage ownership of the total number of Interests outstanding at any point in time, they may be unable to predict the actual share of the vote they may hold from time to time.
The amount of Interests subject to Vote Limits is indicated on the second table in the Principal Interest Holders section of this Offering Circular and will be updated on a semiannual basis in the Company’s Annual Report on Form 1-K and Semiannual Report on Form 1-SA. Additionally, Interest Holders may also contact the Company at hello@rally.com to request information concerning Vote Limited Record Holders of a Series, in which case the Manager will evaluate the request and, to the extent consistent with applicable law, provide responsive information to the requesting Interest Holder. Although the Annual and Semiannual Reports will provide periodic information about the Vote Limited Record Holders, and the ability of Investors to contact the Company is intended to give Investors access to real-time information regarding Vote Limited Record Holders so that Investors may calculate their actual voting power, it may be difficult for Interest Holders to determine their level of voting power at any point in time between such periodic updates.
The Offering price for the Interests determined by us may not necessarily bear any relationship to established valuation criteria such as earnings, book value or the purchase price of assets that may be agreed to between purchasers and sellers in private transactions or that may prevail in the market if and when our Interests can be traded publicly.
The price of the Interests is a derivative result of our negotiations with Asset Sellers based upon various factors, including prevailing market conditions, our future prospects and our capital structure, as well as certain expenses incurred in connection with the Offering and the acquisition of each Underlying Asset. These prices do not necessarily accurately reflect the actual value of the Interests or the price that may be realized upon disposition of the Interests.
The Manager has unlimited discretion to issue additional Interests in any one or more Series, which could be issued at a price lower than the original Offering price or for no consideration, and which could materially and adversely affect the value of Interests and result in dilution to Investors.
If we need more capital to finance our operations, including operations focused on a particular Underlying Asset, we may raise it through a follow-on offering involving the issuance of additional Interests in one or more Series. Additionally, we may induce third-party service providers, including potential Operating Partners, to contract with us by promising to issue additional Interests in one or more Series after the initial Offering of Interests in a Series.
36
Under our Operating Agreement, the Manager has the authority to cause the Company to issue Interests to Investors as well as to other persons for less than the original Offering prices (or for no consideration) and on such terms as the Manager may determine, subject to the terms of the Series Designation applicable to such Series of Interests. Investors do not have preemptive rights, unless otherwise indicated in the relevant Series Designation. If additional Interests are issued in a particular Series, this would dilute the current value of the Interests of that Series held by existing Investors and the amount of any future distributions payable to such existing Investors. Further, any additional issuance of Interests of a Series could result in dilution of the holders of that Series. See “DILUTION.”
If a market ever develops for the Interests, the market price and trading volume of our Interests may be volatile.
If a market develops for the Interests, through the PPEX ATS (see “Description of the Business – Liquidity Platform” for additional information) or otherwise, the market price of the Interests could fluctuate significantly for many reasons, including reasons unrelated to our performance, any Underlying Asset or any Series, such as reports by industry analysts, Investor perceptions, or announcements by our competitors regarding their own performance, as well as general economic and industry conditions. For example, to the extent that other companies, whether large or small, within our industry experience declines in their share price, the value of Interests may decline as well.
In addition, fluctuations in operating results of a particular Series or the failure of operating results to meet the expectations of Investors may negatively impact the price of our securities. Operating results may fluctuate in the future due to a variety of factors that could negatively affect revenues or expenses in any particular reporting period, including vulnerability of our business to a general economic downturn; changes in the laws that affect our operations; competition; compensation related expenses; application of accounting standards; seasonality; and our ability to obtain and maintain all necessary government certifications or licenses to conduct our business.
Note that certain Series, such as Series #MANTLE319 and Series #STEGO, will not be made available for trading on the PPEX ATS, and the Manager may withhold consent to proposed transfers in Series taxed as partnerships, such as Series #STEGO, if such transfer would potentially cause the Series to be taxed as a publicly traded partnership.
Subscriptions are irrevocable except as may be otherwise required by law. Funds from purchasers accompanying subscriptions for the Interests will not accrue interest while in escrow.
Subscriptions for Interests are irrevocable on the part of the subscriber except as may be otherwise required by law. The funds paid by a subscriber for Interests will be held in a non-interest-bearing escrow account until the admission of the subscriber as an Investor in the applicable Series, if such subscription is accepted. Purchasers will not have the use of such funds or receive interest thereon pending the completion of the Offering. No subscriptions will be accepted, and no Interests will be sold, unless valid subscriptions for the Total Minimum applicable to an Offering are received and accepted prior to the termination of the applicable Offering. It is also anticipated that subscriptions will not be accepted from prospective Investors located in states where the BOR is not registered as a broker-dealer. If we terminate an Offering prior to accepting a subscriber’s subscription or receiving subscriptions for the Total Minimum applicable to such Offering, escrowed funds will be returned promptly, without interest or deduction, to the proposed Investor.
Any dispute in relation to the Operating Agreement is subject to the exclusive jurisdiction of the Court of Chancery of the State of Delaware, except where federal law requires that certain claims be brought in federal courts. Our Operating Agreement, to the fullest extent permitted by applicable law, provides for Investors to waive their right to a jury trial.
Each Investor will covenant and agree not to bring any claim in any venue other than the Court of Chancery of the State of Delaware, or if required by federal law, a federal court of the United States, as in the case of claims brought under the Exchange Act. Section 27 of the Exchange Act creates exclusive federal jurisdiction over all suits brought to enforce any duty or liability created by the Exchange Act or the rules and regulations thereunder. As a result, the exclusive forum provision will not apply to suits brought to enforce any duty or liability created by the Exchange Act or any other claim for which the federal courts have exclusive jurisdiction. Furthermore, Section 22 of the Securities Act creates concurrent jurisdiction for federal and state courts over all suits brought to enforce any duty or liability created by the Securities Act or the rules and regulations thereunder. As a result, the exclusive forum
37
provisions will not apply to suits brought to enforce any duty or liability created by the Securities Act or any other claim for which the federal and state courts have concurrent jurisdiction, and Investors will not be deemed to have waived our compliance with the federal securities laws and the rules and regulations thereunder.
If an Interest Holder were to bring a claim against the Company or the Manager pursuant to the Operating Agreement and such claim was governed by state law, it would have to bring such claim in the Delaware Court of Chancery. Our Operating Agreement, to the fullest extent permitted by applicable law and subject to limited exceptions, provides for Investors to consent to exclusive jurisdiction of the Delaware Court of Chancery and for a waiver of the right to a trial by jury, if such waiver is allowed by the court where the claim is brought.
If we opposed a jury trial demand based on the waiver, the court would determine whether the waiver was enforceable based on the facts and circumstances of that case in accordance with the applicable state and federal law. To our knowledge, the enforceability of a contractual pre-dispute jury trial waiver in connection with claims arising under the federal securities laws has not been finally adjudicated by the United States Supreme Court. However, we believe that a contractual pre-dispute jury trial waiver provision is generally enforceable, including under the laws of the State of Delaware, which govern our Operating Agreement, by a federal or state court in the State of Delaware, which has exclusive jurisdiction over matters arising under the Operating Agreement. In determining whether to enforce a contractual pre-dispute jury trial waiver provision, courts will generally consider whether a party knowingly, intelligently and voluntarily waived the right to a jury trial.
We believe that this is the case with respect to our Operating Agreement and our Interests. It is advisable that you consult legal counsel regarding the jury waiver provision before entering into the Operating Agreement. Nevertheless, if this jury trial waiver provision is not permitted by applicable law, an action could proceed under the terms of the Operating Agreement with a jury trial. No condition, stipulation or provision of the Operating Agreement or our Interests serves as a waiver by any Investor or beneficial owner of our Interests or by us of compliance with the U.S. federal securities laws and the rules and regulations promulgated thereunder. Additionally, the Company does not believe that claims under the federal securities laws shall be subject to the jury trial waiver provision, and the Company believes that the provision does not impact the rights of any Investor or beneficial owner of our Interests to bring claims under the federal securities laws or the rules and regulations thereunder.
There will be a separate closing with respect to each Offering. The Company is conducting each Offering on a best efforts, minimum-maximum basis, meaning that no Closing will occur unless subscriptions for the Total Minimum applicable to an Offering have been accepted by the Manager. Upon accepting subscriptions for the Total Minimum, the Manager will cause the Company to effect the Closing of an Offering no later than the date that is one year from the date that such Offering was qualified by the Commission, except that the Manager, in its sole discretion, may extend the Offering Period by up to an additional six months. The Manager will accept or reject each subscription application within fifteen (15) days of receiving such subscription application. If subscriptions for the Total Minimum have not been accepted, an Offering shall be terminated upon the earlier to occur of (i) the expiration of the Offering Period, including any extension, and (ii) any date on which the Manager elects to terminate the Offering for a particular Series in its sole discretion.
In the case of each Series designated with a purchase option agreement in the respective Series Detail Table in Appendix B, the Company has independent purchase option agreements to acquire the individual Underlying Assets, which it plans to exercise upon the Closing of the individual Offering. These individual purchase option agreements may be further extended past their initial expiration dates, and in the case a Series Offering does not close on or before its individual expiration date, or if we are unable to negotiate an extension of the purchase option, the individual
This Offering Circular does not constitute an offer or sale of any Series of Interests outside of the U.S.
Those persons who want to invest in the Interests must sign an irrevocable Subscription Agreement, which will contain representations, warranties, covenants and conditions customary for private placement investments in limited liability companies, see “How to Subscribe” below for further details. A copy of the form of Subscription Agreement is attached as Exhibit 4.1 to the Offering Statement of which this Offering Circular forms a part.
·Asset Leasing: Renting the Underlying Asset to a third party over a defined period of time for the payment of fees, typically on a monthly basis
·Sponsorship & Advertising: Enabling third-party brands to display advertising on or in connection with the Underlying Asset for the payment of fees, typically on a Cost per Impression (CPM), Cost per Click (CPC), or Cost per Action (CPA) basis, or otherwise depending on the circumstances
·Licensing & Royalties: Granting the right for third parties to display, perform or access the Underlying Asset for a fixed fee or a fee calculated as a percentage of the revenue generated by such activities
·Asset Merchandising: Selling goods or services related to the Underlying Asset
The Company has generated Contractual Revenues solely from the usage of the Underlying Assets of certain Series in a domain parking arrangement, but the Company may choose to pursue any of the above channels, or any other channels, to generate Contractual Revenues in the future.
Our objective is to become the leading marketplace for investing in Innovation Assets and, through the Platform, and the PPEX ATS operated by NCPS, to provide Investors with financial returns commensurate with returns in the Asset Class, to enable deeper and more meaningful participation by Asset Class enthusiasts in the hobby, to provide experiential and social benefits comparable to those of a world-class Innovation Asset collector, and to manage the collection in a manner that provides exemplary care to the assets and offers potential returns for Investors.
56
Competition
Although the Company’s business model is uncommon in the Asset Class, there is potentially significant competition for the Underlying Assets, which the Company securitizes through its Offerings, from many different market participants. While the majority of transactions continue to be peer-to-peer with very limited public information, other market players such as dealers and auction houses continue to play an increasing role.
Most of our current and potential competitors in the Asset Class, such as dealers and auction houses have significantly greater financial, marketing and other resources than we do and may be able to devote greater resources sourcing the Innovation Assets for which the Company competes. In addition, almost all of these competitors, in particular the auction houses, have longer operating histories and greater name recognition than we do and are focused on a more established business model.
There are also start-up models around shared ownership of Innovation Assets developing in the industry, which will result in additional competition for Innovation Assets.
With the continued increase in popularity in the Asset Class, we expect competition for Innovation Assets to intensify in the future. Increased competition may lead to increased prices, which will reduce the potential value appreciation that Investors may be able to achieve by owning Interests in the Company’s Offerings and will decrease the number of high-quality assets the Company can securitize.
In addition, there are companies that are developing crowd funding models for other alternative asset classes such as racehorses, wine or art, who may decide to enter the Asset Class as well.
Customers
We target the broader U.S. Asset Class enthusiast and the U.S. millennial market as our key customer bases. The customers of the Company are the Investors in each Series that has closed an Offering. As of the date of this filing, the Company has closed the Offerings highlighted in white in the Master Series Table in Appendix A.
Manager
The Operating Agreement designates the Manager as the managing member of the Company. The Manager will generally not be entitled to vote on matters submitted to the Interest Holders. The Manager will not have any distribution, redemption, conversion or liquidation rights by virtue of its status as the Manager.
The Operating Agreement further provides that the Manager, in exercising its rights in its capacity as the managing member, will be entitled to consider only such interests and factors as it desires, including its own interests, and will have no duty or obligation (fiduciary or otherwise) to give any consideration to any interest of or factors affecting the Company, any Series of Interests or any of the Interest Holders and will not be subject to any different standards imposed by the Operating Agreement or the LLC Act or under any other law, rule or regulation or in equity. In addition, the Operating Agreement provides that the Manager will not have any duty (including any fiduciary duty) to the Company, any Series or any of the Interest Holders.
In the event the Manager resigns as managing member of the Company, the holders of a majority of all Interests of the Company may elect a successor managing member. Holders of Interests in each Series of the Company have the right to remove the Manager as Manager of the Company, by a vote of two-thirds of the holders of all Interests across all Series of the Company (excluding the Manager), in the event the Manager is found by a non-appealable judgment of a court of competent jurisdiction to have committed fraud in connection with a Series of Interests or the Company. If so convicted, the Manager shall call a meeting of all of the holders of every Series of Interests within 30 calendar days of such non-appealable judgment at which the holders may vote to remove the Manager as Manager of the Company and each Series. If the Manager fails to call such a meeting, any Interest Holder will have the authority to call such a meeting. In the event of its removal, the Manager shall be entitled to receive all amounts that have accrued and are due and payable to it. If the holders vote to terminate and dissolve the Company (and therefore the Series), the liquidation provisions of the Operating Agreement shall apply (as described in “Description of the
57
Interests Offered – Liquidation Rights”). In the event the Manager is removed as Manager of the Company, it shall also immediately cease to be Manager of any Series.
See “Management” for additional information regarding the Manager.
Advisory Board
The Manager has assembled an Advisory Board to assist the Manager in identifying and acquiring the Underlying Assets, to assist the Asset Manager in managing the Underlying Assets, and to advise the Manager regarding certain other matters associated with the business of the Company and the various Series of Interests.
The members of the Advisory Board are not managers or officers of the Company or any Series and do not have any fiduciary or other duties to the Interest Holders of any Series.
Operating Expenses
Operating Expenses are allocated to each Series based on the Company’s allocation policy (see “Allocation of Expenses” below). Each Series is only responsible for the Operating Expenses associated with such Series, as determined by the Manager in accordance with the allocation policy, and not the Operating Expenses related to any other Series. Upon the Closing of an Offering for a Series, the Series will be responsible for the following costs and expenses attributable to the activities of the Company related to the Series:
(i)any and all ongoing fees, costs and expenses incurred in connection with the management of the Underlying Asset related to a Series, including third-party operators, income or property taxes (as applicable), annual registration fees, import taxes, transportation (other than transportation costs described in Acquisition Expenses), storage (including its allocable portion of property rental fees should the Manager decide to rent a property to store a number of Underlying Assets), security, valuation, custodianship, marketing, maintenance, renovation, refurbishment, presentation, perfection of title and utilization of an Underlying Asset;
(ii)fees, costs and expenses incurred in connection with preparing any reports and accounts of a Series of Interests, including any Blue Sky filings required in certain states and any annual audit of the accounts of such Series of Interests (if applicable);
(iii)fees, costs and expenses of a third-party registrar and transfer agent appointed in connection with a Series of Interests;
(iv)fees, costs and expenses incurred in connection with making any tax filings on behalf of the Series of Interests;
(v)any indemnification payments;
(vi)any and all insurance premiums or expenses incurred in connection with an Underlying Asset, including insurance required for utilization at and transportation of the Underlying Asset to events (excluding any insurance taken out by a corporate sponsor or individual paying to showcase an asset at an event but including, if obtained, directors and officers insurance of the directors and officers of the Manager or Rally Holdings); and
(vii)any similar expenses that may be determined to be Operating Expenses, as determined by the Manager in its reasonable discretion.
The Manager and Rally Holdings have agreed to pay and not be reimbursed for Operating Expenses incurred prior to the Closing of any of the Series detailed in the Master Series Table in Appendix A. The Manager and the Asset Manager each will bear their own expenses of an ordinary nature, including all costs and expenses on account of rent (other than for storage of the Underlying Asset), supplies, secretarial expenses, stationery, charges for furniture,
58
fixtures and equipment, payroll taxes, remuneration and expenses paid to employees and utilities expenditures (excluding utilities expenditures in connection with the storage of the Underlying Assets).
If the Operating Expenses for a particular Series exceed the amount of revenues generated from the Underlying Asset of such Series and cannot be covered by any Operating Expense reserves on the balance sheet of the Series, the Manager or the Asset Manager may (a) pay such Operating Expenses and not seek reimbursement, (b) loan the amount of the Operating Expenses to the Series, on which the Manager or the Asset Manager may impose a reasonable rate of interest, and be entitled to Operating Expenses Reimbursement Obligations, and/or (c) cause additional Interests to be issued in the Series in order to cover such additional amounts. In connection with the allocation of Operating Expenses to the various Series, the Manager will periodically (and no less than semiannually) review Series’ ability to pay their Operating Expenses. Based on that review, the Manager will determine the method by which such Operating Expenses will be paid, including whether any Operating Expenses Reimbursement Obligations will be incurred.
Indemnification of the Manager and its Affiliates
The Operating Agreement provides that the Indemnified Parties will not be liable to the Company, any Series or any Interest Holders for any act or omission taken by the Indemnified Parties in connection with the business of the Company or any Series that has not been determined in a final, non-appealable decision of a court, arbitrator or other tribunal of competent jurisdiction to constitute fraud, willful misconduct or gross negligence.
Each Series will indemnify the Indemnified Parties out of its assets against all liabilities and losses (including amounts paid in respect of judgments, fines, penalties or settlement of litigation, including legal fees and expenses) to which they become subject by virtue of serving as Indemnified Parties with respect to the Company or the applicable Series and with respect to any act or omission that has not been determined by a final, non-appealable decision of a court, arbitrator or other tribunal of competent jurisdiction to constitute fraud, willful misconduct or gross negligence.
Description of the Asset Management Agreement
Each Series has entered or intends to enter into a separate Asset Management Agreement with its respective Asset Manager. The Series referenced in the Master Series Table in Appendix A will each appoint an Asset Manager to manage the respective Underlying Assets pursuant to an Asset Management Agreement. The services provided by each Asset Manager will include:
-Together with members of the Advisory Board, creating the asset maintenance policies for the collection of assets; and
-Investigating, selecting and, on behalf of the applicable Series, engaging and conducting business with such persons as the Asset Manager deems necessary to ensure the proper performance of its obligations under the Asset Management Agreement, including, but not limited to, consultants, performance rights organizations, revenue management organizations, insurers, insurance agents, maintenance providers, storage providers and transportation providers and any and all persons acting in any other capacity deemed by the Asset Manager necessary or desirable for the performance of any of the services under the Asset Management Agreement.
-Developing standards for the transportation and care of the Underlying Assets.
The Asset Management Agreement entered into with each Series will terminate on the earlier of: (i) one year after the date on which the relevant Underlying Asset related to a Series has been liquidated and the obligations connected to the Underlying Asset (including contingent obligations) have been terminated, (ii) the removal of the Manager as managing member of the Company (and thus all Series of Interests), (iii) upon notice by one party to the other party of a party’s material breach of the Asset Management Agreement, (iv) such other date as agreed between the parties to the Asset Management Agreement, or (v) one year after the date on which any obligations connected to the Underlying Asset (including contingent obligations) have been terminated.
Each Series will indemnify the Asset Manager out of its assets against all liabilities and losses (including amounts paid in respect of judgments, fines, penalties or settlement of litigation, including legal fees and expenses) to which they become subject by virtue of serving as Asset Manager under the Asset Management Agreement with
59
respect to any act or omission that has not been determined by a final, non-appealable decision of a court, arbitrator or other tribunal of competent jurisdiction to constitute fraud, willful misconduct or gross negligence.
With respect to each Series for which DomainX serves as Asset Manager, the terms of the relevant Asset Management Agreement provide that DomainX must approve any sale of the relevant Underlying Asset.
Management Fee
As consideration for managing each Underlying Asset, the respective Asset Manager will be paid a semi-annual Management Fee pursuant to the Asset Management Agreement (see “Description of the Asset Management Agreement” above for additional information), equal to up to 50% of any Free Cash Flow generated by a Series for such six-month period and available for distribution. The Management Fee will become payable only if there are sufficient proceeds to distribute Free Cash Flow to the Interest Holders.
Asset Selection
The Company targets a broad spectrum of assets globally in order to cater to a wide variety of tastes and investment strategies across the Asset Class. We intend to acquire assets from across all sub-categories of the Asset Class, but with particular focus on items with broad appeal and significance. We will pursue acquisitions opportunistically on a global basis whenever we can leverage our industry specific knowledge or relationships to bring compelling investment opportunities to Investors. It is our objective to acquire only the highest caliber assets, although we may opportunistically choose to acquire assets of lesser qualities from time to time if we consider these to be prudent investments for the Investors, and to appropriately maintain, monitor and manage the collection to support its continued value appreciation and to enable respectful enjoyment by the Investors. We maintain an ongoing list of investment opportunities across the various asset categories we track, including:
(i) Tier 1: comprehensive lists of items in each major sub-category of the Asset Class that fit within the broad asset categories described above. Tier 1 assets provide a breadth of content for the Platform and are viewed as assets for general consideration.
(ii) Tier 2: narrow lists of marquee assets that define each investment category as a whole within the collector and investor community. In addition to being prudent investments, Tier 2 assets will also play a key role in promoting the Platform because of their high consumer recognition factor.
(iii) Tier 3: target acquisition lists of assets that the Manager and Advisory Board believe would offer the greatest return on investment potential to Investors across various forms of Innovation Assets.
(iv) Tier 4: current acquisition lists of assets where the Manager and the Company are proactively searching for particular examples to present as opportunities for investment. Tier 4 lists include what we believe to be the most desirable and actionable assets in the Asset Class at any time.
We anticipate that our Advisory Board will assist in the identification of Underlying Assets and in finding and identifying storage, maintenance specialists and other related service providers. This will give the Company access to the highest quality assets and balanced information and decision making from information collected across a diverse set of constituents in the Asset Class, as well as a network of partners to ensure the highest standards of care for the Underlying Assets.
Our asset selection criteria were established by the Manager in consultation with Rally Holdings and members of the Company’s Advisory Board and are continually influenced by Investor demand and current industry trends. The criteria are subject to change from time to time in the sole discretion of the Manager. Although we cannot guarantee positive investment returns on the Underlying Assets we acquire, we endeavor to select assets that are projected to generate positive return on investment, primarily based upon the asset’s value appreciation potential as well as the potential for the Company to generate Contractual Revenues through the Underlying Asset. The Manager, with guidance from Rally Holdings and members of the Company’s Advisory Board, will endeavor to only select assets with, as applicable, known ownership history certificate of authenticity, pre-purchase inspections, highest
60
possible quality grades, potential Contractual Revenues, cultural relevance, to the extent that such metrics exist in a particular type of asset (e.g., domain names), and other related records. The Manager, with guidance from Rally Holdings and members of the Company’s Advisory Board, also considers the condition of the assets, historical significance, ownership history and provenance, and the historical valuation of the specific asset or comparable assets. From time to time the Manager, in consultation with our expert network, Rally Holdings and members of the Company’s Advisory Board, will decide to refurbish assets either prior to designating a Series of Interests associated with such Underlying Asset on the Platform or as part of an Underlying Asset’s ongoing maintenance schedule. Any refurbishment will only be performed if it is deemed to be accretive to the value of the Underlying Asset. The Manager, with guidance from Rally Holdings and members of the Company’s Advisory Board, will review asset selection criteria at least annually. The Manager, in consultation with Rally Holdings, will seek approval from the Advisory Board for any major deviations from these criteria.
Through the Company’s network, Rally Holdings and Advisory Board, we believe that we will be able to identify and acquire Underlying Assets of the highest quality and known provenance, as well as examples of potential “future classics,” and obtain proprietary access to limited production runs, with the intent of driving returns for Investors in the Series of Interests that owns the applicable asset. Concurrently, through the Platform and the PPEX ATS operated by NCPS, we aim to bring together a significantly larger number of potential buyers with Asset Sellers than traditional auction houses or dealers are able to achieve. Through this process, we believe we can source and syndicate Underlying Assets more efficiently than the traditional methods in the Asset Class and with significantly lower transaction and holding costs.
Domain Name Asset Type
Asset Class Description: A domain name is defined as a sequence of usually alphanumeric characters that specifies a group of online resources and that forms part of the corresponding Internet addresses. More simply, a domain name is used for finding and identifying websites on the Internet. Technically, websites are accessed via computers using IP addresses, which are a 32-bit series of numbers; however, because it is difficult for humans to remember long strings of numbers, domain names were developed as an efficient and memorable way to identify websites on the Internet. So essentially, domain names “put a friendly face on hard-to-remember numeric Internet addresses,” and can be equated to the digital real estate of the Internet.
Registration and Availability: In order to acquire ownership rights to a domain name, it must be registered with an accredited registrar. The registrar will check if the domain name is available for registration and create a record, known as a WHOIS record, with the domain name registrant’s information.
At this time, we believe that nearly all domain names with commonly recognizable words have already been registered, and that this is especially true for domain names that end with the .com extension, as this is the most common, identifiable, and desirable domain name suffix. At this time, we believe that it has become virtually impossible to register new desired domain names using the .com extension, resulting in the most valuable and recognizable domain names only to be available for resale in the secondary domain name market, known as the aftermarket.
The Domain Name Aftermarket: The domain name aftermarket is the secondary market for transacting in Internet domain names. In this secondary market, a party interested in acquiring a domain name that is already registered bids in an auction or negotiates a price directly with a seller to acquire the rights in the domain name from the registered holder of that domain name. Given that most high quality domain names have already been registered, the aftermarket has essentially become the primary method to acquire valuable domain names at this time. Similar to art, collectibles and real estate, the domain name aftermarket is facilitated by marketplace platforms, auction houses and brokers that provide communication methods for buyers and sellers to interact, negotiate pricing and transact.
Value and the Secondary Market: The value of a domain name in the aftermarket is ultimately established by what a buyer is willing to pay for any particular domain name. As such, domain names acquired in the aftermarket are akin to works of art, where the value will be dictated by the number, tastes and needs of buyers in the market. Domains are often purchased as an investment, with the hopes that over time the domain names will be more valuable to future buyers. Generally, this market has demonstrated strong and consistent appreciative potential, as more of business and life is conducted digitally, demand has grown for a limited supply of high quality domain names as digital
61
real estate for these activities. There is an active market of domain name investors that endeavor to identify undervalued domains and speculate on the future value of such domains.
Determining the value of a domain name, as with a work of art, is somewhat subjective; nonetheless, there are certain features generally considered meaningful and that positively correlate with higher sale prices. These features include, but are not limited to, the following:
·Top-Level Domain (“TLD”): A domain’s TLD can be a big part of what makes it desirable. For example, a domain name with a .com suffix remains the most popular option (as it is recognizable and common), so many buyers will gravitate towards it. However, newer alternatives can also become trendy (and valuable).
·Popularity and Traffic: If the domain name is currently used for a specific website, the level of traffic that site receives can become a vital factor in calculating the domain’s worth. The reason for this is fairly straightforward, in that if the domain comes with an existing audience attached, the buyer can leverage that traffic for their site right away. If the domain has been active for a while, this can also help its Search Engine Optimization (“SEO”) for the new owner, which may make it even more appealing.
·Keywords: Including the right keywords in the domain name is another crucial aspect of SEO. In most industries, a majority of sites include high-quality keywords in their domains. For example, the top-rated website for the search engine query “hotel” is www.hotels.com. As such, if your domain contains a desirable keyword, this could increase its value.
·Brandability: While a domain’s brandability can be very difficult to define, it is an important consideration for site owners when choosing a name. Many of the most visited websites in the world have clear, memorable and unique domains, such as twitter.com, youtube.com, and facebook.com. If the domain is similarly catchy and attention-grabbing, it may make buyers take special notice.
·Spelling: This may seem obvious, but making sure the domain is spelled correctly can be critical. After all, few buyers will be swayed to use something that looks sloppy and unprofessional. At the same time, using unexpected spelling can sometimes be a benefit, as it could make the domain more brandable. For example, fiverr.com and tumblr.com have taken technically incorrect spellings and used them to create memorable, lasting brands.
·Length: A general rule of thumb is that the shorter a domain is, the more people will pay for it. This is not always the case, as brevity alone is not going to make an otherwise cumbersome domain like zz0xy2c.org more appealing to potential buyers. However, a concise domain is often considered rarer and therefore more valuable. This is due to shorter domains being more memorable, easier to share and more marketable.
Other than appreciation, another way to monetize a domain name is through “domain parking,” which is an advertising practice used primarily to benefit from traffic visiting an under-developed domain name. The domain name will usually resolve to a web page containing advertising listings and links that will be targeted to the predicted interests of the visitors and may change dynamically based on the topics that prove most interesting to visitors. Usually, the domain holder is paid based on how many links have been visited and the productivity of those visits, which can also increase the value of a domain name.
In other instances a domain name may hold certain sentimental value for a buyer, as would a certain piece of artwork. For example, in 2017 Elon Musk reacquired X.com, which was the domain name used by the company he co-founded that would ultimately become PayPal. The domain was essentially defunct when it was reacquired by Musk, and he expressed that he had no current plans for it at the time of that acquisition, but that it had great sentimental value to him. Regardless of sentimental value, a one-character .com domain is extremely valuable in its own right due to (i) the scarcity of one-character .com domain names, (ii) the fact that such domain names attain the shortest possible length of a .com domain name, and (iii) the generic nature of the domain, which allows such domains to be used for a broad range of digital businesses and activities.
Evaluation, Risks, Acquisition and Management: Domain names face certain specific types of risks that can negatively impact their potential value in the market. In order to mitigate these potential risks, due diligence is conducted as a component of evaluating each domain. These risks, and why they matter, are outlined below:
62
·Prior Site Usage: Prior site usage helps determine if a domain name has previously been used in conjunction with illegal, improper or otherwise offensive online content, which could negatively impact the reputation and value of the domain. This type of activity could result in blacklisting of the domain on various platforms and impact certain functionality, such as search engine performance, website resolution and email throughput efficacy.
·UDRP Disputes: All domain registrars must adhere to the Uniform Domain Name Dispute Resolution Policy (the “UDRP”). Under the UDRP, disputes arising from abusive registrations of domain names (e.g., cybersquatting on the registered trademark of another brand) may be addressed by expedited administrative proceedings that can be initiated by filing a complaint with an approved dispute resolution service provider. Like other asset classes, it is important to ensure that there are no outstanding legal claims that could impact a domain and diminish its value. Future challenges, or prior challenges not properly managed, would represent additional risk that could negatively impact the value of the domain name. As such, a review of the UDRP history of a domain (if any) is an important step to identify such additional risk.
·WHOIS History: WHOIS is a widely used Internet record that identifies who owns a domain and how to contact them. Although WHOIS record availability has been hindered in recent years by the enactment of privacy laws such as the European Union’s General Data Protection Regulation (the “GDPR”), WHOIS records have proven to be useful and an essential resource for maintaining the integrity of the domain name registration process. A WHOIS record typically contains the name and contact information of the registrant (who “owns” the domain), the name and contact information of the registrar (the company that logs the registration of the domain name on behalf of their registrant customer), the registration date, the current name servers, the most recent update, and the expiration date, along with other information (such as the technical contact, who may be different from the registrant). The history and detail of domain ownership is important in a manner similar to a title search on a parcel of real estate - to the extent the information is available it can provide a historical record that substantiates ownership and the transfer history of a domain name. At the same time, any discrepancies arising during a WHOIS review can identify potential risks or disputes related to the domain and claims of ownership related thereto.
·Email Blacklists: Having a domain name that is currently on or has been on an email blacklist can significantly hinder email deliverability. Because email deliverability is a key concern for many companies (and their marketing departments), it is important to find out if a domain is listed on any current or prior blacklists with an analysis of any required remediation. If a domain name is on any email blacklists, this could diminish the value of the domain name unless the necessary remediation can be conducted.
·Search Engine Reputation and Backlinks: A domain name’s reputation is influenced by the number and quality of backlinks from external sites, also known as referring domains, that contribute to the overall strength, relevance and diversity of the domain’s backlink profile. It is common for referring domains to link back to content if it is relevant, authoritative or useful in some way to their own domain. Generally speaking, backlinks are considered to be a “vote of confidence” for the content that is being linked to on a domain from outside sources. Backlinks are important for both search engines and website visitors, as backlinks provide a way for people to find other sources of information on the same or related topics. Links create a positive consumer experience because they transfer the visitor directly to additionally desirable information. For search engines, backlinks help to determine the page’s “authority,” which is the page’s importance and value. In the past the quantity of backlinks was the primary indicator of a page’s popularity; however, backlinks are currently evaluated more on the quality of sites from which the links are coming. Further, too many backlinks from unreliable domains can actually hinder the authoritative signals of a domain and can therefore devalue a domain. As such, it is beneficial to analyze these reputational factors to determine (i) if a domain is impacted in this manner through prior usage, and (ii) if/how this impact can be remediated.
·Trademark Review: A domain name that conflicts with one or more established commercial brand marks may carry additional risk that should be considered. If a trademark search turns up any potential conflicts with the domain name, it is important to determine if there is risk of a future legal challenge. A challenge could occur if use of the domain name is likely to confuse customers about the source of trademarked products or services. However, the presence of similar trademarks to the domain name is not immediately disqualifying, as not all marks fall into the same class of goods and services, and some marks may have
63
limitations that mitigate risk of a challenge. Further, generic terms or words cannot typically be trademarked. Because of this, a domain name that has many trademarks associated with the related term may actually be considered “safer” to purchase or as an investment. Generally, the search and review of possible trademark conflicts is important to determine if there is additional risk or benefit related to the domain that could impact value.
Rally Holdings intends to identify potential domain names for acquisition by the Company by considering the characteristics described above, including availability, value in the secondary market and risks that could negatively affect value. When considering a potential domain name for acquisition, Rally Holdings will evaluate the domain name for any prior events or conditions that would disqualify it from acquisition, including, but not limited to, prior use for illegal or inappropriate activities, any specific directly conflicting trademarks or trademark applications, and any outstanding or poorly resolved UDRP claims that would indicate a likelihood of a future challenge. Additionally, Rally Holdings will consider for each domain name, where applicable: (i) WHOIS history, (ii) trademark history, (iii) email blacklist history, (iv) search engine reputation, (v) prior site usage and (vi) URL backlinks, as well as any other criteria which Rally Holdings deems material at the time of consideration. Upon acquisition of a domain name, the Company will transfer such domain name to an account with a Registrar designated by Rally Holdings. The Asset Manager will determine if it is appropriate to make the domain name available for “domain parking” advertising and, if so, contract with a third party for such services.
See “Description of Series” in Appendix B for certain information regarding historical revenues generated by the Underlying Assets under prior ownership. The fact that an Underlying Asset generated revenue prior to its purchase by a Series is not an indication or prediction of future revenue or a representation that the Underlying Asset will generate any revenue in the future. Please see “Risk Factors” related to Contractual Revenues.
Real Property Asset Type
Within our investment policies and objectives, the Manager, with assistance from our Advisory Board, will have discretion with respect to the selection of specific investments, the purchase and sale of real property Underlying Assets within the Innovation Asset class, and identifying service providers, including or through Operating Partners. We believe that successful real property investment requires the implementation of strategies that permit favorable purchases, effective asset management, informed Operating Partner selection, and timely disposition of those assets. As such, we have developed a disciplined investment approach that combines the experience of the Manager and the Advisory Board with a structure that emphasizes thorough market research, stringent underwriting standards, and an extensive down-side analysis of the risks of each investment. The approach also includes active and aggressive management of each asset acquired either directly or through one or multiple Operating Partners. This will give the Company access to the highest quality assets and balanced information and decision making from information collected across a diverse set of constituents in the Asset Class, as well as a network of partners to ensure a high standard of care for the Underlying Assets.
To execute our disciplined investment approach, the Manager will take responsibility for the business plan of each investment. The following practices summarize our investment approach:
·Local Market Research – The Manager will extensively research the acquisition and underwriting of each transaction, utilizing both real time market data and the transactional knowledge and experience of our network of professionals and in market relationships as well as our Advisory Board.
·Underwriting Discipline – The Manager will follow a tightly controlled and managed process to examine all elements of a potential investment, including, with respect to each Underlying Asset, its location, income-producing capacity, prospects for long-range appreciation, tax considerations, potential for Contractual Revenues, and liquidity.
·Risk Management – Risk management will be a fundamental principle in the management of each of our properties whether operated directly or through an Operating Partner. Operating or performance risks arise at the investment level and often require real estate operating experience to cure. The Manager or its designated Operating Partner will review the operating performance of investments against projections and provide the oversight necessary to detect and resolve issues as they arise.
·Asset Management – Prior to the purchase of an Underlying Asset, the Manager will develop an asset business strategy which will be customized based on the acquisition and underwriting data. This is a forecast of the
64
action items to be taken, the required operational expertise, and the capital needed to achieve the anticipated returns. The Manager will review asset business strategies regularly to anticipate changes or opportunities in the market during a given phase of a real estate cycle.
In selecting investments for us, the Manager, in consultation with Rally Holdings and members of the Manager’s Advisory Board, will utilize the Manager’s investment and underwriting process, which focuses on ensuring that each prospective investment is being evaluated appropriately. The criteria are subject to change from time to time in the sole discretion of the Manager and is continually influenced by Investor demand and current industry trends. The criteria that the Manager will consider when evaluating prospective investment opportunities include:
·macroeconomic conditions that may influence operating performance;
·Asset Class market factors that may influence real estate valuations, real estate financing or the economic performance of real estate generally;
·fundamental analysis of the Innovation Asset, including zoning, operating costs and the asset’s overall competitive position in its market;
·Asset Class and leasing market conditions affecting the Innovation Asset;
·the cash flow in place and projected to be in place over the expected hold period of the Innovation Asset to generate potential Contractual Revenues;
·the appropriateness of estimated costs and timing associated with capital improvements of the Innovation Asset;
·a valuation of the investment, investment basis relative to its value and the ability to liquidate an investment through a sale or refinancing of the Innovation Asset;
·review of third-party reports, including ownership records, appraisals, engineering and environmental reports;
·physical inspections of the Innovation Asset and analysis of its core attributes; and
·the overall structure of the investment and rights in the transaction documentation.
If a potential investment meets the Manager’s underwriting criteria, the Manager will review the proposed transaction structure, including, with respect to joint ventures, distribution and waterfall criteria, governance and control rights, buy-sell provisions and recourse provisions. The Manager will evaluate our position within the overall capital structure and our rights in relation to other partners. The Manager will analyze each potential investment’s risk-return profile and review financing sources, if applicable, to ensure that the investment fits within the parameters of financing facilities and to ensure performance of the Innovation Asset.
Future Innovation Asset Classes
In the future the Company may consider offering additional classes of Underlying Assets in addition to domain names, which will be selected broadly based on analysis of the following criteria: (1) historical appreciation of the asset class, (2) expectation of ability to generate cash flow, (3) comprehensibility and appropriateness for a retail investor base, and (4) ability to deliver non-financial returns (i.e., pride of ownership and emotional returns). Examples of such future asset classes may include: automobiles, sports memorabilia, historical documents, music and media royalties, contractual rights and revenues, non-fungible tokens and historical aircraft leasing.
Asset Acquisition
The Company plans to acquire Underlying Assets through various methods, including:
1)Upfront purchase – the Company or a Series acquires an Underlying Asset from an Asset Seller prior to the launch of the Offering related to the Series
2)Purchase agreement – the Company or a Series enters into an agreement with an Asset Seller to acquire an Underlying Asset, which may expire prior to the Closing of the Offering for the related Series, in which case the Company is obligated to acquire the Underlying Asset prior to the Closing
3) Purchase option agreement – the Company or a Series enters into a purchase option agreement with an Asset Seller, which gives the Company the right, but not the obligation, to acquire the Underlying Asset
65
4)Consignment agreement – the Company or a Series enters into a consignment agreement with an Asset Seller, which gives the Company the right, but not the obligation, to acquire the Underlying Asset and under which the Company takes possession of the Underlying Asset during a consignment period
In the case where an Underlying Asset is acquired prior to the launch or Closing, as the case may be, of the Offering process for the related Series, the proceeds from the associated Offering, net of any Brokerage Fee, Offering Expenses or other Acquisition Expenses or Sourcing Fee, will be used to reimburse the Company for the acquisition of the Underlying Asset or repay any loans made to the Company, plus applicable interest, to acquire such Underlying Asset.
Rather than pre-purchasing an Underlying Asset before the Closing of an Offering, the Company may also negotiate with Asset Sellers for the exclusive right to market an Underlying Asset on the Platform to Investors for a period of time. The Company plans to achieve this by pre-negotiating a purchase price (or desired amount of liquidity) and entering into an asset purchase agreement, a purchase option agreement, or a consignment agreement with an Asset Seller for an Underlying Asset, which would close simultaneously upon the Closing of the Offering of Interests in the Series associated with that Underlying Asset. Then, upon Closing a successful Offering, the Asset Seller would be compensated with a combination of cash proceeds from the Offering and, if elected, equity ownership in the Series associated with the Underlying Asset (as negotiated in the agreement for such Underlying Asset) and title to the Underlying Asset would be held by, or for the benefit of, the applicable Series.
In some cases, an Asset Seller may be issued membership Interests in a Series as part of the total purchase consideration to the Asset Seller.
Additional details on the acquisition method for each Underlying Asset are noted in the Series Detail Table relating to each respective Underlying Asset in Appendix B.
Asset Sales and Interest Liquidity
The Company intends to hold and manage all of the assets marketed on the Platform indefinitely. Liquidity for Investors is obtained by transferring their Interests in a Series, through the PPEX ATS operated by NCPS (see “Description of the Business – Liquidity Platform” below for additional information), or otherwise, although certain Series will not be eligible for trading on the PPEX ATS, such as Series #MANTLE319. Additionally, transfers of Interests in Series that have not elected to be taxed as corporations, such as Series #STEGO, will be subject to the Manager’s evaluation of whether such transfers would cause the Series to be subject to an additional Series-level tax as a publicly traded partnership, in which case the Manager would not consent to such a transfer. Series for which secondary trading will be limited are identified on the Master Series Table. For a description of the process Investors may follow to transfer their Interests other than through the PPEX ATS, see “Description of Interests Offered – Transfer Restrictions.”
Even for those Series that are available for trading on the PPEX ATS, there can be no guarantee that a secondary market for any Series of Interests will develop or that appropriate registrations to permit secondary trading, as the case may be, will be obtained and maintained. However, should an offer to liquidate an Underlying Asset materialize, the Manager will consider whether such offer is in the best interest of the Investors. If the Manager determines that an offer is in the best interest of the Investors, the Manager will consider the merits of such offer on a case-by-case basis and potentially sell the Underlying Asset.
In determining whether to sell an Underlying Asset, the Manager may consider (a) guidance from the Advisory Board and (b) preferences of the Interest Holders of the related Series as expressed by the nonbinding voting results of a poll of such Interest Holders on the question whether to sell the Underlying Asset. Furthermore, should an Underlying Asset become obsolete (e.g. due to lack of Investor demand for its Interests) or suffer from a catastrophic event, the Manager may choose to sell the asset. In addition, if the Manager, with advice from the Advisory Board, believes that an Underlying Asset is worth more than the value reflected by its then-current trading price or the price at which it was initially offered to Investors, the Manager may decide to offer the Underlying Asset or component for sale at an auction or actively solicit bids from third parties or otherwise. As a result of a sale of all or substantially all of the Underlying Assets of a Series, the Manager would distribute the proceeds of such sale (together with any insurance proceeds in the case of a catastrophic event covered under the asset’s insurance contract)
66
to the Interest Holders of the applicable Series (after payment of any accrued liabilities or debt, including but not limited to balances outstanding under any Operating Expenses Reimbursement Obligation, on the Underlying Asset or of the Series at that time). In some cases, the Company’s ability to liquidate an Underlying Asset may be subject to certain restrictions or limitations on sale as set forth in the applicable purchase agreement or purchase option agreement. See the “Description of Series” section for each individual Series in Appendix B for further details.
Liquidity Platform (the PPEX ATS)
The process by which the PPEX ATS operated by NCPS makes secondary trading in Interests of certain Series available to Investors is described below. For a description of the process Investors may follow to transfer their Interests other than through the PPEX ATS, see “Description of Interests Offered – Transfer Restrictions.” As described below, certain Series Interests are not made available for trading on the PPEX ATS.
Overview of PPEX ATS Platform
The Company and its affiliates have entered into an arrangement with NCPS and its affiliates to facilitate secondary transactions on the PPEX ATS in certain of the Series of Interests issued by the Company. The PPEX ATS is owned and operated by NCPS. The arrangement with NCPS was established in the fourth quarter of 2021 to provide a venue for secondary trading of Series Interests and is designed to provide Investors with an efficient means to buy and sell Series Interests in secondary transactions. The Manager has entered into a brokerage agreement and a license agreement with the Executing Broker pursuant to which, subject to restrictions under state and federal securities laws and the transfer restrictions listed in the Operating Agreement (see “Description Of Interests Offered – Transfer Restrictions” section for additional details), the Executing Broker is engaged to execute all resale transactions in Interests based on the matching of orders on the PPEX ATS. The Executing Broker is a registered broker-dealer member of the PPEX ATS. NCPS is a broker-dealer registered with the Commission and a member of FINRA and SIPC. Neither the Company, the Manager, nor the Asset Manager matches any orders or executes or settles any transfer of Interests with respect to secondary trading on the PPEX ATS.
Secondary trades of Interests matched on the PPEX ATS are intended to comply with Blue Sky laws either through a manual exemption in states where available, through a direct filing with the state securities regulators where required, or as isolated non-issuer transactions. Each Series of Interests will be identified by a unique CUSIP number.
Certain Series of Interests, such as Series #MANTLE319 and Series #STEGO, will not be eligible for secondary trading on the PPEX ATS. Additionally, transfers of Interests in Series that have not elected to be taxed as corporations, such as Series #STEGO, will be subject to the Manager’s evaluation of whether such transfers would cause the Series to be subject to an additional Series-level tax as a publicly traded partnership, in which case the Manager would not consent to such a transfer. Series for which secondary trading will be limited are identified on the Master Series Table.
Process for Secondary Transactions
From time to time, and at any time, isolated non-issuer transactions in Interests of one or more Series may be effected during trading hours established by NCPS as operator of the PPEX ATS (“Market Hours”) in accordance with the following process. Investors can submit bid and ask quotes through the user interface provided by the Platform at any time. The Platform immediately and automatically routes the quotes (i) to the Executing Broker, and (ii) by virtue of the Executing Broker’s status as a member of the PPEX ATS and the Tools License Agreement between Rally Holdings and the Executing Broker (as described below), to the PPEX ATS, which is owned and operated by NCPS, a registered broker-dealer. For clarity, because the Executing Broker is (i) a registered broker-dealer and a member of the PPEX ATS and (ii) licensed to use the Platform to access and transmit order information entered onto the Platform by Investors, such order information is automatically routed from the Platform to both the Executing Broker and the PPEX ATS simultaneously. The PPEX ATS then matches orders in accordance with the rules established by the PPEX ATS, but no matching of buyers and sellers will occur other than during Market Hours. Bid and ask quotes submitted during Market Hours may be immediately matched by the PPEX ATS, while bid and ask quotes submitted outside of Market Hours are eligible to match only upon the next commencement of Market Hours.
67
Once matched by the PPEX ATS, orders are executed by the Executing Broker. When a trade is executed, the Executing Broker transmits the applicable information (including the number of Interests and price at which they are being sold or purchased) to the Platform, where it is displayed to the relevant Investor. During Market Hours, the Platform periodically sends instructions regarding the transfer of funds for executed trades via the Executing Broker to Dwolla, Inc., the third-party holder of Investor funds (“Dwolla”), which then effectuates the funds transfer between the buyer and seller. After Market Hours end, the Executing Broker provides instructions regarding any transfers of Interests between Investor accounts to the Custodian, which transfers the Interests accordingly. The clearing process, which includes the transfer of funds and Interests, is typically completed within one to two business days. Neither the Platform nor the Executing Broker clears or settles trades.
User Interface and Role of the Platform
The Platform serves merely as the user interface for the purpose of enabling secondary market trading in Interests. On the Platform, Investors input the details of any orders to buy or sell Interests in secondary transactions (including the number of Interests subject to the offer to buy or sell, as the case may be, and the price, if any, at which such offer is being made), and the orders then are routed (i) to the Executing Broker, and (ii) by virtue of the Executing Broker’s status as a member of the PPEX ATS and the Tools License Agreement between Rally Holdings and the Executing Broker (as described below), to the PPEX ATS. For clarity, because the Executing Broker is (i) a registered broker-dealer and a member of the PPEX ATS and (ii) licensed to use the Platform to access and transmit order information entered onto the Platform by Investors, such order information is automatically routed from the Platform to both the Executing Broker and the PPEX ATS simultaneously. After the Executing Broker has executed a trade, information about the matched orders and executed trade is then communicated by the Executing Broker to the buyer and seller using the Platform’s user interface. The PPEX ATS accepts orders transmitted from the Platform only because the Executing Broker (which is a member of the PPEX ATS) is licensed to use the Platform’s technology to transmit order information.
For the avoidance of doubt, the decision whether to engage in secondary market trading is left solely to the individual Investors. Once an Investor, through the Platform as the user interface, places an order to buy or sell Interests, the Platform routes the order information (i) to the Executing Broker, and (ii) by virtue of the Executing Broker’s status as a member of the PPEX ATS, to the PPEX ATS pursuant to the Tools License Agreement between Rally Holdings and the Executing Broker, and the Software and Services License Agreement between Rally Holdings and North Capital Investment Technology, Inc. (each as described below under “Agreements Relating to the PPEX ATS”). Neither the Company nor any other Rally Entity acts as a broker or dealer, and none of them provide Investors any direction or recommendation as to the purchase or sale of any Interests in secondary market transactions. In addition, neither the Executing Broker, the Custodian, nor NCPS makes any direction or recommendation as to the purchase or sale of any Interests. Neither the Company, nor the Rally Entities will ever have custody of an Investor’s membership Interests, cash or other property, and all transfers of cash or securities are performed by a registered broker-dealer or another appropriately licensed third party. NCPS, in its capacity as the Custodian, will have custody of Investors’ Interests in the brokerage accounts opened by each Investor with the Custodian.
The Platform acts as a user interface to receive information from, and deliver and display information to, Investors and the registered broker-dealers. None of the Company, the Manager or the Asset Manager will receive any compensation for their role in the trading procedure unless and until they, or one of their affiliates, register as a broker-dealer. As described above under the “Potential Conflicts of Interest – Conflicting interests of the Manager, the Asset Manager and the Investors” section, the Manager or one of its affiliates in the future may register as a broker-dealer under state and federal securities laws, at which time it may charge fees in respect of trading of Interests.
Agreements Relating to Secondary Trading on the PPEX ATS
The Company has entered into an agreement dated June 14, 2021 (the “PPEX ATS Company Agreement”) with NCPS, pursuant to which NCPS will review the Company’s and Series’ governing documents, offering materials and regulatory filings so that the PPEX ATS may serve as an available venue for the potential resale transactions in Interests to be conducted in accordance with the process described above. The PPEX ATS provides a matching platform for the Executing Broker as a broker-dealer member of the PPEX ATS to submit bid and ask quotes to purchase or sell Interests on behalf of, and as directed by, Investors.
68
The Company paid an initial subscription fee of $12,000 in consideration for two years’ access to the PPEX ATS as an available venue for the potential resale transactions in Interests to be conducted through the Executing Broker as a broker-dealer member of the PPEX ATS. Upon the expiration of the initial two-year term, the Company had the option to extend the term of the PPEX ATS Company Agreement either on an annual basis for $10,000 per year or on a six-month basis for $6,000 per six months. The initial two-year term of the PPEX ATS Company agreement expired on June 14, 2023, and the Company elected to extend the term of the PPEX ATS Company Agreement for one year.
In addition, on October 21, 2021, Rally Holdings entered into a Software and Services License Agreement with NCIT, the parent company of NCPS. Under this agreement, the Platform’s technology is connected via an application programming interface to the PPEX ATS to facilitate the routing of information from the Platform as a user interface to the PPEX ATS as described above. Rally Holdings pays NCIT a monthly fee of $500.
The Company has also entered into an agreement with the Executing Broker (the “Secondary Brokerage Agreement”), dated June 14, 2021, separate and apart from the Brokerage Agreement. Pursuant to the Secondary Brokerage Agreement, the Executing Broker will perform certain services in support of the secondary trading of Interests on the PPEX ATS and will ultimately be responsible for the execution of secondary trades of Interests. As compensation, the Executing Broker will receive 2% of the gross proceeds received related to each transaction (1% from the buyer and 1% from the seller involved in such transaction). The Manager may, from time to time and at its sole discretion, opt to pay the compensation earned by the Executing Broker in connection with its services related to the PPEX ATS.
Rally Holdings has also entered into an additional license agreement, dated June 29, 2021 (the “Tools License Agreement”), with the Executing Broker, pursuant to which Rally Holdings has granted a license to the Executing Broker to use certain of Rally Holdings’ proprietary hosted software tools to perform services for the Rally Entities (“Services”) as called for by the Secondary Brokerage Agreement. There are no additional fees payable by either party under the Tools License Agreement in exchange for the Services. The Tools License Agreement enables the Executing Broker to use Rally Holdings’ technology (1) to obtain order information that Investors have submitted to the Platform, (2) to enable such order information to be simultaneously routed to the PPEX ATS for matching, and (3) after orders have matched, to transmit information concerning matched orders from the PPEX ATS to the Custodian, Dwolla, and the Platform for display to Investors.
The Executing Broker and the Custodian have entered into an agreement, pursuant to which the Custodian will perform the custody and clearing services in connection with transfers of Interests and the Company will pay the fees due to the Custodian under that agreement.
Facilities
The Manager and Rally Holdings are located at 46 Howard Street, Suite 215, New York, New York 10013, and Rally Holdings presently has approximately fifteen full-time employees and part-time contractors. Neither the Manager nor the Company has any employees.
The Manager operates the Company and manages the collection in a manner that prioritizes the ongoing security of all Underlying Assets. The Manager stores the Underlying Assets, along with other assets, in a professional facility and in accordance with standards commonly expected when managing Innovation Assets of equivalent value and always as recommended by the Advisory Board.
The Company has leased space in purpose built, secure, temperature-controlled storage facilities in New Jersey and Delaware for the purposes of storing the Underlying Assets in a highly controlled environments other than when some or all of the Underlying Assets are being utilized for marketing or similar purposes. The facilities used by the Company are monitored by staff approximately 40 hours per week and is under constant video surveillance. Each of the Underlying Assets in the collection are inspected and, if required, exercised appropriately on a regular basis according to the maintenance schedule defined for each Underlying Asset by the Asset Manager.
From time-to-time various Underlying Assets may be held in third-party facilities. In such cases, Rally Holdings endeavors to ensure that the Underlying Assets are stored with the appropriate care and insurance as would
69
be the case if they were held in the facility in which the Company leases space, unless otherwise specified in the description for an Underlying Asset.
Each of the Underlying Assets in the collection is inspected on a regular basis according to the inspection schedule defined, from time to time, for each Underlying Asset by Rally Holdings in conjunction with members of the Advisory Board.
Government Regulation
Federal and state laws and regulations apply to many key aspects of our business. Any actual or perceived failure to comply with these requirements may result in, among other things, revocation of required licenses or registrations, loss of approved status, regulatory or governmental investigations, administrative enforcement actions, sanctions, civil and criminal liability, private litigation, reputational harm, or constraints on our ability to continue to operate. It is also possible that current or future laws or regulations could be enacted, interpreted or applied in a manner that would prohibit, alter or impair our existing or planned lines of business, or that could require costly, time-consuming, or otherwise burdensome compliance measures. As our business expands, our compliance requirements and costs may increase and we may be subject to increased regulatory scrutiny.
Claims arising out of actual or alleged violations of law could be asserted against the Company or its affiliates by individuals or governmental authorities and could expose the Company, its affiliates or each Series to significant damages or other penalties, including revocation or suspension of the licenses necessary to conduct business and fines. See “Risk Factors—Risks Relating to the Offerings—If either the Manager or Rally Holdings is required to register as a broker-dealer, the Manager or Rally Holdings may be required to cease operations and any Series of Interests offered and sold without such proper registration may be subject to a right of rescission” and “Risk Factors—Risks Relating to the Offerings—RSE Markets recently settled an enforcement action with the Commission….”
Regulation of Intangible Assets
Regulation of intangible assets is under active consideration by the United States through various federal agencies, including the Commission, the Commodity Futures Trading Commission (“CFTC”), the Federal Trade Commission (“FTC”) and the Financial Crimes Enforcement Network of the U.S. Department of the Treasury, as well as in other countries. State government regulations may also apply. Furthermore, it is expected that regulations will increase, although we cannot anticipate how and when. As the regulatory and legal environment evolves, we may become subject to new laws and regulation by the Commission and other agencies.
In recent years, the Commission and U.S. state securities regulators have stated that certain intangible assets may be classified as securities under U.S. federal and state securities laws; however, there has not been definitive guidance on this point. A number of enforcement actions and regulatory proceedings have since been initiated against issuers of intangible assets and their developers and proponents. Several foreign governments have also issued similar warnings cautioning that intangible assets may be deemed to be securities under the laws of their jurisdictions.
Regulation of intangible asset exchanges in the future may raise transaction costs, potentially offsetting or eliminating many of the key benefits of intangible assets. Lack of international coordination raises the risk of an uneven global regulatory landscape. The development of the market for intangible assets globally is in relative limbo currently due to regulatory uncertainty.
Additionally, the rules governing the ownership and operation of domain names are controlled entirely by “ICANN” (the Internet Corporation for Assigned Names and Numbers). ICANN is a multi-stakeholder private sector, not-for-profit corporation formed in 1998 for the express purposes of overseeing a number of Internet related tasks, including management of the DNS, allocation of IP addresses, accreditation of domain name registrars and registries and the definition and coordination of policy development for all of these functions. The regulation of Internet domain names in the U.S. and in foreign countries is subject to change.
Regulation of Exchanges
70
A platform facilitating secondary trading of securities may potentially be considered an exchange which would be required to register with the Commission as a national stock exchange or qualify for an exemption from registration, such as being operated by a broker-dealer as an ATS in compliance with Regulation ATS. Section 3(a)(1) of the Exchange Act provides that an “exchange” means “any organization, association, or group of persons, whether incorporated or unincorporated, which constitutes, maintains, or provides a market place or facilities for bringing together purchasers and sellers of securities or for otherwise performing with respect to securities the functions commonly performed by a stock exchange as that term is generally understood, and includes the market place and the market facilities maintained by such exchange.” Rule 3b-16(a) under the Exchange Act further provides that a “market place or facility for bringing together purchasers and sellers of securities or for otherwise performing with respect to securities the functions commonly performed by a stock exchange” means someone who brings together the orders for securities of multiple buyers and sellers and “uses established, non-discretionary methods (whether by providing a trading facility or by setting rules) under which such orders interact with each other, and the buyers and sellers entering such orders agree to the terms of a trade.” Rule 3b-16(b)(1) provides that an entity will not be “a market place or facilities for bringing together purchasers and sellers of securities or for otherwise performing with respect to securities the functions commonly performed by a stock exchange” solely because it routes orders to a registered broker-dealer.
A system that meets the definition of an exchange and is not excluded under Rule 3b-16(b) must register as a national securities exchange or operate pursuant to an appropriate exemption. One frequently used exemption is for a system that operates as an ATS. Rule 3a1-1(a)(2) under the Exchange Act exempts from the definition of “exchange” under Section 3(a)(1) of the Exchange Act an ATS that complies with Regulation ATS. An ATS that operates pursuant to the Rule 3a1-1(a)(2) exemption and complies with Regulation ATS would not be subject to the registration requirement of Section 5 of the Exchange Act.
As has been disclosed by the Company since early 2021, RSE Markets was under investigation by the SEC Staff as to whether the Platform (see “Description of the Business – Liquidity Platform”) previously operated as a securities exchange or ATS under the Exchange Act. On July 12, 2023, the Commission agreed to an offer of settlement of the matter that had been submitted by RSE Markets to the Commission. In connection with the settlement, RSE Markets agreed to the Commission’s entry of the Order instituting cease-and-desist proceedings. As part of the settlement, RSE Markets neither admitted nor denied the Commission’s findings in the Order that, between July 1, 2018 and November 20, 2021, RSE Markets operated the Platform as a national securities exchange without registering it as such under Section 6 of the Exchange Act or operating it pursuant to an exemption from registration; however, it agreed to pay a penalty of $350,000 and refrain from committing or causing any violations or future violations of Section 5 of the Exchange Act.
In late 2021, prior to the settlement, RSE Markets restructured the Platform, which included the Company and Rally Holdings entering into certain agreements (as described elsewhere in this Offering Circular) with the Executing Broker; NCPS, a registered broker-dealer; and NCIT, to provide for secondary market trading in Interests to occur on the PPEX ATS, which is an electronic alternative trading system owned and operated by NCPS and registered with the Commission under the Exchange Act. Following the restructuring, we do not believe that the Platform functions as a national securities exchange or an ATS as currently operated. Specifically, we believe that the Platform is not an exchange because (1) it does not bring together orders for securities of multiple buyers and sellers, (2) it does not use any non-discretionary methods under which any orders to purchase or sell a security interact with each other, and (3) it merely routes orders to a broker-dealer for execution. The Platform provides the interface by which users can submit orders to a broker dealer to buy or sell Interests in secondary transactions. In accordance with Rule 3b-16(b)(1), the Platform immediately and automatically routes those orders (i) to the Executing Broker, and (ii) by virtue of the Executing Broker’s status as a member of the PPEX ATS and the Tools License Agreement between Rally Holdings and the Executing Broker, to the PPEX ATS, an ATS registered with the Commission and owned and operated by NCPS, a registered broker-dealer. For clarity, because the Executing Broker is (i) a registered broker-dealer and a member of the PPEX ATS and (ii) licensed to use the Platform to access and transmit order information entered onto the Platform by Investors, such order information is automatically routed from the Platform to both the Executing Broker and the PPEX ATS simultaneously. The PPEX ATS then matches isolated trades between individual buyers and sellers who have confirmed their intent to complete the trade. Matching occurs pursuant to the rules established by the PPEX ATS. The Platform’s role in the secondary trading process is limited to (1) receiving orders from Investors, who enter their order on the Platform using either the Rally website or app,
71
(2) making those orders simultaneously accessible to the Executing Broker and the PPEX ATS pursuant to the Tools License Agreement and the Executing Broker’s status as registered broker-dealer and a member of the PPEX ATS, (3) displaying and confirming information regarding the execution and settlement of secondary market transactions based on information received from NCPS (via the Executing Broker), and (4) providing an interface by which Investors can provide information in order to open brokerage accounts with the Executing Broker and the Custodian and a cash account with Dwolla.
In this way, the Platform is simply the user interface that Investors engage with when placing orders for secondary trading of Interests. The decision whether to engage in secondary market trading is left solely to the individual Investors, and neither the Company, its affiliates, nor any of the third-party service providers involved in the secondary trading process provide Investors any direction or recommendation as to the purchase or sale of any Interests in secondary market transactions. In reliance upon Rule 3b-16(a) and Rule 3b-16(b)(1), the Company believes it is not required to register the Platform as an exchange or comply with Regulation ATS as an ATS. Nevertheless, federal regulation of securities exchanges and ATSs involves a set of complex statutes and regulations that are subject to change and evolving and differing interpretation. It is possible that contrasting understandings of current or future rules could result in the Commission determining that the Platform is functioning as a securities exchange or ATS or is part of an unregistered exchange mechanism, in which case we would then be required to register the Platform as a securities exchange or qualify and register as an ATS, either of which could cause us to limit, modify, or discontinue the Platform.
All secondary transactions in Series Interests for which the Platform serves as the user interface are effectuated on the PPEX ATS. See “Description of the Business – Liquidity Platform” for more information.
Privacy and Protection of Investor Data
Aspects of our operations or business are subject to privacy and data protection regulation in the United States and elsewhere. Accordingly, we publish our privacy policies and terms of service, which describe our practices concerning the use, transmission and disclosure of information. As our business continues to expand in the United States and beyond, and as laws and regulations continue to be passed and their interpretations continue to evolve in numerous jurisdictions, additional laws and regulations may become relevant to us. Regulatory authorities around the world are considering numerous legislative and regulatory proposals concerning privacy and data protection. In addition, the interpretation and application of these privacy and data protection laws in the United States and elsewhere are often uncertain and in a state of flux.
Growing public concern about privacy and the use of personal information may subject us to increased regulatory scrutiny. The FTC has, over the last few years, begun investigating companies that have used personally identifiable information in a deceptive or unfair manner or in violation of a posted privacy policy. If we are accused of violating the terms of our privacy policy or implementing unfair privacy practices, we may be forced to expend significant financial and managerial resources to defend against an FTC action. On May 25, 2018, the European Union implemented the General Data Protection Regulation (the “GDPR”), a new privacy regulation that imposes new regulatory scrutiny on our business with customers in the European Economic Area, with possible financial consequences for noncompliance. If we are accused of violating the data protection and privacy rights of European Union citizens, we may be forced to expend significant financial and managerial resources to defend against a GDPR enforcement action by a European Union data protection authority or a European Union citizen. On January 1, 2020, the California Consumer Privacy Act (the “CCPA”) became effective. Similar to the GDPR, the CCPA imposes new regulatory scrutiny on our processing of the personal data of our customers in California, with possible financial consequences for noncompliance. If we are accused of violating the CCPA, we may be forced to expend significant financial and managerial resources to defend against an enforcement action by the California Attorney General or, in the event of a data breach, a lawsuit by customers located in California. The CCPA became effective in January 2023. Comprehensive state privacy laws also took effect in Colorado and Virginia in 2023. Complying with these and other existing, emerging and changing privacy requirements could cause the Company to incur substantial costs or require it to change its business practices and policies. Non-compliance could result in monetary penalties or significant legal liability.
72
Consumer Protection Regulation
The Consumer Financial Protection Bureau and other federal and state regulatory agencies, including the FTC, broadly regulate financial products, enforce consumer protection laws applicable to credit, deposit and payments, and other similar products, and prohibit unfair and deceptive practices. Such agencies have broad consumer protection mandates, and they promulgate, interpret and enforce laws, rules and regulations, including with respect to unfair, deceptive and abusive acts and practices that may impact or apply to our business. For example, under federal and state financial privacy laws and regulations, we must provide notice to Investors of our policies on sharing non-public information with third parties, among other requirements. In addition, under the Electronic Fund Transfer Act, we may be required to disclose the terms of our electronic fund transfer services to consumers prior to their use of the service, among other requirements.
Investment Company Act of 1940 Considerations
We intend to conduct our operations so that we do not fall within, or are excluded from, the definition of an “investment company” under the Investment Company Act of 1940 (the “Investment Company Act”). Under Section 3(a)(1)(A) of the Investment Company Act, a company is deemed to be an “investment company” if it is, or holds itself out as being, engaged primarily, or proposes to engage primarily, in the business of investing, reinvesting or trading in securities. We believe that we will not be considered an investment company under Section 3(a)(1)(A) of the Investment Company Act because we will not engage primarily or hold ourselves out as being engaged primarily in the business of investing, reinvesting or trading in securities. We anticipate that the Underlying Assets for each Series will not be securities.
Under Section 3(a)(1)(C) of the Investment Company Act, a company is deemed to be an “investment company” if it is engaged, or proposes to engage, in the business of investing, reinvesting, owning, holding or trading in securities and owns or proposes to acquire “investment securities” having a value exceeding 40% of the value of the company’s total assets (exclusive of U.S. government securities and cash items) on an unconsolidated basis, which we refer to as the “40% test.” We intend to monitor our holdings and conduct operations so that on an unconsolidated basis we will comply with the 40% test with respect to each Series.
If we become obligated to register the Company as an investment company, we would have to comply with a variety of substantive requirements under the Investment Company Act imposing, among other things:
·limitations on capital structure;
·restrictions on specified investments;
·prohibitions on transactions with affiliates; and
·compliance with reporting, record keeping, voting, proxy disclosure and other rules and regulations that would significantly change our operations.
If we were required to register the Company as an investment company but failed to do so, we would be prohibited from engaging in our business, and criminal and civil actions could be brought against us. In addition, our contracts would be unenforceable unless a court required enforcement, and a court could appoint a receiver to take control of us and liquidate our business, all of which would have a material adverse effect on us.
Legal Proceedings
None of the Rally Entities or any of the directors or executive officers of RSE Markets is, as of the date of this Offering Circular, subject to any material legal proceedings.
As has been disclosed by the Company since early 2021, RSE Markets was under investigation by the SEC Staff as to whether the Platform previously operated as a securities exchange or ATS under the Exchange Act. On July 12, 2023, the Commission agreed to an offer of settlement of the matter that had been submitted by RSE Markets to the Commission. See “Risk Factors—Risks Relating to the Offerings—RSE Markets recently settled an enforcement action with the Commission….” for a description of the settlement, which is incorporated herein by reference.
73
Allocation of Expenses
To the extent relevant, Offering Expenses, Acquisition Expenses, Operating Expenses, revenue generated from Underlying Assets and any indemnification payments made by the Company will be allocated amongst the various Series in accordance with the Manager’s allocation policy, a copy of which is available to Investors upon written request to the Manager. The allocation policy requires the Manager to allocate items that are allocable to a specific Series to be borne by, or distributed to (as applicable), the applicable Series of Interests. If, however, an item is not allocable to a specific Series but to the Company in general, it will be allocated pro rata based on the value of Underlying Assets (e.g., in respect of fleet level insurance) or the number of Underlying Assets, as reasonably determined by the Manager or as otherwise set forth in the allocation policy. The table below sets forth a summary of the allocation policy, which is subject to the Manager’s discretion:
74
Notwithstanding the foregoing, the Manager may revise and update the allocation policy from time to time in its reasonable discretion without further notice to the Investors. Under the terms of the allocation policy, the Manager may elect not to allocate certain expenses in the manner described above if it determines such allocation not to be in the best interests of the Company.
(1) Each of the directors of RSE Markets was elected as a director pursuant to a voting agreement among RSE Markets and certain stockholders of RSE Markets.
The following is a brief summary of the background of each executive officer and director of RSE Markets:
Chris is a serial entrepreneur who has developed several online platform businesses. In 2013, Chris co-founded Network of One, a data-driven content investment platform focused on the YouTube market where he worked until 2016. Prior to Network of One, Chris co-founded Healthguru, a leading health information video platform on the web (acquired by Propel Media, Inc., OTC BB: PROM) where he worked from 2005 to 2013.
Chris began his career working in venture capital at Village Ventures where he invested in early-stage companies across the online media, telecommunications, software, medical devices, consumer products and e-commerce industries. Chris worked at Village Ventures from 2002 to 2005.
From 2004 to 2005, Chris also worked as an analyst directly for the management team of Everyday Health (NYSE: EVDY) during its growth phase.
Rob is a designer and creative thinker who has led the development of multiple award-winning technology platforms in both the software and hardware arenas. For the past decade, he has specialized in the product design space having created authoring components, architected the front-end of distribution platforms, and designed interactive content platforms for both consumers and enterprises. Immediately prior to joining Rally Holdings, he led the UX & UI effort at computer vision and robotics startup KeyMe, building interactive products from the ground up and deploying both mobile and kiosk-based software nationwide. Rob worked at KeyMe from 2014 to 2016.
His previous roles include internal software design for Ares Management (2013 to 2014), and Creative Director at ScrollMotion (2010 to 2013), where he led a team of content creators and product developers to release a fully integrated authoring tool and over 300 custom enterprise apps for Fortune 50 and 100 clientele across 12 countries including Hearst, Roche, J&J, Genentech and the NFL.
Rob received his degree in User-Centered Design with a peripheral curriculum in User Psychology from the University of Philadelphia.
Max has spent nine years in the finance industry, working in the investment banking divisions of Lehman Brothers from 2007 to 2008 and Barclays from 2008 to 2016. At both firms he was a member of the healthcare investment banking group, most recently as Director focused on M&A and financing transactions in the Healthcare IT and Health Insurance spaces. Max has supported the execution of over $100 billion of financing and M&A
Prior to his career in investment banking, Max worked in management consulting at A.T. Kearney from 2002 to 2005, where he focused on engagements in the automotive, IT and healthcare spaces. During this time, he worked on asset sourcing, logistics and process optimization projects.
Max graduated from Williams College with a Bachelor of Arts in Computer Science and Economics and received a Master of Business Administration, beta gamma sigma, from NYU’s Stern School of Business.
Joshua is a seasoned operator and entrepreneur with in excess of 15 years of experience successfully building companies – as a founder, investor, board member and CEO.
Joshua co-founded Healthguru in 2006 and led the company from idea to exit in 2013. When Healthguru was acquired by Propel Media, Inc. (OTC BB: PROM), a publicly traded video syndication company, in 2013, Healthguru was a leading provider of health video on the web (as of 2013 it had 917 million streams and a 49.1% market share in health videos).
After the acquisition, Joshua joined Propel Media as President and completed a transformative transaction that quadrupled annual revenue and dramatically improved profitability. When the deal – a reverse merger – was completed, it resulted in an entity with over $90 million in revenue and approximately $30 million in EBITDA.
In the past several years, Joshua has taken an active role with more than a dozen companies (with approximately $3 million to $47 million in revenue) – both in operating roles (Interim President, Chief Strategy Officer) and in an advisory capacity (to support a capital raise or lead an M&A transaction).
Earlier in his career, Joshua was a venture capitalist at BEV Capital, where he was part of teams that invested nearly $50 million in early-stage consumer businesses (including Alloy.com and Classmates Online) and held a number of other senior operating roles in finance, marketing and business development.
Joshua has a Bachelor of Science in Economics from the Wharton School (summa cum laude) and a Master of Business Administration from Columbia University (beta gamma sigma).
Gustave Macheras, Director
Gustave is an entrepreneur and investor with over 10 years of experience in venture capital, private equity, real estate and M&A. He has operated businesses across the automotive and healthcare industries and supported several start-ups as an advisor.
His previous roles include Healthcare Investment Banking Associate at Credit Suisse (2016 to 2018) and Healthcare M&A Senior Associate at Edgemont Partners (2018 to 2019), and Chief Operating Officer at Moonloot Ventures from 2019 to present.
Gustave has a Bachelor of Science in Engineering Sciences from Yale University and a Master of Business Administration from Columbia Business School.
Asset Manager
Each Series has an Asset Manager that is responsible for the asset management services detailed below under “Responsibilities of the Asset Manager.” Except as otherwise noted, Rally Holdings is the Asset Manager of each of
80
our Series. For each Series for which Rally Holdings is not the Asset Manager, the Master Series Table on Appendix A identifies the Asset Manager.
Rally Holdings also serves as the asset manager for series of RSE Collection, LLC, another series limited liability company with similar businesses in the memorabilia and collectible asset class. RSE Collection, LLC commenced principal operations in 2017. While Rally Holdings thus has some similar management experience, its experience is limited, including with respect to selecting and managing assets in the Asset Class.
DomainX serves as the Asset Manager for two Series: Series #URL5 and Series #URL6. DomainX is the parent company of some of the domain name industry’s most famous and successful brands such as MediaOptions, DomainSherpa, DNX and ABCDEFG. DomainX, which was founded in 2020, is experienced in matters relating to domain name brokerage, sales, investment, monetization, and management. Each Series for which DomainX is the Asset Manager has entered, or will enter, into an Asset Management Agreement with DomainX in the form substantially set forth on Exhibit 6.14 hereto.
The founder and chief executive officer of DomainX is Andrew Rosener. Since 2008, Andrew has been involved in over $600 million dollars in domain sales and has played a pivotal role in numerous high-profile domain name transactions, including X.com to Elon Musk, Zoom.com to ZOOM, and Prime.com and Podcast.com to Amazon, as well as thousands of others. Andrew is also the owner of DomainSherpa.com, one of the industry’s leading educational podcasts, which seeks to educate business leaders and investors about the virtues and principles of domain names.
Responsibilities of the Asset Manager
The responsibilities of the Asset Manager for a Series include:
Asset Sourcing and Disposition Services:
-Manage the Company’s asset sourcing activities including creating the asset acquisition policy, organizing and evaluating due diligence for specific asset acquisition opportunities, verifying authenticity and condition of specific assets, and structuring partnerships with collectors, brokers and dealers who may provide opportunities to source quality assets;
-Negotiate and structure the terms and conditions of acquisitions of or consignment agreements, purchase option agreements or purchase agreements for Underlying Assets with Asset Sellers;
- Evaluate any potential asset takeover offers from third parties, which may result in asset dispositions, sales or other liquidity transactions;
-Structure and negotiate the terms and conditions of transactions pursuant to which Underlying Assets may be sold or otherwise disposed, subject to the Manager’s approval.
Asset Management and Maintenance Services with Respect to the Underlying Assets:
-Develop a maintenance schedule and standards of care in consultation with the Advisory Board and oversee compliance with such maintenance schedule and standards of care;
-Purchase and maintain insurance coverage for Underlying Assets;
-Engage third-party independent contractors for the care, custody, maintenance and management of the Underlying Assets;
-Deliver invoices to the Managing Member for the payment of all fees and expenses incurred in connection with the maintenance and operation of Underlying Assets and ensure delivery of payments to third parties for any such services; and
-Generally, perform any other act necessary to carry out all asset management and maintenance obligations.
Specifically for Series #URL5 and Series #URL6, pursuant to the Asset Management Agreement, the responsibilities of DomainX, in its capacity as Asset Manager, will include:
-Domain name custody – securely holding a domain name through a registrar (e.g., GoDaddy)
81
oIncluding managing and coordinating the payment of any fees such as renewal fees related to the custody of the Underlying Assets
-Domain Settings and Direction (i.e., Managing DNS Setting and MX Records)
oManaging domain name e-mail settings and ensuring the URLs point to the appropriate websites
-Underlying Asset Monetization including, among others:
oNegotiating with domain parking providers such as Bodis, Sedo or GoDaddy, as appropriate
oUnderlying Asset marketing, such as through affiliate marketing services such as Commission Junction
-DomainX must pre-approve any sale, transfer or conveyance of an Underlying Asset of these Series.
oIf DomainX were to withhold its approval of any such sale, transfer or conveyance, then the Series would not be permitted under the applicable Asset Management Agreement to sell its Underlying Asset even if the Company or the Manager believes such a sale to be advisable. If, for instance, the Series sold its Underlying Asset despite not receiving DomainX’s approval, such sale may constitute a breach of the Asset Management Agreement between such Series and DomainX.
Advisory Board
Responsibilities of the Advisory Board
The Advisory Board supports the Company, the Asset Manager, the Manager and RSE Markets and consists of members of our expert network and additional advisors to the Manager. The Advisory Board reviews the Company’s relationship with, and the performance of, the Manager, and generally approves the terms of any material or related-party transactions. In addition, the Advisory Board assists with, and makes recommendations with respect to, the following:
(1)Approving, permitting deviations from, making changes to, and annually reviewing the asset acquisition policy;
(2)Evaluating all asset acquisitions;
(3)Evaluating any third party offers for asset acquisitions and approving asset dispositions that are in the best interest of the Company and the Interest Holders;
(4)Providing guidance with respect to the appropriate levels of annual collection level insurance costs and maintenance costs specific to each individual asset;
(5)Reviewing material conflicts of interest that arise, or are reasonably likely to arise with the Managing Member, on the one hand, and the Company, a Series or the Interest Holders, on the other hand, or the Company or a Series, on the one hand, and another Series, on the other hand;
(6)Approving any material transaction between the Company or a Series, on the one hand, and the Manager or any of its affiliates, another Series or an Interest Holder, on the other hand, other than for the purchase of Interests;
(7)Reviewing the total fees, expenses, assets, revenues, and availability of funds for distributions to Interest Holders at least annually or with sufficient frequency to determine that the expenses incurred are reasonable in light of the investment performance of the assets, and that funds available for distributions to Interest Holders are in accordance with our policies; and
(8)Approving any service providers appointed by the Manager or the Asset Manager in respect of the Underlying Assets.
The resolution of any conflict of interest approved by the Advisory Board shall be conclusively deemed fair and reasonable to the Company and the Members and not a breach of any duty at law, in equity or otherwise. The members of the Advisory Board are not managers or officers of the Company, the Manager, the Asset Manager or any Series and do not have fiduciary or other duties to the Interest Holders of any Series.
Compensation of the Advisory Board
Rally Holdings will compensate members of the Advisory Board or their nominees (as so directed by an Advisory Board member) for their service. As such, their costs will not be borne by any given Series of Interests,
82
although members of the Advisory Board may be reimbursed by a Series for out-of-pocket expenses incurred by such Advisory Board member in connection with a Series of Interests (e.g., travel related to evaluation of an asset).
Members of the Advisory Board
We plan to continue to build the Advisory Board over time and are in advanced discussions with various experts in the Asset Class. We have already established an informal network of expert advisors who support the Company in asset acquisitions, valuations and negotiations. To date, three individuals have formally joined the Manager’s Advisory Board:
Dan Gallagher
Dan has extensive public and private sector experience in regulatory matters, financial markets, and corporate legal affairs and governance.
The Manager will receive Sourcing Fees for each subsequent Offering for Series of Interests in the Company that closes as detailed in the “Use of Proceeds” in Appendix B for each respective Series. Additional details on Sourcing Fees received by the Manager can be found in the “Use of Proceeds” in Appendix B for each respective Series.
In addition, should a Series’ revenue exceed its ongoing Operating Expenses and various other potential financial obligations of the Series, the Asset Manager may receive a Management Fee as described in “Description of the Business – Management Fee.”
(1) Certain Interest Holders (referred to as “Vote Limited Record Holders”) have irrevocably elected to limit their voting rights in accordance with the provisions of the Operating Agreement. The percentages in this column do not give effect to such elections, but the details of any applicable Vote Limit are described in footnotes to the applicable Series’ row in the “Percent of Class” column.
(2) Stone Ridge Asset Management’s address is 510 Madison Ave, New York, NY 10022.
(3) Stone Ridge Asset Management has voluntarily made an irrevocable election to subject their holdings to a Vote Limit of 4.99% of the outstanding Interests in Series #MANTLE319.
The following is a summary of the principal terms of, and is qualified by reference to the Operating Agreement, attached as Exhibit 2.2 to the Offering Statement of which this Offering Circular forms a part, and the Subscription Agreement, the form of which is attached as Exhibit 4.1 to the Offering Statement of which this Offering Circular forms a part, relating to the purchase of the applicable Series of Interests. This summary is qualified in its entirety by reference to the detailed provisions of those agreements, which should be reviewed in their entirety by each prospective Investor. In the event that the provisions of this summary differ from the provisions of the Operating Agreement or the Subscription Agreement (as applicable), the provisions of the Operating Agreement or the Subscription Agreement (as applicable) shall apply. Capitalized terms used in this summary that are not defined herein shall have the meanings ascribed thereto in the Operating Agreement.
Description of the Interests
The Company is a series limited liability company formed pursuant to Section 18-215 of the LLC Act. The purchase of Interests in a Series of the Company is an investment only in that particular Series and not an investment in the Company as a whole. In accordance with the LLC Act, each Series of Interests is, and any other Series of Interests if issued in the future will be, a separate series of limited liability company Interests of the Company and not in a separate legal entity. The Company has not issued, and does not intend to issue, any class of any Series of Interests entitled to any preemptive, preferential or other rights that are not otherwise available to the Interest Holders purchasing Interests in connection with any Offering.
Title to the Underlying Assets will be held by, or for the benefit of, the applicable Series of Interests. We intend that each Series of Interests will own its own Underlying Asset. We do not anticipate that any of the Series will acquire any Underlying Assets other than the respective Underlying Assets. A new Series of Interests will be issued for future Underlying Assets. An Investor who invests in an Offering will not have any indirect interest in any other Underlying Assets unless the Investor also participates in a separate Offering associated with that other Underlying Asset.
Section 18-215(b) of the LLC Act provides that, if certain conditions are met (including that certain provisions are in the formation and governing documents of the series limited liability company, and upon the Closing of an Offering for a Series of Interests, the records maintained for any such Series account for the assets associated with such Series separately from the assets of the limited liability company, or any other Series), then the debts, liabilities, obligations and expenses incurred, contracted for or otherwise existing with respect to a particular Series shall be enforceable only against the assets of such Series and not against the assets of the limited liability company generally or any other Series. Accordingly, the Company expects the Manager to maintain separate, distinct records for each Series and its associated assets and liabilities. As such, the assets of a Series include only the Underlying Asset associated with that Series and other related assets (e.g., cash reserves). At the time of this filing, the Series highlighted in gray in the Master Series Table in Appendix A have not commenced operations, are not capitalized and have no assets or liabilities and no Series will commence operations, be capitalized or have assets and liabilities until such time as a Closing related to such Series has occurred. As noted in the “Risk Factors” section, the limitations on inter-series liability provided by Section 18-215(b) have never been tested in federal bankruptcy courts and it is possible that a bankruptcy court could determine that the assets of one Series of Interests should be applied to meet the liabilities of the other Series of Interests or the liabilities of the Company generally where the assets of such other Series of Interests or of the Company generally are insufficient to meet the Company’s liabilities.
Section 18-215(c) of the LLC Act provides that a Series of Interests established in accordance with Section 18-215(b) may carry on any lawful business, purpose or activity, other than the business of banking, and has the power and capacity to, in its own name, contract, hold title to assets (including real, personal and intangible property), grant liens and security interests, and sue and be sued. The Company intends for each Series of Interests to conduct its business and enter into contracts in its own name to the extent such activities are undertaken with respect to a particular Series and title to the relevant Underlying Asset will be held by, or for the benefit of, the relevant Series.
All of the Series of Interests offered by this Offering Circular will be duly authorized and validly issued. Upon payment in full of the consideration payable with respect to the Series of Interests, as determined by the Manager, the Interest Holders of such Series of Interests will not be liable to the Company to make any additional
88
capital contributions with respect to such Series of Interests (except for the return of distributions under certain circumstances as required by Sections 18-215, 18-607 and 18-804 of the LLC Act). Holders of Series of Interests have no conversion, exchange, sinking fund, redemption or appraisal rights, no pre-emptive rights to subscribe for any Interests and no preferential rights to distributions.
In general, the Interest Holders of a particular Series of Interests (which may include the Manager, its affiliates or the Asset Sellers) will participate exclusively in at least 50% of the available Free Cash Flow derived from the Underlying Asset of such Series less expenses (as described in “Distribution Rights” below). The Manager, an affiliate of the Company, will own a minimum of one (1) Interest in each Series acquired for the same price as all other Investors. The Manager has the authority under the Operating Agreement to cause the Company to issue Interests to Investors as well as to other Persons for such cost (or no cost) and on such terms as the Manager may determine, subject to the terms of the Series Designation applicable to such Series of Interests.
The Series described in the Master Series Table in Appendix A will use the proceeds of the respective Offerings to repay any loans taken out or non-interest-bearing payments made by the Manager to acquire their respective Underlying Asset and pay the Asset Sellers pursuant to the respective asset purchase agreements, as well as pay certain fees and expenses related to the acquisition and each Offering (please see the “Use of Proceeds” in Appendix B for each respective Series for further details). An Investor in an Offering will acquire an ownership Interest in the Series of Interests related to that Offering and not, for the avoidance of doubt, in (i) the Company, (ii) any other Series of Interests, (iii) the Manager, (iv) the Asset Manager, (v) the Platform or (vi) the Underlying Asset associated with the Series or any Underlying Asset owned by any other Series of Interests.
Although our Interests will not immediately be listed on a stock exchange and a liquid market in the Interests cannot be guaranteed, through the PPEX ATS (see “Description of the Business – Liquidity Platform” for additional information) or otherwise, we plan to create, with the support of registered broker-dealers, mechanisms to provide Investors with the ability to resell Interests, or partner with an existing platform to allow for the resale of the Interests, although the creation of such a market, either through the PPEX ATS or otherwise, or the timing of such creation cannot be guaranteed (please review additional risks related to liquidity in the “Risk Factors” section and the “Description of the Business – Liquidity Platform” section for additional information).
Further Issuance of Interests
Only the Series Interests that are not annotated as closed in the Master Series Table in Appendix A are being offered and sold pursuant to this Offering Circular. The Operating Agreement provides that the Company may issue Interests of each Series of Interests to no more than 2,000 “qualified purchasers” (no more than 500 of which may be non-“accredited investors”). The Manager, in its sole discretion, has the option to issue additional Interests (in addition to those issued in connection with any Offering) on the same terms as the applicable Series of Interests is being offered hereunder as may be required from time to time in order to pay any Operating Expenses related to the applicable Underlying Asset. For the avoidance of doubt, in the event of any follow-on offering of additional Interests in a Series, the Manager will typically not be entitled to any additional Sourcing Fees unless otherwise indicated in the Use of Proceeds section for the initial Offering for such Series.
Distribution Rights
The Manager has sole discretion in determining what distributions of Free Cash Flow, if any, are made to Interest Holders except as otherwise limited by law or the Operating Agreement. The Company expects the Manager to distribute any Free Cash Flow on a semi-annual basis as set forth below. At this time, the Manager currently intends to retain Free Cash Flow, if any, to fund the future Operating Expenses for each Series. Future decisions concerning the payment of distributions to Interest Holders and the Management Fee from Free Cash Flow will depend upon our results of operations, financial condition and capital expenditure plans, as well as such other factors that our Manager, in its sole discretion, may consider relevant. Accordingly, the Manager does not anticipate paying distributions or a Management Fee from any available Free Cash Flow for the foreseeable future. However, the Manager may change the timing of potential distributions in its sole discretion.
Any Free Cash Flow generated by a Series of Interests from the utilization of the associated Underlying Asset shall be applied, with respect to such Series, in the following order of priority:
89
(i)first, to repay any amounts outstanding under Operating Expenses Reimbursement Obligations for that Series, plus accrued interest;
(ii)second, to create such reserves for that Series as the Manager deems necessary, in its sole discretion, to meet future Operating Expenses of that Series;
(iii)thereafter, to make distributions, no less than 50% of which (net of corporate income taxes, if any, applicable to that Series) shall be distributed to the Interest Holders of that Series (which may include the Asset Seller of its Underlying Asset or the Manager or any of its affiliates, based on each Interest Holder’s pro rata share of Interests of that Series), and no more than 50% of which shall be distributed to the Asset Manager in payment of the Management Fee for that Series.
No Series will distribute an Underlying Asset in kind to its Interest Holders.
The LLC Act (Section 18-607) provides that a member who receives a distribution with respect to a Series and knew at the time of the distribution that the distribution was in violation of the LLC Act shall be liable to the Series for the amount of the distribution for three years. Under the LLC Act, a series limited liability company may not make a distribution with respect to a Series to a member if, after the distribution, all liabilities of such Series, other than liabilities to members on account of their limited liability company interests with respect to such Series and liabilities for which the recourse of creditors is limited to specific property of such Series, would exceed the fair value of the assets of such Series. For the purpose of determining the fair value of the assets of the Series, the LLC Act provides that the fair value of property of the Series subject to liability for which recourse of creditors is limited shall be included in the assets of such Series only to the extent that the fair value of that property exceeds the nonrecourse liability. Under the LLC Act, an assignee who becomes a substituted member of a company is liable for the obligations of his or her assignor to make contributions to the company, except the assignee is not obligated for liabilities unknown to it at the time the assignee became a member and that could not be ascertained from the Operating Agreement.
Redemption Provisions
The Interests are not redeemable.
Registration Rights
There are no registration rights in respect of the Interests.
Voting Rights
The Manager is not required to hold an annual meeting of Interest Holders. The Operating Agreement provides that meetings of Interest Holders may be called by the Manager and a designee of the Manager shall act as chairman at such meetings. The Investor does not have any voting rights as an Interest Holder in the Company or a Series except with respect to:
(i)the removal of the Manager;
(ii)the dissolution of the Company upon the for-cause removal of the Manager; and
(iii)an amendment to the Operating Agreement that would:
a.enlarge the obligations of, or adversely effect, an Interest Holder in any material respect;
b.reduce the voting percentage required for any action to be taken by the holders of Interests in the Company under the Operating Agreement;
c.change the situations in which the Company and any Series can be dissolved or terminated;
d.change the term of the Company (other than the circumstances provided in the Operating Agreement); or
e.give any person the right to dissolve the Company.
When entitled to vote on a matter, each Interest Holder will be entitled to one vote per Interest held by it on all matters submitted to a vote of the Interest Holders of an applicable Series or of the Interest Holders of all Series of the Company, as applicable. The removal of the Manager as Manager of the Company and all Series of Interests must be approved by two-thirds of the votes that may be cast by all Interest Holders across all Series of the Company. All
90
other matters to be voted on by the Interest Holders must be approved by a majority of the votes cast by all Interest Holders in any Series of the Company present in person or represented by proxy.
The consent of the holders of a majority of the Interests of a Series is required for any amendment to the Operating Agreement that would adversely change the rights of such Series of Interests, result in mergers, consolidations or conversions of such Series of Interests and for any other matter as the Manager, in its sole discretion, determines will require the approval of the holders of the Interests voting as a separate class.
The Manager or its affiliates (if they hold Series of Interests) may not vote as an Interest Holder in respect of any matter put to the Interest Holders. However, the submission of any action of the Company or a Series for a vote of the Interest Holders shall first be approved by the Manager and no amendment to the Operating Agreement may be made without the prior approval of the Manager that would decrease the rights of the Manager or increase the obligations of the Manager thereunder.
The Manager has broad authority to take action with respect to the Company and any Series. See “Management” for more information. Except as set forth above, the Manager may amend the Operating Agreement without the approval of the Interest Holders to, among other things, reflect the following:
·the merger of the Company or the conveyance of all of the assets to a newly-formed entity if the sole purpose of that merger or conveyance is to effect a mere change in the legal form into another limited liability entity;
·a change that the Manager determines to be necessary or appropriate to implement any state or federal statute, rule, guidance or opinion;
·a change that the Manager determines to be necessary, desirable or appropriate to facilitate the trading of Interests;
·a change that the Manager determines to be necessary or appropriate for the Company to qualify as a limited liability company under the laws of any state or to ensure that each Series that has elected to be taxed as a corporation for U.S. federal income tax purposes will continue to qualify for treatment as such;
·an amendment that the Manager determines, based upon the advice of counsel, to be necessary or appropriate to prevent the Company, the Manager, or the officers, agents or trustees from in any manner being subjected to the provisions of the Investment Company Act, the Investment Advisers Act or “plan asset” regulations adopted under ERISA, whether or not substantially similar to plan asset regulations currently applied or proposed;
·any amendment that the Manager determines to be necessary or appropriate for the authorization, establishment, creation or issuance of any additional Series;
·an amendment effected, necessitated or contemplated by a merger agreement that has been approved under the terms of the Operating Agreement;
·any amendment that the Manager determines to be necessary or appropriate for the formation by the Company of, or its investment in, any corporation, partnership or other entity, as otherwise permitted by the Operating Agreement;
·a change in the fiscal year or taxable year and related changes; and
·any other amendments which the Manager deems necessary or appropriate to enable the Manager to exercise its authority under the Agreement.
In each case, the Manager may make such amendments to the Operating Agreement provided the Manager determines that those amendments:
·do not adversely affect the Interest Holders (including any particular Series of Interests as compared to other Series of Interests) in any material respect;
·are necessary or appropriate to satisfy any requirements, conditions or guidelines contained in any opinion, directive, order, ruling or regulation of any federal or state agency or judicial authority or contained in any federal or state statute;
·are necessary or appropriate to facilitate the trading of Interests, either through the PPEX ATS (see “Description of the Business – Liquidity Platform” for additional information) or otherwise, or to comply with any rule, regulation, guideline or requirement of any securities exchange on which the Interests may be listed for trading, compliance with any of which the Manager deems to be in the best interests of the Company
91
and the Interest Holders;
·are necessary or appropriate for any action taken by the Manager relating to splits or combinations of Interests under the provisions of the Operating Agreement; or
·are required to effect the intent expressed in this Offering Circular or the intent of the provisions of the Operating Agreement or are otherwise contemplated by the Operating Agreement.
Furthermore, the Manager retains sole discretion to create and set the terms of any new Series and will have the sole power to acquire, manage and dispose of Underlying Asset of each Series.
Under the terms of the Operating Agreement, an Interest Holder may elect to voluntarily and irrevocably limit or eliminate its voting rights with respect to a Series such that it may not vote more Interests than its Vote Limit, as set forth in the election to become a Vote Limited Record Holder attached as Exhibit A to the Operating Agreement. In the event an Interest Holder irrevocably limits or eliminates its voting rights, all of the Series Interests beneficially owned by such Vote Limited Record Holder in excess of the applicable Voting Limit will no longer have any voting rights as long as such Series Interests are held by the Vote Limited Record Holder or an affiliate thereof.
The Transfer Agent keeps records concerning the number of Vote Limited Record Holders of each Series and the Vote Limit applicable thereto. The Transfer Agent also keeps records of the transfers of Interests, and the Manager will analyze any transfer by a Vote Limited Record Holder to determine whether the transferee is an affiliate of the transferring Vote Limited Record Holder. The amount of Interests subject to Vote Limits is indicated on the second table in the Principal Interest Holders section of this Offering Circular and updated on a semiannual basis. Interest Holders may also contact the Company at hello@rally.com to request information concerning Vote Limited Record Holders of a Series, in which case the Manager will evaluate the request and, to the extent consistent with applicable law, provide responsive information to the requesting Interest Holder.
Liquidation Rights
The Operating Agreement provides that the Company shall remain in existence until the earlier of the following: (i) the election of the Manager to dissolve it; (ii) the sale, exchange or other disposition of substantially all of the assets of the Company; (iii) the entry of a decree of judicial dissolution of the Company; (iv) at any time that the Company no longer has any members, unless the business is continued in accordance with the LLC Act; and (v) a vote by a majority of all Interest Holders of the Company following the for-cause removal of the Manager. Under no circumstances may the Company be wound up in accordance with Section 18-801(a)(3) of the LLC Act (i.e., the vote of members who hold more than two-thirds of the Interests in the profits of the Company).
A Series shall remain in existence until the earlier of the following: (i) the dissolution of the Company; (ii) the election of the Manager to dissolve such Series; (iii) the sale, exchange or other disposition of substantially all of the assets of the Series; or (iv) at any time that the Series no longer has any Investors, unless the business is continued in accordance with the LLC Act. Under no circumstances may a Series of Interests be wound up in accordance with Section 18-801(a)(3) of the LLC Act (i.e., the vote of members holding more than two-thirds of the Interests in the profits of the Series).
Upon the occurrence of any such event, the Manager (or a liquidator selected by the Manager) is charged with winding up the affairs of the Series or the Company as a whole, as applicable, and liquidating its assets. Upon the liquidation of a Series or the Company as a whole, as applicable, the Underlying Assets will be liquidated and any after-tax proceeds distributed: (i) first, to any third party creditors, (ii) second, to any creditors that are the Manager or its affiliates (e.g., payment of any outstanding Operating Expenses Reimbursement Obligation), and (iii) thereafter, to the Interest Holders of the relevant Series, allocated pro rata based on the number of Interests held by each Interest Holder (which may include the Manager, any of its affiliates and the Asset Seller and which distribution within a Series will be made consistent with any preferences which exist within such Series).
Transfer Restrictions
The Interests are subject to restrictions on transferability. An Interest Holder may not transfer, assign or pledge its Interests without the consent of the Manager. The Manager may withhold consent in its sole discretion,
92
including (without limitation) when the Manager determines that such transfer, assignment or pledge would result in (a) there being more than 2,000 beneficial owners of the Series or more than 500 beneficial owners of the Series that are not “accredited investors,” (b) the assets of the Series being deemed “plan assets” for purposes of ERISA, (c) such Interest Holder holding in excess of 19.9% of the Series, (d) a change of U.S. federal income tax treatment of the Company or the Series, or (e) the Company, the Series or the Manager being subject to additional regulatory requirements. The transferring Interest Holder is responsible for all costs and expenses arising in connection with any proposed transfer (regardless of whether such transfer is completed), including any legal fees incurred by the Company or any broker or dealer, any costs or expenses in connection with any opinion of counsel and any transfer taxes and filing fees. The Manager or its affiliates will acquire Interests in each Series for their own accounts and may, from time to time and only in accordance with applicable securities laws (which may include filing an amendment to this Offering Circular), transfer these Interests, either directly or through brokers, via the PPEX ATS or otherwise. The restrictions on transferability listed above will also apply to any resale of Interests via the PPEX ATS (see “Description of the Business – Liquidity Platform” for additional information).
The following is a summary of certain material United States federal income tax consequences of the ownership and disposition of the Interests but does not purport to be a complete analysis of all the potential tax considerations relating thereto. This summary is based upon the provisions of the Internal Revenue Code of 1986, as amended (the “Code”), Treasury regulations promulgated thereunder, administrative rulings and judicial decisions, all as of the date hereof. These authorities may be changed, possibly retroactively, so as to result in United States federal income tax consequences different from those set forth below. We have not sought any ruling from the Internal Revenue Service (the “IRS”), with respect to the statements made and the conclusions reached in the following summary, and there can be no assurance that the IRS will agree with such statements and conclusions.
Except as explicitly set forth below, this discussion is limited to U.S. Holders (defined below) who hold the Interests as capital assets within the meaning of Section 1221 of the Code. This summary does not address the tax considerations arising under the laws of any United States state or local or any non-United States jurisdiction or under United States federal gift and estate tax laws. In addition, this discussion does not address tax considerations applicable to an Investor’s particular circumstances or to Investors that may be subject to special tax rules, including, without limitation:
(i)banks, insurance companies or other financial institutions;
(ii)persons subject to the alternative minimum tax;
(iii)tax-exempt organizations;
(iv)dealers in securities or currencies;
(v)traders in securities that elect to use a mark-to-market method of accounting for their securities holdings;
(vi)persons that own, or are deemed to own, more than five percent of our Interests (except to the extent specifically set forth below);
(vii)certain former citizens or long-term residents of the United States;
(viii)persons who hold our Interests as a position in a hedging transaction, “straddle,” “conversion transaction” or other risk reduction transaction;
(ix)persons who do not hold our Interests as a capital asset within the meaning of Section 1221 of the Code (generally, for investment purposes); or
(x)persons deemed to sell our Interests under the constructive sale provisions of the Code.
As used herein, the term “U.S. Holder” means a beneficial owner of the Interests that is, for U.S. federal income tax purposes, an individual citizen or resident of the United States, a corporation (or any other entity taxable as a corporation for U.S. federal income tax purposes) created or organized in or under the laws of the United States or any state or political subdivision thereof or the District of Columbia, an estate the income of which is subject to U.S. federal income taxation regardless of its source, or a trust, if a court within the United States is able to exercise primary supervision over the administration of the trust and one or more U.S. persons control all of the substantial decisions of the trust or if a valid election is in place to treat the trust as a U.S. person.
In addition, if a partnership, including any entity or arrangement, domestic or foreign, classified as a partnership for United States federal income tax purposes, holds Interests, the tax treatment of a partner generally will depend on the status of the partner and upon the activities of the partnership. Accordingly, partnerships that hold Interests, and partners in such partnerships, should consult their tax advisors.
On December 22, 2017, the United States enacted H.R. 1, informally titled the Tax Cuts and Jobs Act (the “Tax Act”). The Tax Act includes significant changes to the Code affecting the Company and its Interest Holders. Most of the changes applicable to individuals are temporary and, without further legislation, will not apply after 2025. The interpretation of the Tax Act by the IRS and the courts remains uncertain in many respects; prospective Investors should consult their tax advisors specifically regarding the potential impact of the Tax Act on their investment.
You are urged to consult your tax advisor with respect to the application of the United States federal income tax laws to your particular situation, as well as any tax consequences of the purchase, ownership and disposition of our Interests arising under the United States federal estate or gift tax rules or under the laws of any United States state or local or any foreign taxing jurisdiction or under any applicable tax treaty.
96
Default Taxation of Each Series of Interests as a “C” Corporation
The Company, although formed as a Delaware series limited liability company eligible for tax treatment as a “partnership,” has affirmatively elected for all but certain of its Series of Interests, including the Series listed in the Master Series Table in Appendix A, to be taxed as a “C” corporation under Subchapter C of the Code for all federal and state tax purposes and the discussion below assumes that each Series will be so treated. Thus, each Series of Interests (except as noted below and on the Master Series Table) will be taxed at regular corporate rates on its income before making any distributions to Interest Holders as described below.
The rule that a separate series of a Series LLC is an eligible entity that may elect to be treated as a corporation for federal income tax purposes is contained in proposed Treasury Regulations that have not yet been finalized (Prop. Treas. Reg. Section 301.7701- 1(a)(5)). This rule is therefore subject to change if and when those proposed Treasury Regulations are issued in final form. If the final rule does not provide that a series of a limited liability company is eligible to elect to be treated as a corporation for federal income tax purposes, Investors in a Series would likely be treated as partners in a partnership and would be subject to current federal income tax on their proportional share of the income of the Series or of the Company.
As of the date of this filing, the only Series with respect to which the Company does not intend to elect to be taxed as a “C” corporation is Series #STEGO. Series #STEGO will be taxed as a partnership, as described below.
Tax Consequences for Series Taxed as Corporations
Taxation of Distributions to Investors
With respect to each Series for which the Company has made an election to be taxed as a “C” corporation, distributions to U.S. Holders out of the Company’s current or accumulated earnings and profits will be taxable as dividends. A non-corporate U.S. Holder who receives a distribution constituting “qualified dividend income” may be eligible for reduced federal income tax rates. U.S. Holders are urged to consult their tax advisors regarding the characterization of corporate distributions as “qualified dividend income.” Dividends received by a corporate U.S. Holder may be eligible for the corporate dividends-received deduction if certain holding periods are satisfied. Distributions in excess of the Company’s current and accumulated earnings and profits will not be taxable to a U.S. Holder to the extent that the distributions do not exceed the adjusted tax basis of the U.S. Holder’s Interests. Rather, such distributions will reduce the adjusted basis of such U.S. Holder’s Interests. Distributions in excess of current and accumulated earnings and profits that exceed the U.S. Holder’s adjusted basis in its Interests will be taxable as capital gain in the amount of such excess if the Interests are held as a capital asset. In addition, Section 1411 of the Code imposes on individuals, trusts and estates a 3.8% tax on certain investment income (the “3.8% NIIT”). In general, in the case of an individual, this tax is equal to 3.8% of the lesser of (i) the taxpayer’s “net investment income” or (ii) the excess of the taxpayer’s adjusted gross income over the applicable threshold amount ($250,000 for taxpayers filing a joint return, $125,000 for married individuals filing separate returns and $200,000 for other taxpayers). In the case of an estate or trust, the 3.8% tax will be imposed on the lesser of (x) the undistributed net investment income of the estate or trust for the taxable year, or (y) the excess of the adjusted gross income of the estate or trust for such taxable year over a beginning dollar amount of the highest tax bracket for such year (for 2021, that amount is $13,050).
Taxation of Dispositions of Interests
Upon any taxable sale or other disposition of our Interests, a U.S. Holder will recognize gain or loss for federal income tax purposes on the disposition in an amount equal to the difference between the amount of cash and the fair market value of any property received on such disposition; and the U.S. Holder’s adjusted tax basis in the Interests. A U.S. Holder’s adjusted tax basis in the Interests generally equals his or her initial amount paid for the Interests and decreased by the amount of any distributions to the Investor in excess of the Company’s current or accumulated earnings and profits. In computing gain or loss, the proceeds that U.S. Holders receive will include the amount of any cash and the fair market value of any other property received for their Interests, and the amount of any actual or deemed relief from indebtedness encumbering their Interests. The gain or loss will be long-term capital gain or loss if the Interests are held for more than one year before disposition. Long-term capital gains of individuals, estates and trusts currently are taxed at a maximum rate of 20% (plus any applicable state income taxes) plus the 3.8% NIIT. The deductibility of capital losses may be subject to limitation and depends on the circumstances of a particular
97
U.S. Holder; the effect of such limitation may be to defer or to eliminate any tax benefit that might otherwise be available from a loss on a disposition of the Interests. Capital losses are first deducted against capital gains, and, in the case of non-corporate taxpayers, any remaining such losses are deductible against salaries or other income from services or income from portfolio investments only to the extent of $3,000 per year.
Tax Withholding and Information Reporting
Generally, the Company must report annually to the IRS the amount of dividends paid to you, your name and address, and the amount of tax withheld, if any. A similar report will be sent to you.
Dividends paid by a Series to a non-U.S. Holder are generally subject to federal income tax withholding at the rate of 30% (or a lower rate determined under a tax treaty). A non-U.S. Holder that is entitled to a reduced rate of withholding will need to provide an IRS Form W-8BEN or similar form to certify its entitlement to tax treaty benefits.
Payments of dividends or of proceeds on the disposition of the Interests made to you may be subject to additional information reporting and backup withholding at a current rate of 24% unless you establish an exemption. Notwithstanding the foregoing, backup withholding and information reporting may apply if either we or our paying agent has actual knowledge, or reason to know, that you are a United States person.
Backup withholding is not an additional tax; rather, the United States income tax liability of persons subject to backup withholding will be reduced by the amount of tax withheld. If withholding results in an overpayment of taxes, a refund or credit may generally be obtained from the IRS, provided that the required information is furnished to the IRS in a timely manner.
Under legislation commonly known as “FATCA,” each Series of Interests will be required to withhold U.S. federal income tax at the rate of 30% on distributions treated as dividends for tax purposes unless the recipient timely provides proper certifications on a valid U.S. Form W-8 or W-9. Withholding under FATCA generally applies to certain “foreign financial institutions” and “non-financial foreign entities.” Withholding will not apply to a U.S. Holder that timely provides a valid U.S. Form W-9.
If we determine withholding is required with respect to a distribution or payment, we will withhold tax at the applicable statutory rate, and we will not pay any additional amounts in respect of such withholding.
Tax Consequences for Series Taxed as Partnerships
We expect that each Series for which no election to be treated as a “C” corporation will be made will be treated as a partnership for U.S. federal income tax purposes and not as an association or publicly traded partnership subject to tax as a corporation. As a partnership, such Series will not be subject to U.S. federal income tax. Instead, each U.S. Holder will be required to take into account its distributive share, whether or not distributed, of each item of such Series’ income, gain, loss, deduction or credit. See “—Taxation of Interest Holders in Series Taxed as Partnerships.”
An entity that would otherwise be classified as a partnership for U.S. federal income tax purposes may nonetheless be taxable as a corporation if it is a “publicly traded partnership”, unless an exception applies. An entity that would otherwise be classified as a partnership is a publicly traded partnership if (i) interests in the partnership are traded on an established securities market or (ii) interests in the partnership are readily tradable on an alternative trading system or the substantial equivalent thereof. With respect to Series whose Interests trade on the PPEX ATS, we expect that such Interests will be publicly traded for purposes of these rules. As of the date of this filing, the Company intends for all Series whose Interests may trade on the PPEX ATS to elect to be taxed as corporations. Series that do not elect to be taxed as corporations will not permit their Interests to be traded on the PPEX ATS; see the Master Series Table for identification of Series for which secondary trading on the PPEX ATS will not be permitted.
We intend to operate such that the Interests of any Series not electing to be taxed as a corporation will not be publicly traded. Specifically, the Operating Agreement generally prohibits any transfer of an Interest without the prior consent of the Manager and specifically prohibits any transfer of an Interest that would subject a Series to any tax to which it would not otherwise be subject. The Manager will consider prior to consenting to any transfer of an Interest
98
in a Series whether such transfer would or could reasonably be expected to jeopardize the tax status of a Series, and with respect to any Series taxed as a partnership for federal income tax purposes, the Manager does not intend to consent to any Transfer of Interests therein. If the Manager determines, after consultation with its legal counsel, that a requested transfer of Interests in such a Series would not jeopardize the Series’ treatment as a partnership for tax purposes, then the Manager may in such circumstances consent to a transfer of Interests in the Series. At present, we do not expect to seek a ruling from the IRS with respect to the treatment of certain Series as a partnership for U.S. federal income tax purposes, and no assurance can be given that the IRS will not take a contrary position. In the event that such a ruling is sought and treats the Interests of such Series as publicly traded, the tax consequences described herein could be materially different, as described below.
If a Series that had not made an election to be taxed as a corporation is nonetheless eventually treated as having publicly traded Interests such that it is deemed to be a “publicly traded partnership,” such Series will be treated as if, on the first day that it is subject to taxation as a corporation, such Series had transferred all of its assets, subject to any liabilities, to a newly formed corporation in exchange for stock of such corporation, and then distributed the stock to the Interest Holders in liquidation of their interests in such Series. This deemed contribution and liquidation should generally be tax-free to the Interest Holders so long as the Series does not have liabilities in excess of the tax basis of its assets at such time. Thereafter, the Series would be treated as a corporation for U.S. federal income tax purposes, and the tax considerations described above under “Default Taxation of Each Series as a ‘C’ Corporation” would apply and could materially reduce an Interest Holder’s after-tax return and thus could result in a substantial reduction of the value of the Interests in such Series.
Taxation of Interest Holders in Series Taxed as Partnerships
Below is a discussion of material U.S. federal income tax considerations applicable to U.S. Interest Holders in Series taxed as partnerships. As of the date of this filing, only Series #STEGO is expected to be taxed as a partnership.
Taxation of Interest Holders on Our Profits and Losses. As partnerships for U.S. federal income tax purposes, these Series generally will not be subject to U.S. federal income tax. Instead, each Interest Holder therein that is subject to U.S. tax will be required to take into account its distributive share, whether or not distributed, of each item of the Series’ income, gain, loss, deduction or credit. It is possible that in any year, an Interest Holder’s tax liability arising from the Series could exceed the distributions made to such Interest Holder. These Series will file a U.S. federal partnership information return reporting its operations for each year and provide a U.S. Internal Revenue Service Schedule K-1 and Schedule K-3 to each Interest Holder. However, Interest Holders may not receive such Schedule prior to when their tax return reporting obligations become due and may need to file for extensions or file based on estimates.
In addition to regular U.S. federal income tax, certain U.S. Holders that are individuals, estates or trusts are subject to a 3.8% tax on all or a portion of their “net investment income,” which may include all or a portion of any interest income we earn that is allocable to such U.S. Holder.
Allocation of Profits and Losses. For each fiscal year, each Interest Holder’s allocable share of income, gain, loss, deduction or credit attributable to a Series taxed as a partnership will be determined by the Operating Agreement and the applicable Series Designation, provided such allocations either have “substantial economic effect” or are determined to be in accordance with an Interest Holder’s interest in the Series. We believe that for U.S. federal income tax purposes, such allocations will be given effect as being in accordance with such Interest Holder’s interest in the Series, and we intend to prepare tax returns based on such allocations. If the allocations provided by the Operating Agreement were successfully challenged by the IRS, the resulting allocations to a particular Interest Holder for U.S. federal income tax purposes may be less favorable than the allocations set forth in the Operating Agreement.
Section 706 of the Code provides that items of partnership income and deductions must be allocated between transferors and transferees of shares. We will apply certain assumptions and conventions in an attempt to comply with applicable rules and to report income, gain, loss, deduction and credit to Interest Holders in a manner that reflects their beneficial shares of our items. These conventions are designed to more closely align the receipt of cash and the allocation of income between Interest Holders, but these assumptions and conventions may not conform with all aspects of existing Treasury Regulations. If the IRS successfully challenges our conventions, our items of income,
99
gain, loss, deduction or credit may be reallocated among the Interest Holders of a Series to the possible detriment of certain Interest Holders. The Manager is authorized to revise our method of allocation between transferors and transferees (as well as among Interest Holders whose interests otherwise could vary during a taxable period).
Adjusted Tax Basis of Interests. An Interest Holder’s initial tax basis in its Interests will generally equal the amount such Interest Holder paid for the Interests. An Interest Holder’s adjusted tax basis will be increased by such Interest Holder’s share of items of a Series’ income and gain and any increase in such Holder’s share of the Series’ liabilities. An Interest Holder’s adjusted tax basis will be decreased, but not below zero, by distributions from the applicable Series, such Interest Holder’s allocable share of items of the Series’ deductions and losses and by any decrease in such Holder’s allocable share of the Series’ liabilities.
Interest Holders who purchase Interests of a Series in separate transactions must combine the basis of those Interests and maintain a single adjusted tax basis for all of those Interests. Upon a sale or other disposition of less than all of the Interests held by such Interest Holder, a portion of that tax basis must be allocated to the Interests sold.
Restrictions on Deductibility of Expenses and Other Losses. An Interest Holder may deduct its allocable share of a Series’ losses (if any) for U.S. federal income tax purposes only to the extent of such Interest Holder’s adjusted tax basis in Interests it is treated as holding at the end of the taxable year in which the losses occur. If the recognition of an Interest Holder’s allocable share of the Series’ losses would reduce its adjusted tax basis for its Interests below zero, the recognition of such losses by such Interest Holder would be deferred to subsequent taxable years and will be allowed if and when such Interest Holder has sufficient tax basis so that such losses would not reduce such Interest Holder’s adjusted tax basis below zero. In addition, the “at-risk” rules, the passive activity rules and the limitation on “excess business losses” could limit the deductibility of losses allocable to an Interest Holder.
In general, neither any Series taxed as a partnership nor any Interest Holder therein may deduct organizational expenses. Such Series may elect to amortize any organizational expenses ratably over fifteen years, or it may elect to capitalize such expenses. No deduction is allowed for Offering Expenses.
Treatment of Distributions. For U.S. federal income tax purposes, distributions of cash by Series taxed as partnerships generally will not be taxable to a U.S. Holder to the extent of such U.S. Holder’s adjusted tax basis in its Interests of a Series. Any cash distributions in excess of a U.S. Holder’s adjusted tax basis generally will be considered to be gain from the sale or exchange of the Interests. Under current law, such gain generally will be capital gain and will be long-term capital gain if such U.S. Holder has held such Interests for more than one year at the time of such distribution, subject to certain exceptions.
Disposition of Interests. A U.S. Holder generally will recognize gain or loss for U.S. federal income tax purposes upon the sale, exchange or other disposition of its Interests in a Series in an amount equal to the difference, if any, between the amount realized on the sale, exchange or other disposition and such U.S. Holder’s adjusted tax basis in such Interests. A U.S. Holder’s adjusted tax basis will be adjusted for this purpose by its allocable share of a Series’ income or loss for the year of such sale or other disposition. Any gain or loss so recognized generally will be capital gain or loss and will be long-term capital gain or loss if such Interest Holder has held such Interests for more than one year at the time of such sale, exchange or other disposition. Net long-term capital gain of certain non-corporate U.S. Holders generally is subject to preferential rates of tax. The deductibility of capital losses is subject to limitations.
The preceding discussion of United States federal tax considerations is for general information only. It is not tax advice. Each prospective Investor should consult its own tax advisor regarding the particular United States federal, state and local and foreign tax consequences, if applicable, of purchasing, holding and disposing of our Interests, including the consequences of any proposed change in applicable laws.
100
