Crowdfunding

by D. Joe Rockett

Crowdfunding has been the source of funding for many and varied projects, from sending kids to college, to financing films. Anyone with a worthy cause, or an innovative idea, whether not-for-profit or for profit, can go online on any one of the many crowdfunding platforms and seek to fund his or her project. Popular crowdfunding platforms include Gofundme, Kickstarter, Indiegogo, Crowdrise and Giveforward. There are over 2,000 crowdfunding sites.

Very broadly speaking, there are roughly four categories of crowdfunding according to Zach Miller's writing in the balance, “A Guide: What is Crowdfunding?” (10/16/2015).

They are: (1) reward-based crowdfunding (people pledging money for a project, such as an artistic project with the expectation of receiving some reward if the project is successful); (2) donation-based crowdfunding (donations for charity projects); (3) peer to peer lending (a crowdfunding platform matches lenders with borrowers, avoiding traditional banking channels); and (4) equity crowdfunding (investment of capital in exchange for equity or debt securities in a for-profit business).

Title III of the Jumpstart Our Business Startups (JOBS) Act and the regulations thereunder regulate the equity crowdfunding of small businesses. President Obama signed the JOBS Act on April 5, 2012. It was not until May, 2016 that the Securities and Exchange Commission (SEC) adopted Regulations that allowed the JOBS Act to be implemented. Under the Act, an entrepreneur may raise up to $1,000,000 in any twelve month period without registration with the SEC, although the issuer is required to comply with Regulation Crowdfunding, including filing a Form C offering statement with the Commission.

Equity crowdfunding subject to Regulation Crowdfunding is conducted through an online platform. The intermediary operating the platform must be either a licensed broker or a funding portal registered with the SEC and FINRA. The issuer may rely on the intermediary to determine that the investors are not exceeding their investment limits under Regulation Crowdfunding, unless the issuer knows the investor is exceeding the limit. Those individual investor investment limits are calculated as a percentage of the investor’s annual income or net worth.

Certain companies are not eligible to use Regulation Crowdfunding. They include non-U.S. companies, SEC reporting companies, certain investment companies, companies that are disqualified under Regulation Crowdfunding, and companies that have no specific business plan other than to merge with an unidentified company.

Securities purchased in a Regulation Crowdfunding offering generally cannot be resold within a period of one year, with certain exceptions, including sales to the issuer, an “accredited investor,” certain family members, and as part of an offering registered with the SEC.

There are some pros and cons to crowdfunding your capital needs.

Among the pros are the ability to develop a relatively easily accessed market following. Potentially it could be a large group of people who are interested in supporting your company and your products or services. This could be important to the success of your fledgling company and to your future capital needs. For that to become a reality, you must treat your investors with the utmost regard and avoid unrealistic expectations. The use of Regulation Crowdfunding is a relatively easy regulatory scheme for accessing many potential investors.

Among the cons of equity crowdfunding is the same fact that creates a pro---a potentially large number of investors in your company. Maintaining a satisfied investor base requires diligent reporting and record keeping and smart business practices. They invest money with you with the expectation that your good ideas and sound business practices will reward them with a nice capital gain when they liquidate their investment. Should you fail in that endeavor, you will have an unhappy crowd and potentially multiple lawsuits, not to mention slings and arrows! Maintaining that large investor base can be time consuming and expensive, with the time and expense bearing a close relationship to the size of the crowd. Another con is the flipside of the relative ease of entry into the market---the exercise of fiduciary duties toward your investors and ongoing compliance with securities laws.

This is only a summary of certain of the requirements of Regulation Crowdfunding as it exists today. President Trump seems to have some interest in deregulating capital markets and initiating changes in laws with the stroke of his pen. He appears to have a Congress willing to support him in those efforts. Regulation Crowdfunding strikes a balance between investor protection and relatively easy access to crowds of investors. Removing the few investor safeguards from the exemption provided by Regulation Crowdfunding could have adverse consequences for investors.

Anyone considering an equity crowdfunding can consult guides available online, including the SEC’s “Regulation Crowdfunding: A Small Entity Compliance Guide for Issuers” at www.SEC.org.

Happy crowdfunding!


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