Crowdfunding: Is It for You? Maybe Not.

27 July 2013 Privacy, Cybersecurity & Technology Law Perspectives Blog

Crowdfunding is increasingly popular and effective for certain types of businesses. The producers of a Veronica Mars movie raised over $2m in ten hours, and Cloud Imperium Games raised over $10m for its upcoming Star Citizen game. Crowdfunding works for these ventures because the producers or game makers have tangible items or services that people receive for their donation.  Movie producers may be selling DVD copies or t-shirts and the game companies may be offering advance copies and special downloads. They are not, however, selling stock or any share of any profits, which would violate state and federal securities laws.

This distinction is an important one for entrepreneurs who are looking to raise capital but who can’t currently take advantage of crowdfunding because their products are a long while off or because they do not have the name recognition to sell t-shirts or ancillary products. What these entrepreneurs have (and have always had) is stock.

Permitted crowdfunding of securities looked to be on its way in last year when President Obama signed the JOBS Act, which included a provision to legalize the sale of securities through crowdfunding Websites. The SEC has still not issued its rules which would put the crowdfunding provisions of the JOBS Act into effect. Even when the rules are in place, crowdfunding still might not be the best option for start-up companies for many reasons, including:

  • A proposed crowdfunding cap of $1m in any 12 month period;
  • A proposed cap on the amount any individual person can invest via crowdfunding (10% of net income for those making $100k or more per year and 5% for those making less than $100k a year);
  • A proposed disclosure filing required to be made with the SEC at least 21 days prior to a crowdfunding (including scaled financial disclosure and a requirement for audited financials for companies raising over $500k);
  • A proposed ban on advertising or other solicitation outside of the SEC licensed crowdfunding site;
  • Proposed post-financing annual and other filings to be submitted to the SEC; and
  • Proposed required due diligence, including background checks on management and large stockholders.

These proposed requirements may make crowdfunding a start-up more time consuming and expensive than desired, especially given the new rules which allow companies to use general advertisements when selling stock in non-crowdfunding situations.

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