Friday, June 8, 2012

WHAT IS CROWDFUNDING AND WHY SHOULD I CARE?

By: BRIAN KEITH FELDERSTEIN, ESQ.

OK… Let's say you just finished your business plan for the next killer app or you’re humming along in your business and have an idea for a new product that you want to bring to market but you don't want to risk personnel, resources, or money to accomplish this new venture. Venture capital is out because your idea is too niche and friends or family are out because your ideas too big.

Enter the world of “Crowdfunding.” Crowdfunding is an alternative method of raising finance for a business project or an idea using an Internet portal like Kickstarter (if you haven't been to this site yet I highly recommend it). Unlike Angel investment where a single individual takes a larger stake in a small business, with Crowdfunding an entrepreneur can attract large numbers of people from all over through a web-based portal site (that has been designated by the SEC and the State as a "Broker-Dealer") each of whom takes a small stake in your business idea by contributing towards an online funding target.

Here is a quick explanation for those who like to watch rather than read:




PlantoStart.com lists the top 10 Crowdfunding web sites available to entrepreneurs and small businesses. These sites are worth a peak at although, other than kickstarter, I  would not recommend jumping on board with them just yet.

Through Kickstarter and these other Crowdfunding sites, you can present videos and documentation of your new idea and ask people to make pledges or provide cash for equity in order to support of your new venture.

Crowdfunding falls under the new Jumpstart Our Business StartUps (JOBS) Act, H.R. 3606. The act makes major changes to the federal securities laws that govern capital raising activities by smaller companies. The idea is to improve access to the public capital markets for emerging growth companies and thereby promote economic growth and job creation in the United States. You can read the full text of the Act here. this Act loosens certain restrictions on private securities offerings by smaller companies as well as regulatory compliance burdens on companies going public.

Among other things, the "JOBS" Act will:
  • Create a new category of issuer called "an emerging growth company" (defined as a company with less than 1 billion in annual revenues), that will be entitled to limited relief from financial reporting and disclosure rules in connection with, and for five years after, an initial public offering.
  • Remove the prohibitions on general solicitation and general advertising for offerings to accredited investors under rule 506 of regulation D.
  • Permit Crowdfunding (and this is important), by allowing issuers to raise up to $1 million from a large number of small investors, subject to some limitations on investor income levels and other restrictions intended to help prevent fraud.
  • Increase the dollar limitations on offerings under regulation A from $5 million-$50 million and enables a state blue sky exemption for regulation A offerings under certain conditions.
  • Raise the threshold number of shareholders for mandatory registration under the Securities Exchange Act of 1934 from 500 to 2000 (or 500 non-accredited investors), excluding shareholders in employee compensation plans and "Crowdfunded" shareholders.

Be warned however, this Act is not ready for prime time just yet and not only do you have to comply with broker-dealer laws (California is especially concerned in this area), but there are a multitude of legal issues and business operational matters that you need to get your hands around before you begin this Crowdfunding adventure.

Yoichiro ("Yokum") Taku provides a mindnumbingly detailed and technical discussion of the how the "JOBS" Act treats Crowdfunding and what all the gobbledygook in the "JOBS" Act actually means. You can read Taku's analysis on this subject in his post "is crowd funding legal?" 

Although I don't recommend reading Taku's article if you are manic depressive or prone to suicidal thoughts, the take away from his article however is as follows:
  1. Companies should not try to utilize Crowdfunding until the SEC finalizes their rule making under the Act... There is too much ambiguous language as certain clauses could have multiple interpretations. When it's you versus the government guess who will win...Therefore,be patient, let the dust settle and wait for my posts letting you know that the JOBS Act train is ready for boarding, at which time you should get in touch with a lawyer (most likely me), and work through all the nuances as it relates to the program.
  2. Crowdfunding will have the ability to expand options available to small businesses seeking finance.
  3. Kids don't try this at home...If you're going to use Crowdfunding to raise capital, you'll need an attorney to ensure your corporate housekeeping is in order. You'll need to be certain that the appropriate number and type of shares is authorized and you need to review provisions relating to voting rights, board composition, and other matters could be affected when you're number of stockholders increases.
  4. Be prepared to file with the SEC...although these filings will be less burdensome than the filings required by public companies, you're still going to have a lot of homework.
  5. Choose your Crowdfunding website with the utmost care...The transaction fees charged by some of these sites still have not been determined and there are risks that the fees may be excessive or that unscrupulous persons will masquerade as registered Crowdfunders.
So to sum things up, if you have an ongoing business and you're looking to launch a new product or service but you don't want to risk the cash then Crowdfunding (when it's ready for primetime) may be just the ticket to get your new idea off the ground.

Alternatively, if you're small and your business idea is still sitting on your desk underneath an old cup of coffee, Crowdfunding may be the best way to give your current boss the bird and start out on your own...Just make sure you have your T's crossed and I's dotted first.








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