August 27, 2014

Crowdfunding: A New Means For Start-up Capital (Part 2 of 2)

This is Part 2 of a two-part series. Click here for Part 1.

On April 5, 2012, President Barack Obama signed The JOBS Act (“Act”) into law and Title III of the Act empowers the SEC to set rules for companies to raise capital through crowdfunding. Crowdfunding will permit entrepreneurs to advertise and seek financing from the general public in relatively small amounts in exchange for an interest in their company. These provisions present great opportunity for new companies and investors alike because start-ups can seek capital from a broad pool of investors and investors can seek financial return through the internet from a company that resonates with them. Permitting a diverse group of unaccredited investors as a shareholder base in a company is a large change in securities regulation.

However, there are significant concerns as to whether the SEC will set rules providing adequate flexibility. Currently, Title III of the Act substantially burdens both issuers and funding portals. Regarding issuers, a sweeping scope of individuals in the company must sacrifice limited liability: directors, partners, principal executive officers, principal financial officers, controller, or any person who offers or sells the security in the offering.  Regarding funding portals, there will be financial costs in providing administrative aid to investors and registering with the SEC. Finally, the language in the Act provides for much disclosure and many regulations that do not significantly depart from current requirements for companies at the IPO stage. For both issuers and funding portals, the regulatory costs may be too great.

Additionally, companies will face uncertainties surrounding later rounds of financing and subsequent restructuring if they decide to crowdfund. It will be vitally important for a company to consider the impact that crowdfunding will have on its projected funding model and its ultimate exit strategy. First, companies should consider whether they plan to seek funding from angel investors, venture capitalists, or other traditional sources because such sources might balk at getting involved with a broad base of unaccredited investors. Second, companies should consider that many restructuring plans require a degree of shareholder approval and such shareholder approval could prove difficult and expensive with a crowdfunded shareholder base. Although speculative, these concerns should be contemplated with each client.

Crowdfunding is an exciting legal development that attorneys should monitor as they advise their business clients. The interest surrounding this funding model is justified because crowdfunding has the potential to change the capital raising landscape for start-up companies overlooked by traditional funding sources. Yet, it remains to be seen whether the SEC will implement rules that address current concerns regarding financial costs and issuer liability. Additionally, companies who seek angel or venture capital funding need to be aware of the pragmatic consequences from accepting funds from the general public. In sum, when the rules are promulgated by the SEC crowdfunding should be considered as a potential funding source for start-up companies, but careful scrutiny should be paid to clients’ future plans.

Joel Jacobson is a Contracts and Operations Associate with H.B. Stubbs Company, LCC – a national design and fabrication firm headquartered near Detroit, MI for exhibits displayed by technology and automotive companies. He focuses on contracts, employment law, and a variety of non-legal business issues. Joel serves on the Executive Council of the Denver Bar Association Young Lawyers Division and has an interest in topics impacting start-up companies in the Denver entrepreneurial community. He can be reached by email at jmjacobson1@gmail.com or on Twitter @J_m_Jacobson.

The opinions and views expressed by Featured Bloggers on CBA-CLE Legal Connection do not necessarily represent the opinions and views of the Colorado Bar Association, the Denver Bar Association, or CBA-CLE, and should not be construed as such.

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