Is Crowdfunding the Best Way to Raise Money for My Startup? (Spoiler Alert: Probably Not)

Excited about the arrival of crowdfunding? You shouldn’t be, writes Brian Korn of law firm Pepper Hamilton:

“When compared to other forms of private placements, crowdfunding is not a feasible option.”

He explains:

“Crowdfunding began with the concept of small enterprises engaging in online capital-raising through social media and raising funds from people they did not previously know (and were not likely to meet). The notion that small individual investors could have the same access to early-stage investment as large venture capital funds, combined with the enhanced ability of start-up companies to raise money beyond their ‘friends and family’ group was a compelling reason for Congress to add crowdfunding to the JOBS Act…

As a result of significant amendments on the Senate floor, crowdfunding emerged in the final version of the JOBS Act with a much heavier set of regulatory, legal and procedural burdens than what had been originally proposed. Regardless of the SEC’s upcoming rulemaking process, these statutory requirements effectively weigh it down to the point of making the crowdfunding exemption under the JOBS Act utterly useless.”

Korn goes on to list ten reasons why startups should not favor crowdfunding over more traditional methods of raising capital. His conclusion? “There are “better ways to raise money:”

“Despite the sound and fury, the crowdfunding exemption will do little to help small start-ups raise capital. That’s because it will not be economically feasible for most companies to comply with the filing and disclosure requirements; take on the risk of legal liability; and undertake annual reporting obligations to raise a maximum of $1 million in a 12-month period.”

Read the full update, The Trouble With Crowdfunding (Pepper Hamilton LLP). Then read more, in this roundup of recent crowdfunding updates from lawyers and law firms on JD Supra Law News:

SEC’s Division of Trading and Markets Grants Relief from Broker-Dealer Registration for Online Platform that Permits Investment in Start-Up Companies (Holland & Knight LLP):

“On March 26, 2013, the SEC’s Division of Trading and Markets issued a no-action letter indicating that it would not recommend enforcement action under … the Exchange Act if a venture capital fund adviser and its management company operated a platform through which its members could participate in Rule 506 offerings. The no-action letter is the first relief from broker-dealer registration for a platform that provides investors with a means to invest in start-up companies following the enactment of the JOBS Act.” Read on>>

Crowdfunding Not Quite As Open As Recent Reports May Suggest (Looper Reed & McGraw, P.C.):

“Both sites pre-screen and approve the companies seeking funds (although AngelList appears to have a lot of start-up that you can peruse without registering). The investors don’t invest directly into the companies, but into investment vehicles (like a separate limited partnership or fund) which then manages the investment on behalf of all of the investors. Therefore, it is not likely the individual investors get to vote their stock or impact management, other than through the collective investment vehicle. Finally, both sites only allow accredited investors to participate.” Read on>>

Accredited Crowdfunding, Internet Advertising And General Solicitation (Leonard, Street and Deinard):

“… some of the accredited crowdfunding sites broadly attract potential investors to their sites by what could constitute advertising on the face of the site or elsewhere. The concern is whether that sort of advertising constitutes a general solicitation and whether the procedures are adequate to determine investors are in fact accredited to qualify for the Regulation D exemption.” Read on>>

The Differences in Unregistered Securities Offerings under Rule 506 and Crowdfunding (The R. Bernard Law Group):

“It is unclear what disclosures will be required on crowdfunding websites or how companies will enforce transfer restrictions or protect unsophisticated shareholders who may participate in these offerings from being diluted. While many will look to crowdfunding as a game changer in fundraising (and it will be once the kinks are worked out), those who have access to accredited investors may find it more useful to go the more traditional route utilizing the Rule 506 exemption under Regulation D, as this continues to be an efficient and sound way for issuers to offer unregulated securities.” Read on>>

SEC Exempts Another Crowd Funding Site From Broker-Dealer Rules (Leonard, Street and Deinard):

“Let’s thank the SEC for their advice on these two matters which will undoubtedly lead to capital formation for small businesses. But a piece really missing is we need SEC guidance on whether these models constitute a general solicitation, destroying the private offering exemption. In the meantime, what are practitioners to think? These entities broadly advertise their wares on the internet, and the SEC must be aware of that. When will the SEC (hopefully) state this is not a general solicitation?” Read on>>

SEC Says Crowdfunding VC Site Not A Broker-Dealer (Leonard, Street and Deinard):

“ operates a really cool website. The publicly available page advertises ‘The best way to invest in startups. Insider access to pre-vetted startups. Low minimum investment sizes. Free membership. Join today.’ Another publicly available page states ‘Investments are made in venture funds set up for the startups, and therefore, the minimum check sizes are 10-20 times smaller than typical angel investments – $1K-$5K typically, vs. $25K-$100K.’” Read on>>

Department Of Corporations Issues Crowd Funding Bulletin (Allen Matkins Leck Gamble Mallory & Natsis LLP):

“Not all crowd funding is constitutes the offer and sale of a security. This acknowledgment is likely to hearten those who are already engaging in crowd funding based on the position that there is no offer and sale of security. The [California] Department [of Corporations] notes, however, that these arrangements may be subject to other laws. The Department doesn’t provide any examples, but several come to mind.” Read on>>

JOBS Act Update (BakerHostetler):

“Companies looking to raise capital through a funding portal that is not registered as a broker-dealer should not pay any type of compensation that would invalidate the funding portal’s exemption from broker-dealer registration. While the [SEC’s Division of Trading and Markets] FAQ indicates co-investments are permitted, the plain language of the Act and the guidance in the FAQ leaves open the question of whether private companies may pay funding portals a fee that would be comparable to the types of fees paid to finders (i.e., an introduction fee).” Read on>>

Crowdfunding Now And What Was Supposed To Be (Looper Reed & McGraw, P.C.):

“Last April’s JOBS (or Jump-Start Our Business Start-Ups) Act was supposed to make it easier for entrepreneurs to raise money using Kickstarter-like campaigns so start-ups could raise small chunks of money from many investors via the internet without worrying so much about Reg D… The SEC was supposed to issue specific regulations for crowdfunding to strike the balance between easier access to capital and preventing widespread fraud against unsophisticated investors. Their deadline was originally December 2012. The December 2012 deadline came and went.” Read on >>

FINRA Issues Voluntary Interim Form for Crowdfunding Portals (Pillsbury Winthrop Shaw Pittman LLP):

“On January 10, 2013 the Financial Industry Regulatory Authority (‘FINRA’) issued a voluntary Interim Form for funding portals (the ‘Interim Form’). The Interim Form is designed for prospective crowdfunding portals under the Jumpstart our Business Startups Act (the ‘JOBS Act’), which was enacted on April 5, 2012. Title III of the JOBS Act, which relates to crowdfunding, requires the Securities and Exchange Commission (the ‘SEC’) and FINRA to promulgate rules before crowdfunding portals can commence operations.” Read on>>

FINRA Releases FAQs On Private Placement Notice Filing Rule (Leonard, Street and Deinard):

“There are two sets of exemptions from the notice filing requirement – one set, contained in Rule 5123(b)(1), contains exemptions based on the types of investors to whom sales are made and apply on a firm-by-firm basis; in other words, in the same offering, one member firm could escape the notice filing requirement by only selling to institutional investors, while another firm might also sell to a natural person and thereby trigger the filing requirement. A second set of exemptions, contained in Rule 5123(b)(2), contains exemptions based on the types of securities being sold in the offering; these exemptions apply to all member firms involved in the offering (or none of them).” Read on>>

Nevada Secretary of State Cites Three Criminal Convictions As Warning To Crowdfunders (Allen Matkins Leck Gamble Mallory & Natsis LLP):

“The Nevada Securities Law is administered and enforced by the Securities Division of the Nevada Secretary of State. Last week, Nevada Secretary of State Ross Miller issued this press release warning investors that three separate criminal convictions in Nevada ‘point to potential trend in illegal crowdfunding’. According to the press release, ‘in each case it was believed that the seller utilized the internet to offer or promote securities’.” Read on>>

Find additional Crowdfunding updates at JD Supra Law News>>