If you are familiar with the Ostrich Pillow, then you’re definitely aware of the growing crowdfunding marketplace. Today, companies such as Kickstarter are leading the way in providing platforms for connecting creative founders with the public. According to the Crowdfunding Industry, as reported by techcrunch, crowdfunding platforms raised almost $1.5 billion and funded over one million projects in 2011. So what is crowdfunding and what issues does it raise from a legal standpoint?
Crowdfunding is simply the process of obtaining funding for some project by appealing to the public. Or, as a recent California Department of Corporations (DOC) bulletin put it:
Crowdfunding began as a way for the public to donate small amounts of money, often through social networking websites, to help musicians, filmmakers and other artists finance their projects. These types of crowdfunding are generally altruistic and contributors (who are not, strictly-speaking, investors) do not receive equity in the projects they are funding.
Sounds a lot like an IPO? Well, not necessarily. Currently, there are at least four types of crowdfunding platforms as identified by Suw Charman-Anderson of Forbes.com:
- Lending: Funders receive income from their loan and expect repayment of original principal investment
- Reward: Funders receive a non-financial benefit, with projects often following a pre-sales model
- Donation: Funders expect no return, motivations are philanthropic
- Equity: Funders receive equity in the projects they back, earn revenue or profit-share
For the purposes of this post, it is the equity platform that is of greatest interest as it alone is the the subject of the JOBS Act. Over a year ago, Congress passed bipartisan legislation known as the Jumpstart Our Business Startups Act (the “JOBS Act” or “Act”). The Act is intended to “increase American job creation and economic growth by improving access to the public capital markets for emerging growth companies.” The Act, in its entirety, can be found here. When fully implemented, the Act will promote capital formation by enabling “emerging growth companies” to sell, through a portal registered with the SEC, up to $1 million in securities over a 12-month period to an unlimited number of investors, i.e. the crowd. Furthermore, the Act lowers the burden of capital formation by exempting these crowdfund offerings from registration with state or federal authorities. The Act attempts to balance these benefits that may encourage fraud by requiring the emerging growth companies to disclosure all material facts and risks associated with the investment.
Most importantly, the Act calls upon the Securities and Exchange Commission (SEC) to adopt rules and regulations implementing the Act. And, until the SEC implements the Act through its rulemaking authority, this type of equity crowdfunding remains illegal. To date, the SEC has yet to act, putting the agency nearly 4 months behind their deadline.
The entrepreneurs that I know are excited for this opportunity. As are investors who want to be a part of something. The appeal of the reward and donation type crowdfunding platforms seems to be largely one of community, similar to the underpinnings of social networking in general. How else could a project like this ever get funding?
Certainly, there are legitimate reasons for the SEC to carefully craft rules to implement the Act. Protecting the investing crowd from fraud is an important objective. Similarly, ensuring the investing crowd have adequate and accurate information to make an informed investment decision is principle inherent to our public equity markets. But these problems are by no means any reason for them to bury their heads in the sand.