Crowdfunding: What is it and Where is it Going?

by Dickinson Wright

On May 7, 2014, a group of four experts (Frank Williams, Four Bridges Capital; Gene Wright, Georgia Crowdfunding Association; Phil Shmerling, InCrowd Capital; and Zan Nicolli, Dickinson Wright) gathered via conference call for a roundtable discussion on crowdfunding. Joined by business journalists, the group discussed what crowdfunding means today, what this form of capital raising means for businesses and the ideal outcome of crowdfunding legislation. Zan Nicolli, in our Troy office, offered her securities expertise, sharing insight on the JOBS Act, individual state laws and the risks and opportunities for business owners.

Below are excerpts from Zan Nicolli’s participation in the roundtable.

Q: What does today’s market mean by crowdfunding?
A. Under the JOBS Act and proposed regulations there is not a specific definition, which is interesting given the 600 pages of regulation. But, a rough definition is exactly what it sounds like, that is, it concerns investing by a crowd or group of interested investors from the general public, which could include anyone presented with an opportunity to invest in a private business venture. On a Federal level, it’s through the Internet. It’s an investment opportunity with an expectation of getting the profit back from others, which brings crowdfunding under all of the complex securities laws.
Q: What kinds of investors are drawn to the idea of crowdfunding?
A. The crowdfunding exemption was intended to give the general public the opportunity to invest in startups, but in protected amounts of investments, so they aren’t at risk of losing their entire net worth. Also, of course, it was intended to make capital raising easier for startups and small companies. Whether we’ll have a crowd that’s interested in getting together to invest in a particular business or patent really is unclear. It will be most effective for community investment. Those who aren’t necessarily wealthy can know a local business that’s starting and take a chance by making an investment. Various states that enacted their own crowdfunding laws are recognizing that. Those laws are completely dependent upon the companies and investors being from that particular state.
Q: What does this money seem like to businesses? For whom does it work? For whom does it not work?
A. There are opportunities and risks for company owners. Companies have to think long and hard about whom the investors are and how many they’re bringing in. Shareholder relations can be a costly thing that a small company may not anticipate. If there are too many shareholders, you start getting into potentially becoming a public company. An additional risk is secondary trading of crowdfund shares. Private placements, mostly with a handful of accredited investors, they become a limited partner with operating agreement provisions that gives them an exit strategy. Here an exit strategy isn’t clear for the average everyday investor. The Federal act requires an investor to hold shares for one year. Regulations are being developed on whom you can transfer to. Shareholder relations is certainly a risk for a company using the crowdfunding route.
Q: What’s the ideal outcome?

A. The Crowdfunding Act is very interesting because securities laws started in 1933 after the Great Depression. After that time, there have been about a dozen significant securities laws, all designed to protect investors and prevent fraud. There has been little focus on raising capital and benefitting companies and startups until the JOBS Act. This is the first law that wants to ease regulatory burdens. The ideal outcome will be to strike the perfect balance between easing burdens/costs for startups and small private companies and protecting investors so they don’t lose their life savings, and make sure there aren’t bad actors out there taking advantage of the public. It will take time to reach a happy medium in practice, but I don’t think crowdfunding is going away.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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