Is Crowd Funding Right For Your Business?
The Jump Start Our Business Startups Act (JOBS Act) is now signed into law. Part of that legislative package is the CROWDFUND Act, which permits a company to raise capital in exchange for equity (or other securities) through “crowd funding.” Previously, a company could not raise money use modern conventions (e.g. the internet or social networks) to solicit investments without registering the company with the SEC (a very expensive endeavor).
In my opinion, the crowd funding method will be a complete game-changer in the way entrepreneurs and startup businesses access capital, as it opens a new non-traditional method of raising capital. The entire process of raising capital will become more accessible and efficient for entrepreneurs, startup businesses, and investors. Check out this project, which raised $1.4 million in a matter of days using Kickstarter, a website implementing crowd funding techniques without exchange of securities or ownership.
For some companies, the crowd funding exemption may be a godsend that will help provide the business the capital injection necessary to grow to the next level. However, it won’t be right for every company seeking capital, as complying with the crowd funding exemption comes with its costs. Thus, the decision on whether to seek capital through crowd funding should be carefully considered. Of course, if crowd funding is the right path, then the company should properly prepare for such an undertaking.
Some of the major factors to consider before jumping into the crowd funding craze are as follows.
1. Securities Law Compliance. Complying with securities laws is crucial to raising capital and requires the counsel of an experienced attorney. Compliance will include, but is not limited to, making the proper filings with the SEC and the various state securities authorities and providing the proper written disclosures to the SEC, state securities authorities, and prospective investors. Unlike other the traditional methods of raising private capital, the crowd funding exemption requires that the company make the proper to the SEC and various states of the crowd funding offering before offers are even made to prospective investors. Failing to do so will disqualify the company from the crowd funding exemption. In addition to, and as part of, the notice filings with the SEC and various states in which offers are made, the company seeking capital is obligated to disclose certain information. One of the most important disclosures required is the anticipated business plan of the company. As a result of disclosing the business plan to a wide array of investors and various government agencies, the company can be sure that the business plan will become publicly available to its competitors. In fact, it’s likely that such information will be readily available and searchable on the SEC’s website once filings with the SEC are made. Of course, there are several other procedures that a company must follow to comply with law. But, I’ll spare you all the boring compliance details. Contact us if you’re interested in learning more about the technical compliance rules.
2. Amount of Capital Needed/Investor Limitations. The crowd funding exemption only permits raising up to $1,000,000 in a 12-month period; however, there are certain additional requirements related to financial statements if the company desires to raise more than $100,000 and even more requirements related to financial statements if the company desires to raise more than $500,000. Likewise, depending on the net worth and income of the prospective investor desiring to participate in the offering, an investor’s investment in the company may be limited to an amount between $2,000 and $100,000. There are limitations on the number of shareholders that a company may have as well (for both securities compliance and tax compliance). Be sure to stay within the proper limits.
3. Corporate Clean Up. Are your corporate books and charter documents prepared for these new shareholders, security-holders, or members (collectively “shareholders”) (with whom you likely have no personal relationship)? Bringing on new shareholders requires careful corporate planning. The rights and preferences of the new shareholders should be carefully enumerated and specified prior to issuing them the securities. Such preparation may require small “housekeeping” matters (like minutes and record keeping), but, it may likely entail revamping the company’s charter documents (e.g. articles of incorporation, bylaws, operating agreement, shareholder agreement, etc.). Also, once such person becomes a shareholder, they will be entitled to certain inspection rights on your corporate records. Are you prepared for shareholders to be poking around in the company books?
4. Long Term Considerations. Are you looking for capital only? Or do you really need “smart money” (i.e. sophisticated investors with industry experience, connections, and insights)? If the company really needs “smart money,” crowd funding will almost certainly be the wrong path.
Also, do you really want all of these shareholders in your company? The nature of raising capital through crowd funding increases the risk of accepting funds from disruptive shareholders. Entrepreneurs may not be appreciative of inquiries and complaints from numerous shareholders, whether warranted or unwarranted. Of course, there are additional additional administrative duties that come with more shareholders as well. For example, company’s are typically required by law to hold periodic shareholder meetings and provide certain information to shareholders. Likewise, certain actions by a company will require approval from the shareholders and, depending on how much ownership is sold in the crowd funding round, the company may have to obtain consent from the crowd fund shareholders to take certain actions. Hosting meetings for, providing information to and obtaining consents from shareholders can become an administrative nightmare for a company.
Finally, will the round of crowd funding be the only source of financing that the company ever needs? Or will the company likely want more traditional financing in the future? If so, I’m not sure how such traditional financiers will feel about the crowd fund shareholders when it comes time to make a deal. The current sentiment seems to be that such traditional financiers will disfavor companies that use crowd funding. But only time will tell if having crowd fund financing will truly kill a deal down the road.
These are just a few of the considerations that a company must contemplate before entering undertaking a crowd funding offering. A company considering crowd funding should consult with an experienced corporate and securities attorney prior to making the decision. Likewise, if the company ultimately decides to seek capital through crowd funding, it should work closely with an experienced corporate and securities attorney to prepare for the offering. Please contact us if we can be of any assistance to you or your business.