46
Legal Focus
JULY 2014
Crowdfunding
For many companies, crowdfunding is the only viable source for financing. After the last fiscal crisis, it has become increasingly difficult for companies, especially startups, to obtain financing from traditional sources of financing. Going to the public to obtain financing unlocks an entirely new universe for companies to obtain capital. It also provides a new avenue for smaller investors to invest in deals that they would not otherwise be offered through traditional investment banks and placement agents. We find out more by speaking to Stephen Katz, Director of the Corporate Law Practice Group at Peckar & Abramson, PC.
What can you tell me about the SEC’s new crowdfunding rules?
The SEC’s crowdfunding rules are still not yet in effect. After much deliberation and apparently quite a bit of thought about the issues surrounding crowdfunding, the SEC published its proposed rules in October of 2013. The hope is that the rules will become effective at some point this summer. Until the rules become effective, companies cannot do crowdfunding through the sale of securities to the public at large, except in the limited circumstance of sales of securities to accredited investors under Rule 506 of the Securities Act of 1933. Crowdfunding from the public at large is currently limited to donation based funding without the sale of securities on websites such as Kickstarter, Rockethub and Indiegogo.
The rules create the regulatory playing field for smaller companies to sell securities on a crowdfunding platform without the time and cost of having to do a public offering. The rules also provide for a new form of funding platform specifically created for crowdfunding called a “crowdfunding intermediary”. A crowdfunding intermediary is essentially the online host for crowdfunding deals. It is not a broker dealer and does not have to register as a broker dealer, however, it will have to register as funding portal and it will be subject to FINRA regulation and oversight. Traditional broker-dealers will also be permitted to host crowdfunding offerings on portals maintained by broker-dealers.
The rules also aim to protect against fraud by requiring financial disclosure by issuers, due diligence obligations of operators of funding portals, prohibitions against “bad actors” from utilizing crowdfunding portals. Additional investor protections are contemplated by limiting the amount an investor can invest in crowdfunded securities offerings based upon the investors net worth and income and limiting the amount a company can raise in a twelve month period to $1 million dollars. the offerings to be conducted. Another important protection contemplated by the proposed rules is that the entire offering and all communications must be conducted completely online on the funding
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portal. This will provide investors with a level playing field as all investors will be able to evaluate the same information, communicate with each other on the funding portal and essentially form a consensus of the crowd about a particular company and its offering.
Do you think the rules will result in a positive change for crowdfunding?
The rules will certainly create a much greater market for crowdfunding in the U.S. by allowing crowdfunding through the sale of securities. Assuming the final rules as enacted are adequate to minimize fraudulent activities while not adding too much cost and difficulty to conduct crowdfund offerings and comply with the regulations, it should be a very positive change for crowdfunding.
What are the benefits of crowdfunding?
Crowdfunding provides companies access to capital from the public without the cost, time and effort of selling securities through a registered public offering. It provides smaller companies with access to the public to obtain funding where traditional sources of funding are unavailable, inadequate or too costly. It also gives small investors a new platform to seek investment opportunities.
What challenges accompany crowdfunding?
The biggest challenges accompanying crowdfunding through the sale of securities is the uncertainty around the new SEC’s proposed rules and how they will be interpreted and enforced. In the U.S., the sale of securities through crowdfunding is uncharted territory. There is significant concern about the potential for abuse of the new rules on the one hand and also concern that the rules will be too cumbersome and costly for the market for crowdfunding to develop to its full potential.
How has/can your firm assist the client when such challenges arise?
We have been very actively monitoring the new rules and discussing them with industry leaders and
regulators and we can help clients navigate the murky waters surrounding crowdfunding regulations.
What are the common legal implications faced by your clients when involved in crowdfunding?
The legal implications of crowdfunding include the same implications as with any other securities offering conducted in the United States, namely investor protection. Issuers and portals need to make sure they are complying with all the rules and regulations in order to protect themselves from investor claims and regulatory issues.
Has obtaining finance become more or less difficult in recent years? Why?
With the recent economic downturns and increased volatility in the markets, obtaining financing has definitely been more difficult in recent years.
Do you foresee the need for further legislative change in the next 12-24 months, if so why?
There will absolutely be a need for further legislative change. As with any new rules and regulations, there will need to be adjustment to meet the realities of the market and there will undoubtedly be some unforeseen circumstances that will arise that will need to be addressed by additional legislation and regulations.
Is there anything else you would like to add?
In general, we view the ability to sell securities through crowdfunding transactions as a very positive development and we are ready, willing and able to assist all participants looking to engage in crowdfunding transactions. LM
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