Is Crowdfunding Evil?

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A preliminary presentation on investment crowdfunding and what you have to do to avoid trouble

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Is Crowdfunding Evil?

  1. 1. Is CrowdFunding Evil? Only If You Aren’t Careful
  2. 2. DISCLAIMER The contents of this presentation are for general information purposes only and should not be considered legal advice. No lawyer-client relationship is created between the author and reader. Always speak with your attorney before seeking to solicit investment.
  3. 3. TOPICS This panel will discuss issues related to the benefits and perils of securities-based crowdfunding for companies seeking investment and potential investors, including: •The legal basis and requirements for investment crowdfunding •The risks of investment crowdfunding •The possible advantages of crowdfunding •How companies and investors can avoid trouble
  4. 4. WHAT IS CROWDFUNDING Crowdfunding describes different means of raising money from a diffuse base of people the recipient does not necessarily know or meet: •Donation Crowdfunding - solicitation of money to achieve a goal (charity/art project etc.) •Perk Crowdfunding - offer of a benefit in exchange for donation (tangible or artistic) •Presale Crowdfunding - company offers a product in exchange for advanced funding to make that product •Investment Crowdfunding - company offers a security (debt or equity) in exchange for money. In the US this is done pursuant to the provisions of the 2012 JOBS Act
  5. 5. INVESTMENT CROWDFUNDING IN THE US Offerings of securities have to be registered with the SEC or qualify for an exemption Prior to the 2012 JOBS Act offerings viewable by the general public had to be registered with the SEC The JOBS Act changes this in a couple of ways: •Creates a new exemption for Accredited-Investor only Regulation D offerings that allow general solicitation (506(c) offering) •Creates a new exemption for limited solicitation/limited amount offerings to the general public (Section 4(a)(6) offering)
  6. 6. INVESTMENT CROWDFUNDING IN THE US The JOBS Act DID NOT change the basic rules of securities offerings, which, if you aren’t careful, can get you in trouble: •A raise must be registered or meet the requirements for the exemption -- otherwise it is invalid •Issuers can be liable for securities fraud for material misstatements or certain omissions •Liability can take the form of criminal and civil penalties, rescission of the raise, and exclusion from the capital markets in the future
  7. 7. OFFERING REQUIREMENTS Certain requirements need to be met for a company to be able to offer securities. Among them are: Making certain the offering is without defect: •Legally possible •Properly authorized by the company Ensuring company communications are accurate, complete, and in proper venue: •Misleading material statements or omission of information needed to make a statement not misleading are forbidden •Type or location of communication may be limited Ensuring that the investor is actually allowed to make the investment: •506(c) - Are investors accredited? •4(a)(6) - Is investor under their investment limit? (responsibility of investment platform)
  8. 8. OFFERING REQUIREMENTS Where are problems likely to occur? Defect in the raise: • Corporate defect (problem with incorporation, not in good standing, etc.) • Offering defect (type of security not allowed, not properly authorized by board, etc.) Communication inaccurate or in the wrong venue: • Contains information that is misleading or incomplete • Occurs outside approved methods or locations (requirements vary based on type of offering) Investor is ineligible to invest in this deal: • 506(c) - Investor isn’t accredited • 4(a)(6) - Investor has already invested their limit for the 12mo period.
  9. 9. OTHER POTENTIAL PROBLEMS Legal problems are not the only possible problems for companies that seek investment via crowdfunding •Current shareholders may be diluted •Bond obligations may divert capital from operations •Companies will have ongoing obligations to their investors, many of whom may be distant and unknown •Will have to take new investors (and their rights) into account when planning the company’s future moves •May have to deal with less-sophisticated but more activist investors •Mistakes/miscommunications during the raise live on on the internet - forever •Future Investors/Acquirers may be leery of a messy cap table
  10. 10. SO WHY CROWDFUND? With the potential problems why would companies seek investment from crowdfunding? Better terms •You may be able to negotiate better terms from the crowd than from a bank or VC •Crowdfund investors may have better expectations on profitability, timing, and control Better Access •You can use the internet to tap funding from anywhere •Possibly less need to be in a “hot” industry or space Ability to Build Brand •If done right you can build a brand along with your investor base •But if done wrong you have angered a group of people on the internet
  11. 11. HOW DO YOU DO IT RIGHT? So how do you do Crowdfunding right? Get your ducks in a row •Make certain your corporate formation and governance are taken care of •Decide the type of offering you want and make certain it is legal, feasible, and properly authorized by the company Be transparent and honest •Helps avoid misstatements and mistaken investor expectations •May help you get more attention from investors Get the help you need •Broker-Dealers, Portals, Lawyers, CPAs, and others can help ensure compliance Pay attention to investor obligations after the raise •Some legal requirements may attach •Investors are with you long after you cash the check
  12. 12. WHAT ABOUT INVESTORS? What Risks Should Investors Consider Before Crowdfunding? The Company •Most young companies fail •Companies seeking crowdfunding may not have the same growth prospects as those that get VC funding The Investment •Resale of these securities will likely be restricted in some way (e.g can only be sold to Accredited Investors) •You may only have limited rights with your investment Fraud •It is possible fraudsters will try to sell shares in nonexistent companies •Even well meaning companies may be overly optimistic in their pitch materials
  13. 13. WHAT ABOUT INVESTORS? What Should Investors Consider Before Crowdfunding? Have Reasonable Expectations •It is unlikely you are investing in the “next big thing” •Decide what you want out of the investment (psychic benefit, financial return) and if this investment is likely to give you that Understand what you are buying •Know what your exit options for the security are •Understand your rights as an investor Protect Yourself •Is something sounds too good to be true it probably is •If you have questions or concerns ask the company, if you don’t get a good answer walk away
  14. 14. CONCLUSION Investment crowdfunding is a potentially powerful tool for companies and investors. Done wrong it can create significant problems, but done right it can create and new and dynamic market and spur and democratize economic growth and wealth creation. It rests with companies and investors to make certain it is done right.

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