Access to money is one of the most important issues for business and individuals and often times, one of the most difficult. However, over the past few years, crowdfunding- a form of raising money from the public for a specific purpose through general solicitation- has exploded into the market as a new tool for raising capital.
The applications are seemingly limitless. Crowdfunding can be applied to nearly any industry and any (legitimate) fundraising initiative, and it is being utilized in some form or another worldwide. Crowdfunding campaigns have been used to finance films, television shows, video games, new technologies, restaurants, charitable purposes, businesses, litigation, and so on. According to The Crowdfunding Centre, a London-based industry data analysis firm, as of October 2014, crowdfunding reaches more than 160 countries, is available to 90% of the world population and generates approx. $2 million a day. Equity crowdfunding is projected to have a $550 billion growth over the next decade. In addition to providing a new source of capital, crowdfunding can be a significant tool for branding and market validation.
The two primary means to raise money through crowdfunding are (i) donation-based crowdfunding (hereafter, “DCF”) and (ii) equity-based crowdfunding (“ECF”).
The DCF model is a form of capital financing via general public solicitation of a monetary donation for a specified objective. Individuals and companies create and promote their DCF campaign via platforms like Kickstarter and IndieGoGo. Donation-based crowdfunding can be used for anything from raising money to fund a school field trip, to getting bailed out of jail, but the more commercial applications of DCF generally deal with pre-sale situations and provide a useful way to gauge market demand for a product. Campaigns with tangible items and rewards and those with a set goal and end date generally tend to have more success. Unlike ECF, donation-based crowdfunding is not specifically regulated by the government. Fortunately, due to the social media aspects and transparent nature of the process, campaigns that do not deliver on their goals are called out by the crowd, creating a sort of organic monitoring and verification system.
Equity-based crowdfunding- a form of raising capital by selling equity for a given venture via general solicitation to the public- is regulated by federal and state laws. It was officially ushered into the business mainstream with the passage of the JOBS Act in 2012. There are two primary distinctions with ECF- selling equity to (i) accredited investors (which requires meeting a number of legal criteria, including having a high annual income or substantial assets) and (ii) non-accredited investors. The general concept is to distinguish wealthy individuals (i.e., accredited investors) from the non-wealthy ones (non-accredited) under the premise that wealthy individuals are presumably more sophisticated in financial matters and less susceptible to fraudulent offerings; therefore, accredited investors require fewer disclosures and protective frameworks for capital offerings.
With respect to accredited investors, Title II of the JOBS Act removed the prohibition on general solicitation for private placement offerings. As a result, the majority of the larger ECF portals currently operate pursuant to Title II and facilitate and promote ECF offerings to accredited investors only. Title III of the JOBS Act added a new section to the 1933 Securities Act titled Section 4(a)(6), which provides an exemption from registration requirements for ECF campaigns open to non-accredited investors. Congress directed the Securities and Exchange Commission to establish a framework for regulating the new exemptions, but the Commission has yet to issue the final rules.
If the Commission is able to craft an efficient regulatory framework for ECF for non-accredited investors, it will have a tremendous impact on all industries, especially those that are currently underserved by investors. In the UK, such offerings are already permitted and account for nearly 40% of the ECF market.
Crowdfunding presents a brave new world for business owners by providing a new way to access capital. The laws and business applications are evolving rapidly. Our firm represents clients in a wide range of matters related to crowdfunding, including entrepreneurs interested in forming an ECF portal, investors looking to invest in ECF campaigns, companies looking to post their equity offerings on existing ECF platforms as well as parties looking to address business disputes and recover damages in connection with crowdfunding campaigns.