Crowdfunding is Here! Part 4

WEEK 4 OVERVIEW & ANALYSIS

Equity crowdfunding represents unchartered waters for the SEC, and it’s still not clear whether it provides a comprehensive solution to capital access.  As such, the SEC has agreed to submit a report within three years detailing the impact of the equity crowdfunding regulation on capital formation and investor protection.  The report will review the incidence of fraud, investor losses, compliance with investor contribution limits, fee and compensation structures for the platforms, and the concept of a centralized database of investor contributions.  Industry analysts also will be watching to see if the regulations’ reporting requirements create the same expense and compliance issues that already make it challenging for small scale entrepreneurs to access capital.

Whether or not you believe these new regulations will facilitate a small scale entrepreneur’s ability to access capital, here are five things you should understand about the functionality of the crowdfund exemption:

  1. Equity crowdfunding is completely different from donor-based crowdfunding such as Kickstarter, GoFundMe, or Indigogo.  On donor-based platforms, crowdfunded money is classified as a gift or exchange of services.  Equity-based crowdfunding means that entrepreneurs sell equity ownership in exchange for investment money.
  1. There’s a ton of red tape before a company can start selling securities online.  In addition to filing an annual report with the SEC and providing it to all investors, the Commission has a laundry list of requirements a company has to disclose to prospective investors.
  1. It costs money to raise money.  The SEC estimates that registering and meeting their requirements will cost $20,500-$56,500 for companies seeking to raise between $100,000-$500,000.  That figure doesn’t include the marketing costs associated with leveraging a successful crowdfunding campaign.  Costs would include online platform fees totaling $15,000-$30,000, preparation and filing of SEC forms at $2,500-$5,000, issuing an annual report at $1,500-$3,500, and financial statement audits at $1,500-$18,000.
  1. There are two options for crowdfunding platforms.  Companies can only run one crowdfunding campaign at a time, so it’s important to choose carefully.  Some platforms operate as funding portals, which are prohibited from providing advice or compensation, soliciting investors, or handling investor funds or securities.  Other platforms operate as broker-dealers, which help companies navigate legal red tape, assist in matching companies with investors, and provide other investment advice.  All crowdfunding platforms are required to register with the SEC.
  1. Attracting investors may still be an up-hill battle.  Investors are not allowed to resell their securities until one year after purchase, which means entrepreneurs will have to work hard to gain investor confidence.  Beyond that, it’s unclear if a secondary resale securities market will eventually develop.  If it does not develop, this could drop the demand for and value of crowdfunded securities.

As with any new government regulation, there are a lot of moving parts.  You do not want to engage in an equity crowdfunding campaign without advice from the professionals.  The stakes are too high.  Founders need assistance protecting their intellectual property, regulatory compliance, incorporation, document preparation, and valuation of the securities.  We highly suggest that anyone interested, whether as an entrepreneur seeking capital or an investor looking for new opportunities, talk to your attorney, or potentially an accountant or securities expert before embarking on the next wave of crowdfunding.

– Malika Simmons

 

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