Thomas Palmer and Andrea Schmidt
The Daily Record Newswire
“Crowdfunding,” under the JOBS Act, will create an unprecedented opportunity for entrepreneurs and small businesses to raise capital by selling securities to ordinary investors using the Internet and social networking sites.
When implemented, JOBS Act crowdfunding will permit small companies to raise up to $1 million per year. Until the new crowdfunding rules are finally adopted by the Securities and Exchange Commission, however, such offerings remain unlawful under the securities laws.
Rulemaking by the SEC has been delayed, perhaps until the end of 2013, so it’s unlikely that JOBS Act crowdfunding will be available before sometime in 2014. A crowdfunding industry has nevertheless emerged that may provide viable crowdfunding-like alternatives for some entrepreneurs. These alternatives are similar to — but also different from — the type of crowdfunding envisioned by the JOBS Act.
In order to prevent abuses of crowdfunding, Congress imposed restrictions on crowdfunders in the JOBS Act to protect investors. These include required disclosures at the time of the offering about the company’s officers, larger shareholders and business. In some cases, audited financial statements also are required, depending upon the amount of capital to be raised.
In addition, crowdfunding offerings must either be conducted through a traditional securities broker or a “funding portal” that does not offer investment advice or solicit sales of securities. If the offering is successful, the company must also comply with continuing disclosure requirements.
These regulatory burdens – likely expensive and time-consuming — may limit the usefulness of crowdfunding for startups and other small businesses even after it becomes available, causing many entrepreneurs to consider alternatives.
Rewards-based options
The simplest and most widely recognized alternative is probably the rewards-based crowdfunding provided by Kickstarter, Indiegogo and others. Rewards-based crowdfunding does not involve the offer or sale of a security. Instead, startups promise to provide a product or service to the investor in the future.
In one highly successful example, Elevation Labs of Northeast Portland raised more than $1.4 million on Kickstarter to produce an aluminum dock for an iPhone. Investors who contributed a minimum amount received a heavy-weight iPhone dock in return.
Smaller rewards-based crowdfunding campaigns have also been successful. Kickstarter has evolved into a favorite mode of generating startup capital for Portland’s booming food cart industry.
Accredited investor platforms
Other alternatives involving the actual sale of securities, not products, include accredited investor crowdfunding platforms. These online platforms are open only to “accredited,” or wealthy, investors. An accredited investor is generally one who has $1 million or more in liquid assets or $200,000 in annual income.
Accredited platforms such as FundersClub and AngelList have formed funds that make investments in small companies. These funds offer their own securities to investors. The funds receive a share of the eventual profits, if any, from the startup companies in which they invest – but no transaction fees, which means they don’t need to register as a securities broker.
An alternative type of accredited investor platform is the broker-dealer model, such as CircleUp Network, that has partnered with a registered securities broker. This type of platform may collect traditional transaction fees based on the amount of securities of the startup company that are placed with accredited investors.
One of the main disadvantages of all of these platforms (unlike the original concept of crowdfunding) is that they are limited to accredited investors. Meanwhile, the pool of potential retail investors among the general public will be much larger after JOBS Act crowdfunding becomes available.
In addition, companies wishing to raise funds on an accredited investor platform face significant competition from other young businesses and must typically submit to an exhaustive vetting process prior to being accepted by the platform.
Traditional options
These entrepreneurial alternatives to JOBS Act crowdfunding may be quite useful for some small companies, but founders should not overlook traditional private placements to friends, family and angel investors that may involve fewer restrictions and fewer disclosures. Such traditional private placements may also be less expensive and less time-consuming to complete.
Offerings within one state, which are registered with the state and can be sold to a broad base of investors within that state, may also be another alternative for some companies, such as those with a local retail presence.
Until the final SEC rules related to crowdfunding are adopted, we will not know with certainty whether the costs will outweigh the benefits. Other creative platforms that comply with current securities laws, as well as traditional private placements, may under most ordinary circumstances be superior alternatives for many young companies.
Accredited investor funding portals
• AngelList (https://angel.co/) originally introduced startups to accredited investors. Recently it expanded its services, together with SecondMarket, to allow investors to invest directly through AngelList. Companies listed on AngelList are vetted by AngelList, and only accredited investors can view current investment opportunities. AngelList does not currently charge in connection with transactions, but that may change in the future.
• FundersClub (https://fundersclub.com/) allows accredited investors to become equity holders in venture funds managed by FundersClub. The venture funds then invest in pre-screened private companies. FundersClub currently does not charge fees, other than administrative fees, for its services.
• Fundable (www.fundable.com/) offers rewards-based or equity-based funding. Equity-based funding is available to accredited investors only. Fundable allows companies to create a profile for free, but charges $99 per month to raise money.
• CircleUp (https://circleup.com/) raises equity earmarked for small businesses in the consumer products and retail industries. There is no cost for a company to join CircleUp, but CircleUp charges a fee based on the amount raised in the offering.
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Thomas Palmer is chairman of the corporate finance practice group at Tonkon Torp LLP. Contact him at 503-802-2018 or tom.palmer@tonkon.com.
Andrea Schmidt is an associate in the corporate finance practice group at Tonkon Torp LLP. Contact her at 503-802-5703 or andrea.schmidt@tonkon.com.
