Published in the Union Leader (11/16/2015)
Q: I’m the founder of a small business that, though successful, will require an additional infusion of capital if operations are going to continue to grow. I’ve exhausted my current network of investors, primarily friends and family, leaving me to consider other alternatives to finance the company’s growth. Is crowdfunding a viable option?
A: On October 30, 2015, in what has been hailed by some as a seismic shift in federal securities regulation, the United States Securities and Exchange Commission (“SEC”) adopted long-awaited rules to permit companies to sell unregistered securities to the general public through so-called “equity crowdfunding” offerings, limited to $1 million during a twelve-month period. It is expected that the final SEC rules, known as “Regulation Crowdfunding,” will become effective as early as the second quarter of 2016, in essence opening up a new frontier for small business owners, start-ups, and entrepreneurs seeking outside investment.
There is understandable optimism that Regulation Crowdfunding will revolutionize the means by which small businesses and early stage start-ups raise capital from investors. Indeed, this model may very well present an attractive option for many businesses that would not generate interest from venture capital or otherwise have access to broad-based investment. That said, companies considering a possible crowdfunding offering in the future cannot be blinded by the perceived upside, and must be aware of the limitations, costs, and the demands crowdfunding entails, both in terms of the disclosure and financial reporting requirements, and the challenges that can be expected to come with numerous outside shareholders who may not be experienced investors.
The concept of equity crowdfunding is, at its core, a logical extension of the powerful crowd-based fundraising model that has taken hold in the age of social media: a company, using an internet-based platform, solicits relatively small individual investments from a large pool of potential investors and, in return, grants to each investor a share of the financial returns or profits generated from the business activities financed through the funding initiative. While this framework has undeniably proven its worth in fundraising efforts for a vast array of not-for-profit ventures in recent years, the profit-sharing or “equity” crowdfunding model has been difficult for regulators to reconcile with a regulatory regime that has traditionally relied on elaborate registration, disclosure, and reporting requirements to combat fraud and protect investors that purchase securities offered through general solicitation.
Compliance with these investor protection mechanisms can be both time-consuming and costly for the issuer, historically resulting in considerable hurdles for small, privately-held businesses seeking to raise capital from a broader base of investors. Although conscious efforts were made to minimize these burdens for companies pursuing an offering under Regulation Crowdfunding, compliance demands associated with a crowdfunding offering should not be underestimated or taken lightly.
Prospective issuers contemplating an offering should be prepared to publicly disclose considerable information, including: information about the company, its officers, directors, and shareholders; the planned use of the crowdfunded proceeds; the target amount and price determination method; information on the company’s financial condition; and, perhaps most importantly, financial statements that, depending on the amount of equity offered and sold, are accompanied by information from the company’s tax returns, reviewed by an independent public accountant, or audited by an independent auditor.
Simply put, whether the crowdfunding model is a proper fit for you and your business and whether the business is ready to meet the compliance and disclosure standards required by Regulation Crowdfunding are two distinct issues that require careful consideration and advance planning before setting to work on your first crowdfunding campaign.
Bradford Melson can be reached at [email protected].
Know the Law is a bi-weekly column sponsored by McLane Middleton, Professional Association. We invite your questions of business law. Questions and ideas for future columns should be addressed to: McLane Middleton, 900 Elm Street, Manchester, NH 03101 or emailed to [email protected]. Know the Law provides general legal information, not legal advice. We recommend that you consult a lawyer for guidance specific to your particular situation.