The Startup Lawyer, with Jamie Fugitt
The JOBS Act passed in April 2012 with deadlines for certain high-profile items (equity crowdfunding and loosened general solicitation regulations) pegged for fall of 2012.
Tech entrepreneurs and startups collectively cheered: “Yay, we can get investments on the internet from random people!” And, “my lawyer told me not to generally solicit investments. I’m not sure what that meant, but I don’t have to worry about it anymore!”
Not surprisingly, the 2012 deadlines passed without final crowdfunding rules and without investment solicitation changes. So, where are we now?
In late January, the SEC folks in charge of JOBS Act implementation met with some VC-types and a roomful of lawyers and discussed the present and future of the JOBS Act. (Sounds like a party, right?) Here are three important points from the SEC directors at the conference (and an extra note on strategy and planning from national VC):
What is the new timeline? There is no timeline. The SEC is working hard to finalize the crowdfunding and solicitation rules (and feels national pressure to get it done), but there will not be any new deadlines or time commitments. The SEC’s focus (rightly so) is on creating a good and workable system from the start. This requires careful planning. So, no, you can’t crowdfund your startup for equity today or anytime in the near future. And, no, you still can’t generally solicit investments.
What will equity crowdfunding (eventually) look like? It is not certain at this point, but the SEC gets that most crowdfunding will happen on the internet. As such, the current plan centers on “funding portals” – aka crowdfunding websites. The specifics of what these sites can do, and how they can do it, are still on the table. For example, must the sites be simple, unvetted lists of investment opportunities, or can they be curated lists of targeted, featured or even promoted offerings? Will these sites standardize or limit the investment terms offered through their portals, or will companies be able to structure their offerings as they choose? These issues (and many others) are extremely important, but currently unclear. The final rules will answer these questions. And ultimately, the final rules will affect how successful equity crowdfunding is in practice, especially for higher-value companies that could raise money in a traditional way.
Does equity crowdfunding mean early stage investments will be easier and cheaper? Leading crowdfunding sites will no doubt feature “funding portals” that feel effortless and quick through rock star UX/UI design and back-end development. But these same sites will also feature (less prominently) careful disclaimers that tell companies to seek independent counsel before making a crowdfunding offering. These disclaimers have a purpose. The SEC is not designing a DIY system for equity crowdfunding. There will be specific rules to follow. There will be regulatory hurdles to jump. If a company fails these obligations, it will risk very real consequences. Simply put, crowdfunding is not a less regulated minor league of investments. It is still the majors. It may be an expansion team, but it is “the Bigs” all the same.
How will VCs and other traditional funding sources view crowdfunded companies? The Chair-elect of the National Venture Capital Association gave these thoughts (summary):
Crowdfunding is a good and exciting tool. If used smartly, it will increase access to capital for young companies and could democratize early stage investing. For example, crowdfunding will allow an easier path to seed funding at a time when startup costs are decreasing dramatically. A web company with a few hundred thousand dollars today can achieve important milestones that would have cost $1mm plus a few years ago. An easier path to these early but critically important funds should increase the number of founders with a realistic chance to build an emerging company ripe for VC attention.
But if used recklessly, equity crowdfunding will create a host of problems for founders, and possibly “fatal” ones. For example, a “wild west” cap table loaded with crowdfunders will be “completely unattractive” for VCs. The fear is these crowdfunders will be less sophisticated about the business model, more impatient about investment returns, and more likely to hamstring the company for unimportant issues. These risks can be overcome with good planning, structuring and management, but it is easier to prevent them while they are risks than it is to correct them when they are problems.
Takeaway point: just because you are allowed to do it doesn’t mean it is a good idea. Be smart. Consider equity crowdfunding to be a fundraising supplement and manage it like the rest of your fundraising tools.
DISCLAIMER: As always, my posts are not legal advice.
(Jamie Fugitt is an attorney with the Little Rock firm of Williams & Anderson PLC with a focus on startup law and legal innovation. He is a graduate of the University of Arkansas and Harvard Law.)