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Entries in Compliance (1)


True Crowdfunding Platforms Still a Long Way Away

I’ve always thought of crowdfunding as a key development that had the ability to dramatically change how startups are funded. While crowdfunding has evolved to the point of becoming a viable and legitimate means through which to raise capital for “projects,” there still is a long way to go before crowdfunding can be used to raise capital for companies in exchange for equity. The good news is that there seems to be some promise on the horizon.  

A while back I wrote about Profounder, a site I thought had made significant progress on the crowdfunding front.  When Profounder launched back in early 2010, it seemed to have developed a platform that allowed entrepreneurs to raise funding for their companies from the public. What I thought was impressive about Profounder was that it appeared they had found effective workarounds to SEC Regulation D. Regulation D essentially requires registration with the SEC if there is any offer to sell securities (typically the case when a company is raising capital in exchange for equity). There are a few exemptions to the rule though, and Profounder looked to have found a way to apply them to build a true crowdfunding platform. Here were a few key workarounds I had identified:

  • A required password protected pitch page
  • The need to have a “substantial pre-existing relationship” with potential investors
  • Entrepreneurs could only raise up to $1 million
  • Entrepreneurs had to provide investors with a certain percentage of revenue each year - notice you are not offering up equity in the company
  • The number of investors was limited to 35, all other investors after the 35th could not receive a percentage of revenue; instead they were rewarded for their contribution by giving that same percentage of revenues to a nonprofit in their honor

While there were clearly limits, it was the most progress anyone had made. Since its launch though, Profounder has pivoted away from this crowdfunding model to simply providing the “tools for entrepreneurs to raise their investment capital,” as opposed to an actual online platform. I think reasons for why this pivot was made may have been raised on Quora back in December of 2010. Profounder looked to have found an exemption under Rule 504 which actually allowed for the raising of up to $1 million in capital from unaccredited investors (no net worth requirement). The issue with Rule 504 is that state laws come into play, which can be incredibly difficult and complex to manage, particularly when you start to deal with more than a coupe of states. I think Profounder maybe underestimated the complexity or could not figure out a way to manage it for the users of its service in a cost effective manner. Furthermore, there probably were issues around general solicitation (which is barred under Regulation D). To circumvent this, Profounder made sure that users had a “substantial pre-existing relationship” with potential investors. One issue with this is that it leaves it up to the user to determine what is “substantial.” Another is that to avoid issues with the SEC and tap only those you really have a “substantial” relationship with severely limits the “crowd” in crowdfunding.

I’m not sure if Profounder ran into issues or simply found that compliance was too burdensome to allow for a true crowdfunding platform. Regardless, the compliance issue is what has been a major hindrance to the emergence of true crowdfunding platforms. Yes, we have sites such as Kickstarter which allow for the raising of money for projects, but note that no ownership is exchanged and no investment returns are provided aside from a “reward.” Because of this Kickstarter avoids all SEC issues. It’s also why crowdfunding has been centered on the creative arts.

Once relatively new exception I have found is a site called Venture Bonsai. Venture Bonsai actually lets you raise an investment round inside the service; however it is limited to companies based in Europe where securities laws are a bit more lax as they relate to private placement. The legal framework used can be found on their site – I thought this bit was a good overview:

“This framework is built in such a way that the Share Issue can be arranged within the service as easily as possibly while still following the regulation related to private placements within the European Union. The example documents have been built in such a way that they can be modified to meet the minor differences in each national legislation.”

So there’s some progress being made across the Atlantic, but what about here in the US? Well the good news is that there has been enough interest in the space to get the attention of the SEC. In April, the SEC said it was in the very early stages of a review of securities law as it related to crowdfunding. In a letter, SEC Chairman Mary Schapirio said they have “‘been discussing crowd-funding and possible regulatory approaches" with small-business representatives and state regulators. Apparently “A petition calling for the securities rules to be eased for crowd-funding share issues of up to $100,000 has been backed by almost 150 organizations and individuals,” according to the Wall Street Journal.  While not a substantial amount, the ability to raise $100,000 through crowdfunding would at the least make it easier for entrepreneurs to raise capital and would make for a competitive alternative to angel funding for some. 

Being able to crowdfund capital for a startup means that more companies get started and more innovative ideas get the chance to be proven.  I can’t help but think that it would be good for job growth and the economy. It would also change the venture landscape, perhaps for the better, as more new startups are generally a good thing for venture firms. Hopefully a decision by the SEC comes soon and true crowdfunding platforms emerge. In the meantime I’ll be monitoring the SEC’s actions regarding crowdfunding and will share any updates.