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Kickstarter and other crowdfunding platforms to grow in the very near future

Kickstarter is one of the main examples of a crowdfunding type of company.  It solicits money to help fund new projects or companies.  So is this general advertising, solicitation, and funding by a non-broker/dealer or intermediary that is not allowed by law? Yes and no.

Although their terms of use and other information on their website do not specifically state this, they are essentially relying upon the fact that the money used is in the form of a gift (or pledge as they call it) to the company.  The person pledging the money does not get an ownership interest or much else in exchange for their contribution.  Usually a company obtains funding by selling stock or getting a loan and enters into a sale of stock or sale of a promissory note.  These are securities and are subject to federal and state law regarding their offering, purchase, and sale.  Generally, a company cannot use general advertising or solicitation of the investment if they want to use the exemptions from registration available by law.  Two examples: First, Facebook files for an IPO and the world knows they are selling stock.  They have filed a registration statement, or S-1, with the SEC and this complies with laws to allow them to be able to publicly announce the sale.  Second, Most startup or small companies do not have the resources or want to try to go through the process of filing with the SEC.  They rely upon exemptions from registration to sell stock.  The law puts certain requirements that need to be met to be able to use those exemptions, one of which is that they can’t go out and issue a press release or put on their website that they are trying to raise $1 million by the sale of their stock.

If Kickstarter or any other similar platform started selling an investment in the company where the investor gets something in return like a loan or stock, they could be guilty of federal securities law violations, especially if they took a percentage of the funding raised without being a licensed broker/dealer.  However, here comes H.R. 2930.

There is a bill that is in the US Senate waiting for a vote that would allow a crowdfunding exemption and the use of intermediaries in connection with certain limited sales of securities, H.R. 2930, the so-called “crowdfunding exemption or bill.”  (Actual Text & Bill Summary).  It has already passed the US House and was part of a jobs bill pushed by both republicans, democrats, and the president.  It sounds like that bill is going to be put for a vote in the Senate in the next few weeks.  All conventional wisdom says that it should pass with flying colors, be signed by the president, and become law relatively quickly.

So how will this affect Kickstarter or other similar fund raising sites?  If the company follows the intermediary limits in the law and future SEC rules, they could start helping companies raise money with a $10,000 cap and potentially get paid to assist, even though that would be selling a security. The $10,000 cap is technically listed as “per investor” so they could help raise up to the $1 million 12 month cap with only up to $10,000 per individual investor and take a cut on those rounds.  Whether Kickstarter wants to change their model to include investments remains to be seen, but I am sure companies looking for money or those wanting to be the middle man will start popping up all over. They can publicly advertise and close deals; however, even the middle man can be prosecuted or sued if anything in the process could be seen as misleading, false, or inaccurate. That is a lot of liability to take on with major disclosure requirements for the company and intermediary.  The other problem for companies and intermediaries is the cost to comply with all the disclosure and other regulation involved in the process.  Also, if the company does one full crowdfunding raise and gets the max of $10,000 per investor, that is a minimum of 100 new investors or 200 investors, if they provided audited financials and raise the $2 million cap.  There are laws and SEC rules in place for certain companies that have over 500 investors requiring the timely and costly registering of securities with the SEC.

We will see in the next few weeks when it will likely go into affect. In the end, I predict it really won’t provide a huge amount of “useful” capital to the market, but we will see probably a lot of new companies or websites trying to capitalize on this new small funding market.

I particularly like the statement by Columbia Law Professor John Coffee, Jr. when testifying about HR 2930 in front of the SEC, “every barroom in America might come to be populated by a character, looking something like Danny DeVito, obnoxiously trying to sell securities to his fellow patrons. He could provide each fellow patron with a business card that noted that the securities carried high risk, but would need to provide no other disclosure.