When Crowdfunding Isn’t Crowdfunding

What Many People Refer to as “Crowdfunding” – Isn’t

I try to make careful distinctions about the legal categories we use when it comes to the issuance of securities or of raising money as contributions.

The popularity of Kickstarter, GoFundMe and IndieGogo, all true crowdfunding platforms, has enamored so many that investors and portal operators alike have eagerly embraced the notion and begun calling what they engage in “crowdfunding” even though that is not what it is.  How did that happen and what is the problem with it anyway?

Let’s start with the basics. The premise behind crowdfunding is the opportunity for the “crowd” to participate early on in investing in a product, idea or company and help it to reach its first stage of high trajectory success.  So if you not only want a Fit-bit, but want it to be such a popular item that your friends will envy what you have, instead of pre-ordering it while the manufacturer tries to raise money through traditional channels, you make a contribution online, get your “reward”, a Fit-bit, and voila, it’s not long before your family and neighbors are asking, “how’d you get that?” Next step, they order their own.

To the manufacturer, all they really did was a make a sale. But they made the sale in such a way  as to turn their customers into evangelists. This is the greatest product in the world. So the early version of crowdfunding was the most effective form of bootstrapping since the snow shovel industry invented blizzards. You make sales, lots and lots of sales – okay, receive “contributions”- and you don’t need equity investors, or even borrowers. You don’t dilute your growing ownership equity in the company. So crowdfunding was working – except for one thing. It wasn’t an investment system…yet.

Then in April 2012, Congress passed, and President Obama hastily signed, the JOBS Act. The acronym stands for Jumpstart Our Business Startups. The idea was that there are tons of entrepreneurs out there with great ideas they just can’t get to market because of the cost, and they need, upfront investment to make it happen.  And they weren’t accessing the capital readily, were not in a position to borrow funds, and just needed to get going for their business to succeed.

Back in 2011, when the JOBS Act was proposed, the word on the street was that software application companies, local retailers, and mom and pop businesses were dying on the vine because the banks were very tight with their money, and they did not have access to accredited investor money for the most part, because it was only interested in larger, later stage deals.  So investment, or regulation, or Title III crowdfunding was created by the legislation with two things in mind. One, giving the small business operator the chance to raise some early stage capital, and two, giving the ordinary investor, who is not an accredited investor, a chance to participate in the market early on and reap some rewards typically only enjoyed by larger scale investors.

Unfortunately, there have been two problems with this scenario. The small businesses have not been able to raise much startup capital; and, the ordinary investor has not been able to participate. Why?  It’s easy to say the US market does not desire this type of investment opportunity. Perhaps that is true. But its fair to recognize: (1) it took four years for the SEC to promulgate final regulations on Title III crowdfunding, and (2) even then, the regulations seem to me to quantifiably exceed their statutory authority.

So into the void, “faux” “crowdfunding” portals have swept into the marketplace. Mostly, these portals are using online listings to raise money from “accredited investors”. I put that phrase in quotes because, for the most part, verification of accreditation is a self-directed activity, subject to no second- or third-party scrutiny. Do investors who do not meet the accredited investor standard actually invest in these deals? Surely at least a few do. But it seems as if all the arbitrary standards imposed by the SEC may have actually backfired, because as far as I can tell, you can accomplish everything you would through a Title III raise, without being subjected to its regulations, and potentially allowing non-accredited investors into the mix, who may be investing greater than the limits arbitrarily imposed by the JOBS Acts’ regulatory scheme.

Technically, however, these portals, Fundrise, Angel List, Crowdrise, etc., are not truly crowdfunding, because at least in theory, their listings are not available to the crowd. This is why I say that what many people refer to as “crowdfunding, isn’t.

If you’re interested in how you can utilize these methods, what it means to be an accredited investor, what to do if you want to be a company-issuer of securities, or what to do if you’re an investor with questions about crowdfunding, I would be happy to answer your questions. Just call my office, (317) 604-1276 if you’d like to discuss. Otherwise, we’’ follow up with answers to some questions raised by this post in our next edition at the end of May.

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