Crowdfunding Law

Let's Get Crowdfunding Right

Month: August, 2012

Investment Portals: One-size Fits All Crowdfunding Offering Terms Will Not Work

Some would-be equity-based crowdfunding portals intend to permit listing companies do only a single form of offering.  Whether that is common stock, preferred, debt or what have you, this strategy is not likely to work in the real world for issuing companies.  Crowdfunding investment portals will need to permit issuing companies to be much more innovative in structuring offerings than a “one-size fits all” approach if the portals intend to be remotely relevant.  

Last month I attended a Q&A with the group from the SEC charged with writing the regulations for internet portals operating equity-based crowdfunding platforms. I was extremely impressed by David Blass, Chief Counsel, S.E.C. Trading and Markets Division, and his team members who are charged with drafting these regulations.  I was less impressed by the questions that came from the audience.  One such attendee represented a would-be investment portal and asked Mr. Blass several leading questions suggesting that the SEC should, by regulation, require a certain structure of the investment for crowdfunding investments. The attendee had a very specific notion of what that form would be.  Mr. Blass, speaking for himself and not the SEC, politely disagreed.  Mr. Blass consistently provided the same answer to different forms of the same “question.”  Specifically, he noted that the SEC should not be concerned with the many forms that the structure of an offering can take.  He stated that the SEC should be focused on making sure that the structure chosen is adequately and properly disclosed to those to whom the offering is made.  In other words, if issuing companies make the structure complex, they better find a way to adequately describe what people are getting and how it works.

Not only is Mr. Blass’ position entirely sensical, the crowdfunding exemption needs this flexibility to be relevant in the world of corporate finance.  The reality is that corporate finance is extremely complex and is dependent upon the specific business, the nature of the business model, the stage of the business, the level of technical and other risks and the nature of the use of proceeds.  In some situations, common stock will make sense.  In other situations, the risk might be a debt risk with an equity kicker.  In still other businesses, a project finance structure may be more appropriate.  If portals do not understand these different circumstances, they will quickly find themselves irrelevant amongst their peers in the industry.  Further, if investment portals require listing companies to use a single form of offering, very few companies will use that platform.  Portals have a strong interest in having paternalistic instincts toward investors. Portals need to be comfortable that the form of an offering listed on their site is properly disclosed.  It is not going to be simple.  Portals should understand that in advance–the SEC is not going to be able to dumb this down to a “one-size fits all” mandate.

Three Myths Regarding Investment Crowdfunding Platforms

As I interact with players in the investment crowdfunding arena, I am starting to hear some consensus opinions from crowdfunding portals and would-be crowdfunding portals that seem me to be unlikely.  For what it is worth, I think these are myths that will turn out to be mostly untrue.

Myth One: Crowdfunding Platforms will play a Primary Role in the Success of any Offering

I don’t think this is likely to any strong degree.  Keep in mind that investment crowdfunding platforms are not permitted to market specific offerings.  They will only be allowed to direct attention directly to their platform generally.  Similarly, investment portals cannot offer investment advice to potential investors.  Like donation-based crowdfunding has taught us, success is usually won or lost based on the individual efforts of the project owners themselves.  Getting the word out about the offering is going to be the responsibility of the issuer.  Sure, some sites will aggregate lots of general traffic and that will be an advantage but the work is going to need to be done by the issuing companies–regardless of which platform they use.  However, if you cannot market and push your project, you will not get your offering funded–whether the offering is on a high traffic site or not.  Because investment crowdfunding will be “all or nothing,” getting less than your goal means you get nothing at all. Crowdfunding sites will quickly learn that they are not the most important component of the success or failure of investment offerings.

Myth Two: Software is a an Important Differentiator for Crowdfunding Portals

With many internet companies, proprietary software is a must (either actually or because institutional investors perceive it to be that way).  Many crowdfunding sites are spending large amounts of money on the creation of software that will meet the requirements of the JOBS Act, the SEC and FINRA (when all of those requirements are known).  I am surprised that all of these sites are duplicating efforts and expense–at least as to the back-end development work.  Software is not really going to be the critical factor for these platforms.  It is all likely to be the same at the end of the day.  No offense to my developer friends, but back-end software is not going to drive this train.  Front end developers and designers may find more appealing UI/UX–but that is where the money should be spent.  Veteran back-end developers like Mike Pence at Hayduke Labs understand this component.  That is understandable because Mike has seen it all as the lead developer on Kickstarter before anybody ever heard of Kickstarter.  He is coordinating efforts to develop a back-end solution collaboratively amongst various crowdfunding platforms.  Likewise, white label solutions will come forward and those that spend too much too early will likely look foolish in retrospect.  Collaboration is probably in everybody’s best interest.

Myth Three: Large Numbers of Crowdfunding Portals will Consolidate Quickly After Investing Begins 

Maybe this is a reason for some of the lack of cooperation amongst portals.  This one also strikes me as bit of wishful thinking by would-be portals.  Crowdfunding is not like many other internet businesses.  Everyone will not join the “Facebook of investment crowdfunding.”  In this manner, I expect investment crowdfunding will be like traditional investment banking.  Sure, there will be some “bulge bracket” platforms that emerge.  However, there will still be an abundance of platforms.  Some platforms will be niche or geographically specific.  Some will simply be boutique.  Investment crowdfunding will be an ocean and not a pond and there will be room for all types of platforms to be successful.

I’m interested in the views of others on these topics.

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