New York Corporate and Securities partner Marc Leaf was quoted in a New York Times article titled, “Doubt Arises as Investors Flock to Crowdfunded Start-Ups” by Nathaniel Popper. The article discussed the regulatory and compliance issues that exist for crowdfunding websites.
Crowdfunding is an evolving method of raising money using the internet. Until recently, businesses could not publicly offer stock, notes and other securities without registering under the Securities Act and complying with a wide swath of regulatory requirements. Exemptions were available for offers to institutions, wealthy investors and persons with whom the issuer had a prior relationship, but most Americans were shut-out from investing in start-ups and other private companies.
The JOBS Act and related SEC rulemakings created a series of new exemptions, including Regulation Crowdfunding and amendments to Regulation A known as Regulation A+, which allow some offerings to be made directly to retail investors, with scaled-back disclosure and compliance requirements. Crowdfunding in particular is geared towards small investors, as offerings are limited to an aggregate of $1 million raised, and individual investments are capped at a percentage of the investor’s income or net worth, measured over a 12 month period. This new exemption is tailored to the dynamics of the internet, as offerings can only be made over an interactive platform maintained by a registered intermediary, which may be either a broker-dealer or a new class of intermediary with fewer regulatory requirements called a “Funding Portal”.
The Times article noted that, while some websites follow the regulations for crowdfunding portals laid out by the SEC, others have allowed noncompliant companies with “major red flags” to list their startups. Low compliance rates and high valuations have led some crowdfunding advocates to call for a set of industry standards that crowdfunding sites would adhere to when vetting potential investments. As quoted in the article, Marc said that so far, “many companies were asking for investments on terms that few real venture capitalists would accept.”
“I would expect them to be very risky,” Marc said. “The question is, over time, will we see that there is wisdom in the crowds or will we see that there is a madness in the crowds?”
Drinker Biddle & Reath LLP publishes the Drinker Biddle Crowdfunding Report, a downloadable open data set providing information on offerings conducted under the Regulation Crowdfunding exemption, together with analysis and practice tips. The Report has been updated to include data on all valid filings through December 31, 2016.