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Crowd Funding: The Rules of the Game

Imagine that you need to raise $100,000 for your business. With limited options, you seek the internet as source of funds. You place a campaign on a third party website that allows you to reach infinite amounts of people, who may want to donate to your cause in exchange for different types of creative gifts you offer in return. A California based company, Pebble Technology did just that and surpassed its $100k goal to set an incredible record of securing over $10 million dollars in just thirty days! Granted, this is probably the highest campaign to date; however, it begs the questions: How did they do it and what are the rules of the game?

Well, as most entrepreneurs know, access to capital has been increasingly difficult for small businesses, which in turn affects jobs, tax revenues, and a host of related areas.  Fortunately, on April 5, 2012, the Jumpstart Our Business Startups Act (JOBS) was signed into law, allowing crowd funding to exist as a way to infuse much needed capital into the business sector.  Crowd funding is a way for the "crowds" to invest online in ventures of their choosing in exchange for equity.  Currently this does not comport with securities laws; however, the Securities and Exchange Commission (SEC) is actively setting forth rules that implement the JOBS Act provisions on crowd funding, so that the balance between access to capital and reduction/prevention of fraud can effectively be balanced.  One of the key issues relates to third party websites that serve as a conduit between the entrepreneur and the investor. These portals are the subject of debate in terms of how their role will be shaped to effectuate that balance of providing access to capital and protecting from investor fraud.  While sites currently exist under the donative (gift) model, where causes, business, and various projects have sought funds in exchange for gifts, this area of business and law is about to propel to new levels, particularly once the SEC and FINRA (Financial Industry Regulatory Authority) rules are established.

Does Your Business Need Cash?

If you own a business and need an infusion of cash, borrowing from banks has become increasingly difficult during these recessionary years.  Most business owners logically look toward family and friends as sources of capital.  On face value this may be just fine; however, the "devil is in the details."

Technically, whenever a business is raising money it's in exchange for shares of stock or membership units.  Those shares or units are the evidence of ownership as a result of receiving the funds.  These shares or units are securities, and as such, are governed by both state and federal laws.  Granted, many small businesses taking money from friends and family fall within exemptions to state and federal securities laws; yet, it is critical to ensure that your company does in fact fall within and comply with those exemptions. Otherwise, penalties can be assessed, and depending on the circumstances, there can be other more serious consequences if any fraud or misrepresentation to the person or entity giving the money is proved (if a dispute happens down the road).

So if your business needs money and it can’t be obtained through traditional sources, what should you do?

•  Most of the exemptions to securities registration prohibit advertising, so you should not advertise that you need money unless you talk to a lawyer knowledgeable in the area.  There are limited "tombstone ads" that may be placed, but this shouldn't be done unless you have sought legal advice.

•  Assuming you are just asking a family member or friend for the money, you should definitely have the necessary legal documents drafted. These documents will reflect what needs to be done from the company's perspective in terms of complying with your Bylaws or Operating Agreement.  Other related documents will address the sale of the share or units in exchange for the funds, and still more documents will address appropriate disclosures to protect your company. Overall, you will generate some paper, but the "bark" here is bigger than the "bite."

•  Your company will need to file appropriate documentation with the state Department of Corporations. This is done online and is to be done within 15 days of the company issuing any stock in order to avoid penalties.

While all of this may seem a bit burdensome, in the end, doing this will position your company to reduce risk with respect to regulatory compliance and an investor who was your family member or friend, but is now your plaintiff.


This information is intended for general educational purposes and not specific legal advice.