Crowdfunding and its Legal Issues

I recently conducted a talk with attorney Wayne J. Chi at The Box Jelly on crowdfunding. During the talk we discussed the various legal issues surrounding this alternate method of raising capital. Wayne brought with him his experiences of being an attorney and an entrepreneur. Some of his clients in California have used crowdfunding for things like app development. As an entrepreneur he is trying to launch his own crowdfunding site, Rice Bowl Project, to be used for social causes.

For my own part, I stuck to the general problems a business faces when engaging in crowdfunding. I have an interest in this phenomenon as it is within the realm of social media and the law, and many of my clients try to find resources to get their dream business off the ground. For the rest of this post I will briefly touch upon the securities issue, which is the biggest concern about crowdfunding and the legislation going through Congress that might provide an exemption. While, crowdfunding has been an effective source for small projects, like films, apps, and social causes, its use for funding a business is met with caution by the Securities and Exchange Commission (SEC). This federal agency is responsible for the oversight of stocks, the markets, in which we trade, and things that look like stocks. This is where the SEC has issues, when a business gets a whole bunch of money before it has gotten started, and has in exchange given the promise of something in a future return, such as “ownership.” Notice that the pledge system, used by many crowdfunding sites, looks like this type of deal, which the SEC has determined is a security. In order to do a securities sale (or even an offer to sell), a business must go through a long process of registering the sale or it can file for an exemption, which in turn has a whole laundry list of requirements.

In the case of, two individuals sought to raise $300 million and in exchange pledges would receive beer and “crowdsourced ownership” of the company. The SEC stepped in and the two men agreed to cease their operations. In addition, it is not just the businesses, but the crowdfunding platforms themselves that have to register. They are considered a broker-dealer, and anyone familiar with investments knows that broker-dealers have to go through significant time and effort to register with the SEC. However, all of these roadblocks have galvanized some to creating an exemption in securities law for crowdfunding. HR 2930 would just do that, and has recently passed the House. While the President has indicated he is willing to sign such a bill into law, its fate in the Senate at this time is unknown. While many startups would like to see this bill passed there are still some concerns to be addressed.

Businesses still need to be concerned about a variety of other issues with crowdfunding, even when not exchanging ownership. The doling out of services and products for these pledges still invites contractual issues, such as disclaimers, warranties, and misrepresentation. The use of the web to promote your project brings a whole host of advertising law concerns. Finally, a lot of crowdsourcing sites require some sort of disclosure by the business, which could impact some of your intellectual properties. All of these legal issues should be met with care and possibly be discussed with an attorney.

Image (By The Library of Congress)