7 Cautions for Entrepreneurs Considering Crowdfunding

From Mike Drzal, LeClairRyan:

Here is a list of 7 cautions for entrepreneurs thinking about using the new “crowdfunding” exemption from the registration requirements of the securities laws (.pdf).

1.  There is a limit of $1.0 million in any 12-month period.  This limit means crowdfunding may not be suitable for many companies, e.g., high growth companies that need more capital to support their growth.

7 Cautions for Entrepreneurs Considering Crowdfunding2.  The limits on investments by individual investors create a high likelihood that a company using crowdfunding will end up with a large number of small shareholders.  In addition to the practical problems created by having to deal with a myriad of small shareholders, having a capitalization chart cluttered with  small investors is not viewed as a positive by organized angel groups and venture capital firms.

3.  Importantly, the company using crowdfunding cannot conduct the offering itself but rather must use a broker or a “funding portal.”  This will burden a relatively small capital raise with a certain amount of red tape and additional expense by way of fees paid to the intermediary.

4.  Background checks are required on the key management of the issuing company.  Not necessarily a negative, but something to consider.

5.  Companies using the crowdfunding exemption are subject to a number of disclosure requirements.  These include: (a) filing a business plan with the Securities and Exchange Commision (SEC); (b) filing financial statements with the SEC; (3) risk disclosures; and (4) other disclosures that may be prescribed by the SEC.  This is poison for companies trying to stay under the radar so that competitors don’t swoop in.

6.  Annual filings will need to be made to the SEC and disclosed to shareholders.  This means disclosure of information not required in traditional private placements.

7.  There are restrictions on the resale of securities purchased in a crowdfunding transaction.  This may scare away small investors who don’t have the net worth to sustain an illiquid investment.

Bottom line, the attractiveness of crowdfunding is seriously diminished by the expense, restrictions, and disclosure requirements mentioned above.  How widely crowdfunding will be used remains to be seen, but recourse to this funding avenue is not a no-brainer by any stretch.

Read The Crowdfunding Bill: Opening the Floodgates, a client alert from LeClairRyan (.pdf).

Mike Drzal will be the keynote speaker at the VT KnowledgeWorks Entrepreneurship Challenge in Blacksburg, Virginia on April 11, 2012.

Of further interest: Three Fundamental Tools in the Fundraising Toolbox by Mike Drzal and more from LeClairRyan on Handshake 2.0.

LeClairRyan specializes in high-tech corporate law.LeClairRyan is a law firm that has deep entrepreneurial roots, having originally been founded as a venture capital boutique. With more than 350 attorneys and offices from Virginia to New York to California, the firm provides business counsel and client representation in matters of corporate law and high-stakes litigation. Its mission is to achieve excellence for its clients by providing integrated, responsive and timely services.

LeClairRyan and VT KnowledgeWorks are clients of Handshake Media, Incorporated, the parent company of Handshake 2.0.

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  1. Interesting from the Wall Street Journal:

    Doing Equity Crowd Funding Right
    Small businesses are getting a powerful new financing tool. But there are plenty of pitfalls.


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