Crowdfunding may provide an interesting way for some
companies to raise capital. It's definitely getting a lot of the hype
since passage of the Jumpstart Our Business Startups (JOBS) Act
earlier this month. I've read articles talking about how crowdfunding is
going to disrupt funding for small businesses (in a good way).
Personally, I don't see it...certainly not in the short-term. Perhaps the
SEC's pending rulemaking will make this an amazing option, but right now I'm
not sure that otherwise financeable companies will find this option better than
the other existing methods. The currently projected costs are simply
too great. The process is expensive both initially in setting up the
intermediary/crowdfunding process itself (vs. dollars raised) and also on
an ongoing basis in terms of shareholder maintenance. Add to that the
likelihood that crowdfunded companies, at least early on, probably will be
targeted by plaintiff class-action lawyers, possibly based on nothing more than
the fact that the concept is new and untested. SEC rulemaking is scheduled
for 270 days from passage but may take even longer. Until then, anyone
trying to setup a crowdfund will be doing so at their own peril, without an
understanding of the rules that may apply to them retroactively. In
short, for private companies, crowdfunding remains an enigma and all we
reasonably can do for the rest of this year is debate its merits.
For fund managers, however, the implications
of crowdfunding are already clear - you can't use it.
Almost all private funds are deemed to be "investment
companies" under the Investment Company Act, and "investment companies" are
required to register under the Investment Company Act of 1940 (the "Investment
Company Act") (similar to what mutual funds must do) unless they fall
within an exemption from the registration provisions.
Fund managers of private equity funds typically rely
on one of two exemptions from being treated as an "investment company":
The new crowdfunding rules specifically prohibit
investment companies, including those that are exempt from investment company
registration under Section 3(c) or 3(b), from crowdfunding:
(f) Applicability.-Section 4(6) shall not apply to
transactions involving the offer or sale of securities by any issuer that...(3)
is an investment company, as defined in section 3 of the Investment Company Act
of 1940, or is excluded from the definition of investment company by section
3(b) or section 3(c) of that Act; or (4) the Commission, by rule or regulation,
In short, you can't crowdfund a fund.
the Venture Alley for more articles about business and legal issues
important to entrepreneurs, startups, venture capitalists and angel investors.
For more information about LexisNexis products and
solutions connect with us through our corporate site.