The JOBS Act, which became law on April 5, 2012, included for the first time in the U.S., a legal structure that will permit the use of general solicitation in connection with small, non-registered investment offerings in the context of crowdfunding. The SEC still needs to adopt implementing regulations before this funding vehicle becomes available and the market decides if it is viable. This will take several months, if not a year. But in the meantime, the naysayers are hard at work, proclaiming their opinion that crowdfunding is a dangerous idea.
From the perspective of the company seeking funding, many "experts" are sounding the warning that it is a very bad idea for a small, early-stage company to have a large number of small investors, which is likely to happen if capital is raised through investment crowdfunding. These experts are not wrong that this is a concern, but we believe that the risks can be managed in such a way as to make investment crowdfunding a viable vehicle to raise capital.
It will always be preferable for a company to have a small number of investors, if possible. With each additional investor comes one more person who may increase administrative burdens by frequent calls and e-mails requesting information and offering unsolicited advice, requesting investor meetings, and exercising rights to inspect books and records or attend and participate in investor meetings. Litigation with investors can also be more challenging (and expensive) with larger numbers of investors. More investors can make the sale of the company more cumbersome. And some prospective angel or institutional investors for later rounds of financing may be put off if there is a large number of existing investors.
That said, obviously, there are many companies, large and small, that manage successfully with a large number of investors. And if the only alternative to crowdfunding is no funding, then the better approach may be to mitigate the downside of a large number of investors with good legal planning.
For example, stock to be sold using crowdfunding may be non-voting stock with transfer restrictions imposed. The company may retain redemption rights in order to have a vehicle to remove investors under specified circumstances. And a minimum investment amount should be required to eliminate the possibility of really small investments and a resulting increase in the total number of investors. These are elements that should be evaluated whenever an investment is sold. With the potential for a large number of investors, this analysis takes on heightened importance. There may also be state laws applicable to companies with a specified number of shareholders which you can opt out of with proper advance planning. With good legal counsel, you should be able to take steps to mitigate the increased risk associated with having a large number of investors.
You should also accept responsibility for keeping your investors informed. You should issue regular status reports, which you can do electronically at little cost. Even if business is not going as hoped, if you keep investors informed, they are less likely to make trouble. It is when a company goes "dark," and investors are unsure what is going on, that investors are most likely to become active and challenge management. You hold the power through regular and accurate communication to mitigate this risk.
In short, while the existence of a large number of investors does present certain challenges, with the help of good legal counsel, you should be able to manage this risk. If your choice is crowdfunding or no funding, crowdfunding may be a good choice.
For more information please contact Iris Linder at 517-371-8127 or by using the form below.
Iris' practice focuses extensively in corporate and securities work. She has experience representing companies in connection with fund formation and private placements of securities, as well as SEC reporting and registration. She also works on venture capital investment transactions, representing both investors and portfolio companies.View All Posts by Author ›