Check out this really nicely done analysis of how legal and other costs kill the federal crowdfunding exemption before it is even legal: “Death by Expense” of Crowdfunding?, by Nancy Fallon-Houle, It is posted on the Corporate Counsel site and I got the link from watching Joe Wallin and Antone Johnson tweet about it.
Fallon-Houle's main point is that public offerings, and particulary those targeted at unsophisticated investors, must have disclosure documents. And disclosure documents are expensive. They are expensive becuase disclosure documents are expensive to prepare. And they are expensive because the actual organization, business and affairs of the company being described actually have to conform to what the disclosure document says. That is to say, there is invariably clean-up to do, things to fix that weren't done right in the first place.
"Crowdfunding offerings are small capital raises by definition; however, the legal fee costs are not scalable to 'small', simply because of the small amount of capital raised! In fact, the legal fee cost tends to be higher for smaller raises. Smaller raises are typically effected by unseasoned Issuers, who sometimes do their own intellectual property work without counsel, who form their own entities without counsel, and using parochial ideas about percentages of ownership; therefore often shooting legal holes in the investment. Small unseasoned issuers sometimes can even be loose cannons (from a legal standpoint), including on social media, and including comments about the offering that may possibly be illegal."
One facet of Fallon-Houle's analysis is a variation of the Fred-Wilson-$5,000-in-legal-fees-seed-financing-challenge: that's not an unreasonable budget for a small note or Series Seed financing to a small group of all accredited investors; but it's the clean-up and organizational stuff previously not done, that breaks the budget.
It's hard to take issue with Fallon-Houle's thesis: of course disclosure has to be made.
But do lawyers have to be the ones organizing the company and fixing things?
A couple years ago, I raised the question, don't lawyers have to be pushed out of investment crowdfunding, in order for it to work? My thought then - and from the perspective of today, after we've seen the proposed Regulation Crowdfunding, I think I was right - was that companies wishing to access a crowdfunding exemption should be templatized. That is to say, they should have a form of organization, stock, agreements with founders (including IP assignments and vesting), and other arrangements that are standardized and do not vary from company to company. Ergo, no clean up necessary; instead, opt in to the same structure and set of agreements every single other company accessing the exemption chooses.
Of course, you can't templatize all of the contracts that the given startup will end up negotiating and signing with outside parties. :/
Photo: Harsha K R / Flickr.