28 posts categorized "Guest Posts"

Support Washington State Crowdfunding

Guest Post from @joewallin

If you live in Washington State and want to support crowdfunding in Washington State, now is the time to email your Washington State Senator and ask that they support HB 2023. 

You can find all of the State Senators' emails at this web address

Please send your Senator an email urging them to pass HB 2023, which would authorize crowdfunding in Washington State.

An example email might be: 

Re: Please Pass HB 2032

Dear Senator, 

I am a member of Washington's entrepreneurial community. Please support HB 2032, which would authorize crowdfunding in Washington State. The bill is the product of over a year's work between the Washington Department of Financial Institutions, entrepreneurs, securities lawyers, and other stakeholders. It enjoys broad bipartisan support. It passed 89-9 out of the House, and unanimously out of the Senate policy committee.

Please vote yes and help entrepreneurs from all over Washington State. Thank you! 

Please help.

Action February 25 on the Washington State crowdfunding bill

Note from Bill: this is a guest post by  & Joe Wallin.

Tomorrow, Tuesday, February 25th, the Washington State Senate is having a hearing on HB 2023, titled the Washington Jobs Act of 2014.

HB 2023 is a state crowdfunding bill.

It would allow Washington startups to raise up to $1M during any 12 month period, from accredited and non-accredited investors. There are individual investor caps in the state bill that track the same individual investor caps in the federal JOBS Act.

If passed, the bill would be substantially more accessible for startups than the federal crowdfunding bill. 

You can read the latest text of the bill at this link: http://apps.leg.wa.gov/documents/billdocs/2013-14/Pdf/Bills/House%20Bills/2023-S.E.pdf

There are several articles that have been written about this bill that can help you get up to speed on it:

If you would like to attend the Senate hearing tomorrow, your presence at the hearing and support of the bill would be greatly appreciated.

If you want to attend, please RSVP at hb2023.eventbrite.com

Other data:

Full text of the bill: 2023-S.E

House bill report: 2023-S.E HBR APH 14

Official web site: http://apps.leg.wa.gov/billinfo/summary.aspx?bill=2023

Senate Committee web site: http://content.govdelivery.com/accounts/WALEG/bulletins/a6a571

Map of Olympia, WA: Campus map

Why Kickstarter Can’t Change the World But Somebody Else Can

Note from Bill: this is a guest post by Danan G. Margason, an internet and transactional lawyer and a former rower for the US National Team. I asked Danan to write a post for our community because I was fascinated by what he told me about his parents wanting an alternative to a stock portfolio managed on Wall Street. Danan sees the potential equity crowdfunding might have for empowering people locally.

A few days ago Bill linked to a fascinating interview with Kickstarter CEO Perry Chen. The most revealing part of the interview, as Bill pointed out, is when Chen says that the “disruptive aspect [of Kickstarter] is the removal of the investment component. People are supporting projects because they want to see them happen. It’s so different than supporting a project because you hope it profits.”

In other words, Kickstarter doesn’t want to become a marketplace for equity investors—they want to abandon the equity model entirely.

For me this was a shock. While Kickstarter made similar claims when it started, I operated under the belief that Kickstarter’s only rationale for banning equity investing is that it’s illegal under our existing legal framework (this, of course, could change with the JOBS Act). I assumed, as did many others, that Kickstarter would adopt an equity model as soon as it had the chance. While it’s great that projects on Kickstarter raise an average of $5,000, that’s nothing compared to what could be raised if companies were able to offer equity.

But by now Kickstarter’s intentions are clear. The JOBS Act passed over 7 months ago and the Kickstarter team has had ample time to consider the pros and cons of adopting an equity model. They decided against it.

What does this mean for Kickstarter and for investors? To me, the key word for Kickstarter is “projects.” Chen says the word throughout his interview, and if you go to the Kickstarter website it’s plastered everywhere. Not once does Chen, or the web site, use the word “company.” This is because Kickstarter doesn’t want to bring companies, and their investors, into the fold. They simply want to be the go-to site for funding creative, interesting, one-off projects.

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I’m disappointed. While I’m happy to offer kudos to Kickstarter for staying true to its vision, Kickstarter is squandering an opportunity to do something tremendous. I firmly believe that projects are worthwhile and deserving of funding, but projects also aren’t going to change the world. Investments and companies, I think, can.

My parents are a perfect example of how this would work. At a recent dinner for my dad’s birthday, my mom said she wished there was a way to sell their entire stock portfolio and reinvest the money in local companies. They wanted the things you would expect: more awareness of what they were funding, better relationships with the companies they love, and more money directly tied to their community.

But while my parents’ vision is a simple, powerful, and brilliant, it’s also virtually impossible to implement. Current securities regulations effectively prevent unsophisticated investors like my parents from obtaining equity in small companies. And even if systems allowed them the flexibility to invest, there’s no single resource that allows for objective evaluations of startup prospects.[1]

For this reason, I think a company that can effectively facilitate investments in small companies will fundamentally change the way we do business. It would alter investment strategy by shifting power away from corporations and back into the hands of local consumers (and if done right, unaccredited investors would still be protected). The possibilities are astounding:

  • Imagine a world where you could support your local coffee shop not just by telling your friends, but buy actually owning a piece of it.
  • Imagine a world where instead of desperately protesting Wal-Mart’s demolition of the local grocery store, community members could rally to buy shares of the store and prevent its sale in the first place.
  • Imagine a world where instead of waiting for a bank to loan money for a new neighborhood restaurant, you could encourage people at the block party to become investors and create the ideal restaurant for the area.

I thought Kickstarter, with its popular brand and useable platform, would be the company to make this happen. Sadly, it won’t.

Fortunately startups like Fundable and CircleUp are trying to fill Kickstarter’s void. Other models exist too, like the “Slow Money” movement that encourages people to invest in local food sources (supporters have raised over $20 million for 170 small food enterprises in the past 2 years).

But for an idea so groundbreaking, I’m surprised we haven’t seen more. During my lifetime I expect to see a fundamental shift in the way we invest. I expect local, socially conscious investing to become the norm, and Wall Street fund managers to become more and more obsolete. It’s possible, perhaps even probable, that it will happen over the next decade. It gives me chills with excitement, and why not?

The internet has cut the middleman out of nearly every industry. Wall Street investors are the obvious next target.


[1] I want to make a distinction between “unsophisticated” and “unaccredited.” While my parents probably qualify as accredited, they would, like most people, have a terribly difficult time navigating the world of venture capital. 

Rob Weiss on Thomas Klein's call for regulatory competition: this may not be the best way to fix equity crowdfunding

Note from Bill: The following is a guest post by Robert Weiss, a finance and securities lawyer based in New York City. We met at the Docracy "Equity Crowdfunding Dissected" event in Brooklyn, and in the week since have been exchanging thoughts (including comments on the "Individual Crowdfunding Account" idea). Follow Rob on Twitter or connect with him on Linkedin.

This post is a response to an exciting post by Thomas Klein published at VCExperts.

In that post, Mr. Klein argues that truly effective reform of US securities regulation would result from creating competition between state legislators and securities regulators, on the one hand, and the US Congress and the SEC, on the other hand.

Muni regulationsThe “competition” would be over issuers (or perhaps more precisely over filing fees, taxes or other kinds of revenue a jurisdiction, whether it be state or federal, would raise from securities issuances under its authority).

Drawing on empirical research regarding the salutary effects of regulatory competition in the corporate law context, Mr. Klein concludes that regulatory competition in the securities context would benefit both issuers and investors by (1) improving the quality of both regimes and (2) providing maximum flexibility for issuers of securities.*

Among other areas, Mr. Klein directs his argument to the JOBS Act, and specifically the new law's crowdfunding provisions, which he finds to be unworkable because too restrictive. We are more likely to find. he argues, a workable solution through regulatory competition between state and federal regulatory regimes.

Mr. Klein’s argument does indeed address problems inherent in the JOBS Act’s structure and provisions. It probably is folly to expect that, by piling on "more of the same" from the tried and true paradigm of additional disclosure, a meaningful crowdfunding exemption can result.

But I have a couple of counter-points I think we should consider.

(1)  Corporate law may not be the right analogue to equity crowdfunding.

Mr. Klein (and others) present strong evidence that regulatory competition in corporate law has benefited both companies and, at least with respect to public companies, their investors.

The research also points out that most public company equities are held by institutional investors that are likely to be more sophisticated than the SEC itself. (Many people advocating for less regulation make this point.) This distinction is critical to getting the benefits from regulatory competition in corporate law: smart investors prefer investing in companies subject to good corporate governance regimes, and states want to attract successful companies so as to increase franchise or corporate tax revenues; accordingly, states have an incentive to have good corporate governance regimes so as to attract those kinds of companies.

It’s not clear, though, that less sophisticated investors (e.g., small investors participating in equity crowdfunding) could or would impose the kind of market discipline necessary to make regulatory competition worthwhile in equity crowdfunding. Other industries, where there are greater asymmetries among participants, may be more analogous to equity crowdfunding, and regulatory competition in those areas has not always been beneficial. 

Consider the insurance industry. Each US state regulates insurance business conducted within its borders. There is no federal insurance regulator or regulatory regime (though the federal government has imposed regulation in certain areas, most recently with the Affordable Care Act and Dodd-Frank). Now, insurance seems far afield from securities regulation. After all, insurance companies must be licensed ex ante to do business in each state; except for those states whose blue-sky laws include merit board reviews (which are few and dwindling), complying with the securities laws is a disclosure matter, and problems are resolved ex post. But the first and foremost purpose of insurance regulation is to protect policyholders, who are almost always at a distinct disadvantage in understanding the terms of insurance policies.

Similarly, one of the hard problems in crowdfunding is whether and to what extent we are willing to expose potentially unsophisticated investors to extremely opaque, and highly risky, investments. At least as far as protecting investors who may not be informed or sophisticated, insurance regulation may be a better analogue than corporate law.

The benefits of regulatory competition in insurance regulation for policyholders are not clear. Opinions differ, of course, but there is evidence that having over 50 separate regulatory regimes (1) imposes substantial cost on insurers that want to do business in multiple state, and, more importantly for this analysis, (2) pressures legislatures and regulators to deregulate in order to attract business to the state, a regulatory “race to the bottom” that puts state revenues, rather than policyholders, first. (See, for example, Professor Daniel Schwarcz’s article “Regulating Insurance Sales or Selling Insurance Regulation?: Against Regulatory Competition in Insurance”, 94 Minn. L. Rev. 1707 (2010).)

To combat these effects, insurance regulatory regimes have converged on certain key points; associations of regulators like the National Association of Insurance Commissioners have created model rules and forms that diminish the costs of operating in multiple states while attempting to ensure minimum levels of policyholder protections. In other words, an important result of regulatory competition in insurance is the convergence of state standards toward a single set of common rules that arguably serves its primary purpose (protecting policyholders) less well than it otherwise might.

(2)  Who would pay for it? 

Nearly all the states are struggling to handle their current corporate, tax and other administrative burdens. Few states currently have both (a) securities laws and regulations robust enough to address all of the issues raised in modern securities issuances and (b) enforcement authorities large, expertised and resourced enough to handle an upsurge in issuances. Requiring the states (whether directly or indirectly) to take on securities regulation would impose tremendous new burdens on them.

Who would pay for this?

Some commentators argue that those states that don’t want to incur great expense here could simply instantiate federal law. But why would we recreate the wheel? If we ended up with 50 state regimes that more or less mimicked the current federal regime, what would we have achieved?

There are fundamental issues with the JOBS Act, as Bill and others have described at great length. It’s important for us to resolve those questions, and I think many are resolvable. (For example, as noted above, we need to decide under which conditions we’re willing to expose non-sophisticated investors to ultra-high risk investments.) In theory, having 50 different problem-solvers each taking its best shot at resolving them would be great. But given the other constraints on time and resources, and the questionable value of regulatory competition in the crowdfunding context, it seems better, at least in my opinion, to address them at the federal level.

*Legal scholars have made comprehensive arguments for and against regulatory competition in the securities context.  Mr. Klein cites an especially good article in support of regulatory competition by Professor Roberta Romano of Yale Law School that I recommend if you are interested in the topic.  The article is “Empowering Investors: A Market Approach to Securities Regulation”, 107 Yale L.J. 2359 (1997-1998).

Photo: Frank Farm / Flickr.

Kickstarter to Backers: "We're Not a Store"

Introductory note from Bill: Jonathan Sandlund is a crowdfunding evangelist who blogs at TheCrowdCafe and is passionate about making investment crowdfunding work for communities. The two of us recently collaborated on a G+ hangout on progress toward implementation of equity crowdfunding. You can get in touch with him on Twitter at @jsandlund.

Kickstarter announced some seriously loaded changes to their fundraising rules Friday, candidly telling its users, "Kickstarter is Not a Store." Undoubtedly, this announcement was in response to growing coverage of the troubles befalling a number of high-profile Kickstarter projects post-investment. The rules largely fall into two buckets:

(1) Risk Disclosure: Project creators are now required to answer, “What are the risks and challenges this project faces, and what qualifies you to overcome them?” Their answer will be unavoidably placed directly below the project description section. 

(2) Crowd Control: To protect the crowd from itself, Kickstarter is also adding new restrictions to campaigns, notably only in the Hardware & Product Design category. Fundraisers can now only offer rewards in single quantities (or a "sensible set" if deemed appropriate); additionally - and this is where things get interesting - they are no longer permitted to use product simulations or product renderings in their campaigns. If it's not tangible, forget it.  

Summed up, Kickstarter is nailing a headboard to every campaign that reads: "Great ideas do not guarantee great execution. Caveat emptor."

StompyBut is this just caveat emptor? By disallowing simulations and renderings for products, the “crowd controls” don’t just inform my decision, they effectively make it for me. It’s a mechanism that systematically reduces risk in the equation, even if I want it, by emphasizing more mature products over ideas. Armed only with words, devoid the power of visualization, ideas will struggle to stay relevant.

Would Stompy, "An open-source, 18ft wide, 4,000 pound, 6-legged hydraulic robot that you can ride," have been funded with only representations of "what is" and not "what can be"? I doubt it. 

While certainly well-intentioned, I find these rules quite heavy handed, if not draconian. Even in the most regulated of markets, public securities, companies are permitted to provide illustrations of “what can be,” i.e. forward-looking guidance.

Shifting to investment-based crowdfunding and jumping on my soap box, Kickstarter's decision sets the stage for a debate that holds deep implications for the crowdfunding industry. What is the role of the platform and at what point is the burden of decision, and risk, passed to the individual? These questions will become increasingly important as crowdfunding matures to include investment securities. 

Personally, I'm worried. It seems as if we're over-optimizing for failure, at times even confusing it with fraud.

While adequate disclosure and risk-controls are critical, failure should not be shunned, and responsibility for it should not be placed on intermediaries. Platforms like CircleUp will draw from domain-expertise to provide curated, de-risked deal flow (to date they have only approved 2% of applications for their portal). This is awesome, and a huge value-add. Failure will be more controlled, likely drawing higher per-investment sizes. It’s a model that works, but not the only one. 

Regulations, and rhetoric, must also support platforms that want to facilitate investments in 18ft, 4000 pound, 6-legged rideable robots. Because its these kinds of risks, and the invariable failures that follow, that plot the map to innovation. 

It’s unfortunate to see Kickstarter respond to media scrutiny by limiting its users, opposed to seeking a solution that informs backers and empowers project creators to make better decisions. I hope investment crowdfunding platforms don’t follow suit. The burden of information should lie on the platform; the burden of risk should lie squarely on us.

David Ziff on doing your (legal) best

Introductory note from Bill: Ken Adams, this post is for you. When you started explicating obscure caselaw references at the drop of a Disqus comment, I knew I had to call in a big gun.

In Washington State, that big gun would be the intellectual howitzer, David Ziff. Ziff writes the Ziff Blog, "a blog mostly about Washington law," and tweets as @fizztown.


Bill Carleton pointed me to the comments section on this post regarding "best efforts" clauses, "commercially reasonable efforts" clauses, and the differences (if any) between them. At the outset, I agree with Bill that a "commercially reasonable efforts" clause is preferable to a "best efforts" clause -- even if courts tend to interpret the clauses the same. Why? Well, as a general matter, plain language is always preferable in my book. If what you mean is "commercially reasonable efforts" then just use "commercially reasonable efforts" rather than use a term of art that says something else but is generally understood to mean the same thing. 

The general rule in favor of plain language has specific advantages here. (1) Judges are sometimes wrong! How easy for a plaintiff argue the following against your client, the defendant: Other contracts say "reasonable," this contract says "best," and if the defendant wanted to say "reasonable" he could have used reasonable. Look! The word "reasonable" is used in X other places in the contract! I would not be surprised at all for that argument to have some chance of success, especially if "reasonable" is used elsewhere in the contract. (2) Why risk a claim of unilateral mistake or some sort of failure of meeting of the minds. How do you know the other side understands that "best" means "reasonable"? As the lawyer, you can confirm with your own client, but what about the other side? Are you going to have a conversation with the other side to confirm that you both mean "reasonable" when you say "best"? And if you're having that conversation, goodness, why not just write "reasonable" in the first place? It seems a bit silly.

That's all well and good, but things get more interesting in the comments. Ken Adams (of Koncision Contract Automation, and the author of A Manual of Style for Contract Drafting, among other pursuits) weighs in on a couple points. First, he notes that courts interpret all "efforts" clauses the same -- "best," "reasonable," "commercially reasonable," etc. That's my general understanding as well. I did some research but I could not find any case where the court distinguished between the clauses. That is, I couldn't find an example of a court saying, "Well, this is a 'reasonable efforts' clause, not a 'best efforts' clause, so the defendants actions were sufficient for compliance." Nor could I find an example of a court distinguishing prior precedent by saying, "Well, that case involved 'best efforts' but this is just a 'reasonable efforts' case."

Beer distribution warehouse

Which brings us to Bloor v. Falstaff Brewing Corp., 601 F.2d 609 (2d Cir. 1979), a nifty little Second Circuit case about best efforts. In the comments, Bill asked Ken about Bloor and how it related to the best/reasonable distinction. (At least, I assume that's what the point was, because Bloor is a "best efforts" case and -- as we'll see later -- the opinion could be read as setting a somewhat onerous definition of "best" that might go beyond "reasonable.") Ken responded that Bloor "doesn't say what people think it says." I must admit that, having never heard of Bloor or discussed it with anyone else (maybe I read it in law school or came across it studying for the NY bar?), I have no idea what people think Bloor says. So perhaps I'm at a disadvantage here. But I know what I think it says, which I guess is something.

Ken says that Bloor stands "for the proposition that U.S. courts haven't required that a party under a duty to use best efforts to accomplish a specific goal make every conceivable effort to do so." And indeed, that is what the court says. The relevant "best efforts" clause "did not require Falstaff to spend itself into bankruptcy to promote the sales."

But if one were to read this case as a basic run-of-the-mill "best efforts" case I can see the confusion. Here's a basic (incomplete) outline of the facts: A beer company was losing a ton of money. The owners sold the company to Falstaff in exchange for (1) cash and (2) a percentage of future sales. The contract required Falstaff to use "best efforts" to sell beer. But remember that the company was losing HUGE amounts of money when Falstaff bought it. Falstaff rejiggered the company, spent less on advertising, lowered expenses, and sales went down, but as a result Falstaff made a profit! Good for Falstaff! Certainly, the contract did not obligate Falstaff to run the company at a loss, all so Seller could get its percentage payments, right? Seller, however, was obviously not happy because the reduction in sales resulted in a reduction in the Seller's percentage take. So Seller sued for breach of the "best efforts" clause. The court concluded that Falstaff did indeed breach the "best efforts" clause, even though Seller continued to sell beer while making business decisions that turned a sink hole company into a profitable company.

It would be easy to read the case as requiring "best efforts" even when those efforts are to a party's (serious?) commercial detriment. (Perhaps that is what people think the case means?) But I think that would be a mistake for a couple of reasons. The less interesting reason first: The case needs to be read in light of the court's factual findings. The trial court did not find, as a matter of fact, that Falstaff could not have turned a profit without lowering sales, or that Falstaff's consideration of profit over sales constituted a breach of the contract. Rather, the trial court essentially found that Falstaff engaged various sorts of trickery and malfeasance to structure the company in a way that minimized the required percentage payments to the Sellers and to therefore maximize its own profit. As the court found: "Falstaff simply didn't care about [Seller's] volume and was content to allow this to plummet." Well, that's no good. That's not "best effort" or "reasonable effort"; that's no effort. I don't think any party would argue that a "best efforts" clause could be satisfied with no effort. Importantly, once Seller showed that Falstaff made no effort, the burden was on Falstaff to prove why it couldn't have done differently, or some sort of impossibility or whatever. The point is, Seller didn't have to come up with what efforts Seller could/should have made. Seller failed; that was enough.

But here, I think, is the more interesting reason for the court's holding: Most "best efforts" clauses are of the sort that require best efforts to sell something. Try to sell it! Make a reasonable effort! However that is not what the clause here required. I intentionally sort of fudged that above (sorry!) to allow for more confusion. Rather, the clause stated:  “After the Closing Date the (Buyer) will use its best efforts to promote and maintain a high volume of sales . . . .” (emphasis added). So two important points. (1) Falstaff was obligated to use its best efforts (or reasonable efforts) not just to sell the beer, but to sell a high volume of beer. (2) How do we know what a "high volume" is? Well, the goal is to maintain the volume from the pre-sale era. That was a lot of beer. And since it was a historical amount, it was an amount both parties knew! In other words, they understood what levels of sales "maintain" meant. By referencing the maintenance of the normal historical "high volume" of sales, and by setting a per-volume percentage payment, the contract allows the Seller to have some idea, based on passed sales, about the level of percentage payments it could expect over the course of the contract. That amount was no doubt reflected in the payment price. Generic "best efforts" clauses are a bit squishy. But "best efforts" tied to a historical sales number that both parties recognize -- that's a more tangible expectation and something that, I'd imagine, courts are more likely to enforce than the squishier version.

Some final/additional thoughts: 

"Best efforts"-type clauses come up in two situations: (a) express clauses, and (b) implied obligations based on requirements contracts. I wonder whether courts interpret these two obligations the same? I don't see why they should, but I tend to think that they do. For example, Bloor itself cites to the New York case of Feld v. Henry S. Levy & Sons, Inc., which involved a requirements contract for the sale of goods under the UCC and the resulting implied "best efforts" obligation. It seems strange to me that an obligation implied by law by a requirements contract would be interpreted the same as an express written obligation agreed upon by two sophisticated entities in the sale of a company.

This is especially true in a state like Washington (and New York!) that implies a duty of good faith and fair dealing onto every term in a contract. This implied duty of good faith is a (not THE) source of the implied "best efforts" obligation in a requirement contract. But that implied duty of good faith would equally attach to the percentage payment provision of the sales contract in Bloor. Wouldn't it be a violation of the percentage provision, as viewed through the good faith obligation, to structure the company in a way that minimized the payments to the Seller? I would think so. And if so, then what extra work is the "best efforts" clause doing? Anything? Shouldn't we interpret the written "best efforts" or "reasonable efforts" clause to be something more than the already-existing implied duty of good faith? I would think the law would want to avoid that sort of redundancy.

There is another reason to view implied obligations (from requirements contracts) differently than express "best efforts" clauses: consideration. Washington courts may be wary to imply a "best efforts" obligation unless such an implication is necessary to save the contract for lack of consideration.See, e.g., Oliver v. Flow Int'l Corp., 137 Wn. App. 655, 661 (2006) (refusing to imply obligation to sell/patent/make despite royalty terms because contract was supported by other consideration). In a requirements contract, for example, the implied "efforts" are the only consideration supporting the contract. Therefore, shouldn't the implied obligation be extremely minimal? Perhaps the peppercorn of efforts? That doesn't seem to be what courts do, but why not? It seems like a bargained-for expressed "best effort" or "commercially reasonable" effort would be higher than the effort necessary to supply consideration to a contract. Wouldn't a promise to do a shoddy, slow, and late job on something be sufficient consideration? Then why imply more? I wonder how much of the implied obligation in the requirements setting is (a) guessing at the intent of the parties, (b) providing consideration, (c) re-writing the contract to what the court considers fair.

But all that is just to say that implied "best efforts" obligations, implied "good faith" obligations, and express "efforts" obligations of any kind all seem to have different justifications. It seems to me like they all get interpreted the same, though I'm not sure why that should be so.

Photo: James Hall / Flickr.

Hey Crowdfunding Fans: Get Congress to Democratize the Existing Laws!

Note from Bill: This is a guest post from Joe Wallin. I really appreciate Joe sharing his views here because he's bringing ideas to the debate that I think crowdfunding advocates should hear, think through, debate, and fold into their advocacy.

Dear Crowdfunding Advocates & Enthusiasts:

It is great that you are excited about the crowdfunding proposals being kicked around Congress. I too am excited about the prospect of crowdfunding becoming legal in the new year.

Making Crowdfunding Legal Is A Great Idea

Crowdfunding is a great idea. It would be great for companies to be able to easily raise small amounts of money from hundreds or even thousands of small investors over the Internet or through other public means, legally, and without having to spend fortunes in legal and accounting fees complying with legal and regulatory mandates at both the federal and state level.

Today, companies don't need to raise huge sums of money to build what could be the next great mobile game or software or other product, resulting in a company that could employ many people. Our laws should be changed to allow entrepreneurs to democratize the funding of these enterprises.

The Trouble With Current Crowdfunding Proposals

The trouble with the current crowdfunding proposals? I don’t think Congress is going about making crowdfunding legal in the right way. And I think that it is wasting precious time fuddling with various and competing proposals that ultimately won’t work when it could easily and should be able to quickly change existing law to achieve the goals we all share.

What Existing Laws Could Easily Be Slightly Changed To Achieve Our Goals?

What existing laws could be changed to achieve our goals? All we need to do is amend Rule 506 of Regulation D to do the following:

  • allow general solicitation;
  • allow non-accredited investors to investors in Rule 506 offerings without triggering Rule 506’s onerous information sharing provisions even if non-accredited investors are involved--so long as the non-accredited investors invest less than $1,000 (or pick your number) a piece and the total raised from non-accredited investors is less than $1M (or pick your number).

Why is this better than what is currently being proposed? Because it is simpler. Simpler is not always but is frequently better. Let's look at what is currently happening with crowdfunding proposals in Congress. There are multiple, competing crowdfunding legislative proposals proposed. Each is complex. It is unclear which one will emerge as the consensus appraoch. And even if one of them passes, it will likely be years before the regulations are adopted and everything is in place to allow them to be used readily. The likely outcome of all this effort is that nothing will get passed (or that that what will pass will be unusable), and us crowdfunding advoicates will have nothing to celebrate.

What Could Congress Do Instead?

403177992_1b31d0ffba_zInstead of trying to pass a new, complex law, Congress should just improve upon what is already on the books. I am referring to Rule 506 of Regulation D, the securities law exemption most widely used by startups.

Rule 506 works. And one of the reasons it is so widely used is because of federal preemption. It is unclear how new crowd funding rules and regulations will work with state law. They very well may give state regulators significant authority over crowd funding financings. This may make crowd funding just impractical--look at how well Rule 504 doesn’t work (and how rarely it is used because of the lack of federal premption). In other words, the new proposals may not work as well with state law as Rule 506 does--which could render them not nearly as usable as we all hope them to be.

What Should Congress Do?

Congress should just fix the laws currently has in place. That would actually work. And it could work immediately. Specifically, Congress should make Rule 506 usable in the crowd funding context. How?

  1. Remove the ban on general solicitation--period; for all offerings. Allow companies to advertise for funds on their web sites. On the Internet. Everywhere.
  2. Reduce the financial threshholds to qualify as an accredited investor. Consider reducing them to really, really low threshold amounts.
  3. Allow non-accredited investors to invest in Rule 506 offerings as long as non-accredited investors don’t invest more than $1,000 per offering or $1M in the aggregate.
  4. Repeal the ridiculous and onerous new bad actors rules and regulations.
  5. Allow “sophisticated” investors to qualify as “accredited investors.” What do I mean by this? Perhaps a test administered by the SEC, or NASAA, that once investors pass allows them to check the box that they are accredited. This “test” would essentially educate potential investors about the risks and the likelihood that they are going to lose money.

I hope that in the new year Congress will see fit to pass laws which actually make life easier for entrpreneurs and startup companies. I have a long list of suggestions I have made in this regard, that you can read about on Quora here

Photo by S.S.K.

Joe Wallin is a startup and emerging company attorney who practises law at the Davis Wright firm. He blogs at Startuplawblog.com and is Bill's fellow Seattle Dude behind the Startup Trivia app.

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