An Intern’s Thoughts on Crowdfunding and Compliance

*Our summer intern, Diana Leung, who will be heading to Georgetown University in the fall, weighs in on disclosure compliance.

The brilliant start-up companies that define crowdfunding are transforming the meaning of the American Dream. Citizens not only have an equal opportunity to achieve prosperity through the traditional conduits of society but can now do so through their own original thoughts and ideas. Entrepreneurial success is no longer limited by the confines of well-established industries nor to the incredibly wealthy – from biodegradable toothbrushes to microwavable notebooks, crowdfunding is bringing creativity to fruition.
But, crowdfunding still bears the imperfections of a nascent market. Many issuers, knowingly or not, are failing to comply with legal disclosure requirements:

Be specific. Risk is inherent to crowdfunding. Small companies lack the experience and resources that enable large corporations to succeed. Investors’ understanding of this renders generic risk factors, pertaining to all small companies, redundant. Issuers should instead focus on the risks that aren’t generic or common to all companies – such as the outsourcing of production to a foreign country potentially affecting product quality. In doing so, issuers would be in compliance with the SEC’s disclosure requirement that risk factors be specific to the issuer and tailored to the offering.

Discussion of financial condition
Be detailed. Can the company sustain its operations despite a failed capital raising campaign? Issuers should disclose other available sources of capital to the business, or the lack thereof. Will the market be saturated by the next season? Issuers should disclose whether historical results are representative of future expectations. Has the company turned a loss into a profit since the last financial statements were compiled? Issuers should discuss financial performance since the end of the period covered by the financial statements.

Use of proceeds
Be descriptive. A reasonably detailed use of proceeds section should include descriptions of each itemized use. An issuer should disclose the TV advertising campaign it plans to launch or the ten computer programmers it plans to hire after the closing rather than broadly categorizing these expenses under ‘Marketing’ and ‘Product Development’. Investors should know how their money will be spent.
Compliance is key to both investor and issuer protection. Investors need to be aware of company risks, finances, and future expectations in order to make informed decisions. Issuers need to be thorough and accurate in their disclosures in order to avoid lawsuits and trouble with the SEC. Fortunately, the rewards down the road are well worth the troubles.

Crowdfunding is enabling entrepreneurs to create the first Hollywood studio owned by fans (Legion M) and build a bionic pancreas for those living with type 1 diabetes (BetaBionics). Before, only accredited investors could invest in movies and TV shows, and the development of biotechnology was reserved for the large research institutions. But with crowdfunding, an average investor can invest in Hollywood and altruistic investors, who are more interested in helping people than realizing economic gains, can pursue a technology that medical device companies are too big to be involved with. Crowdfunding is opening industries and changing lives.

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