“Crowdfunding”—raising money over the Internet from many people, each of whom contributes only a small amount—is a billion-dollar business that is poised to grow. On websites like Kickstarter and IndieGoGo, artists, entrepreneurs and others ask “the crowd” to contribute capital to their ventures, generally in exchange for the fruits of the project, such as a book or CD. The investors never receive never stock, bonds or other securities, however, because federal securities law, at least as it stood for decades, effectively banned the crowdfunding of securities.
This all changed in 2012, when Congress amended the federal securities laws to overturn this prohibition. In Title III (the “CROWDFUND Act”) of the Jumpstart Our Business Startups (JOBS) Act, Congress established a new exemption from the registration requirement for crowdfunded securities. President Obama signed the JOBS Act into law in April 2012, and it will go into effect once the SEC completes its rulemaking process.
My paper introduces the CROWDFUND Act and its key provisions. Importantly, issuers may only crowdfund up to $1 million annually, and the annual aggregate amount of crowdfunded securities that investors may purchase is capped at 5% of their annual income.
The paper explains that the CROWDFUND Act can be expected to have two primary effects on securities law and capital markets. First, it will liberate startup companies, small businesses and others to use peer networks and the Internet to obtain modest amounts of business capital at very low cost. Second, it will help democratize the market for financing speculative startup companies and allow investors of modest means to make investments that had previously been offered solely to wealthy, so-called “accredited” investors.
In the final portion of the paper, I offer two novel predictions as to how securities crowdfunding will play out in practice.
First, I predict that an active market for corporate control may develop for companies that sell equity via crowdfunding. Proxy contests over crowdfunded issuers will likely be much more affordable than in the traditional context, because shareholders can organize on the Internet, including via social media. In addition, tender offers for registered securities are subject to strict limits under the Williams Act, but those rules would not seem to apply to unregistered shares purchased via crowdfunding. Founders can avoid hostile takeovers, though, if they act with a little foresight.
Second, I predict that crowdfunding issuers may prefer to sell debt securities, such as bonds, rather than equity (i.e., stock), to the public. Selling stock to strangers, even only a minority interest, can lead to serious distractions for company founders/management. Shareholders can bring derivative actions against founders in their personal capacity, demand books and records, and propose shareholder resolutions. Bondholders, by contrast, can do none of these things. So there is good reason to expect that debt will become the security of choice for those that raise capital under the CROWDFUND Act.
The full paper is available here.