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crowdfunding platforms

Are all these new crowdfunding sites operating in full compliance with securities laws?

These days it seems there’s a crowdfunding platform for … well, just about everything. We all know the pioneers, Kickstarter and Indiegogo being chief among them, but there are many, many more platforms to choose from out there (at least 1,250 according to one report), and a new one seems to come online every day.

We think crowdfunding is perfectly suited to not only raise funds but also build community. Being crowdfunders ourselves (of the “investment crowdfunding” variety), we have seen firsthand how crowdfunding can help get projects off the ground and connect to a community of loyal supporters, while sharing profits with them in return.

There is no doubt crowdfunding has disrupted traditional finance, and revolutionized the way people raise funds. For that, we only have to take a quick look at the top-highest crowdfunding projects of all time: $87 million for “Star Citizen,” a video game (goal: $500,000); $20 million for “Pebble Time,” a smartwatch (goal: $500,000); and, our favorite, $13 million for the “Coolest Cooler,” the “Swiss Army knife” of coolers (goal: $50,000). We hope that those who gave so generously are feeling okay about for-profit companies that use the crowd in place of having to deal with those pesky investors that expect a return if a profit is made, but we also question the integrity of the approach if a company has no intention of sharing its profits with its backers.

And then there are the new “investment” crowdfunding sites we have been tracking. As with their predecessor donation-based crowdfunding platforms, new equity crowdfunding platforms formed under the various provisions of the JOBS Act of 2012 seem to crop up every day, promising growth capital for entrepreneurs and returns for investors. And on top of these new platforms, there is still the question whether the most highly anticipated and much-ballyhooed provision of the JOBS Act, Title III will ever come to fruition, providing equity crowdfunding for “the masses,” both accredited and unaccredited investors.

One example that recently caught our eye was an online retailer that launched a new crowdfunding platform that allows their independent retailers to post new “project” ideas they want to develop, with campaigns that include the scope, goals, and products they wish to offer, and then describe how receiving “funding” will help them to grow. The individuals that “fund” these projects will, hopefully, receive one of the products that are produced if the entire new project can get “funded.”

At first blush it looks very similar to other non-securities crowdfunding platforms—more of a pre-order approach for a product to be made once enough funds are received to make the product. What made this interesting to us, however, was how the company described this new platform. In their words, they said that this would provide “financing and product development” to the small businesses listed on their website, and they characterized this as a “viable and friendly alternative to traditional financing channels.” Suddenly we are now seeing new platforms moving from simply pre-ordering products to financing new businesses, with the online retailer taking a 3.5% fee on all of the financing if the new project reaches its goal, while the consumer simply receives a product.

We’re all for innovations that empower people to access capital in a way that lets them achieve their mission, but the sheer number of crowdfunding sites that are proliferating these days, and the similarities to investing and brokering by some does give us pause as we reflect on the possible challenges. Perhaps these new platforms will continue the disruption started a decade ago where new companies opted to get funded via pre-orders instead of seeking investment dollars first. Here in California, we have watched and waited to see if the state regulators would intervene and consider these pre-orders to be securities, as they did long ago with their decision on pre-payment for a membership in a country club that did not yet exist.

While no actions have been taken yet on these new platforms, we wonder whether the regulators will begin to look at these sites differently when the facilitator is charging a success fee for having connected new businesses seeking “alternative financing” opportunities with individuals willing to fund them, even if all they hope to get from the funding is a product that will be made.

Are these platforms actually offering “securities” that should be regulated? Are platforms that are run by broker dealers actually performing their obligations around due diligence and ensuring that the offering is suitable for each investor? And what happens when an investor decides that they got a raw deal, never received a product, or thought they should be getting some other kind of return for having helped finance a new business? These platforms are still so new that it is hard to predict whether the regulators, working slow and steady (at a pace far different from those running with the bulls), once they have sorted through all of these new changes, will begin to act.

Thinking about launching a crowdfunding portal? (Who isn’t?) Before you do, know what you’re getting into. Crowdfunding as a market has yet to mature, and there is the real possibility of major shakeout from one or a few big players running afoul of securities laws. Our advice: don’t take that risk; do your compliance first, and stay within the bounds of the law. You’ll thank us when the bubble bursts and the crowdfunding platform implosion comes.