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The JOBS Act: Three Tips for Making the Best of the Equity Crowdfunding Exemption

William Carleton, Contributing Editor, VCExperts


It's probably time to start thinking about steps that might be taken by *issuers* (securities talk for entrepreneurs, startups and companies raising money) and *funding portals* (a new necessity conceived by the JOBS Act) to make a go of the equity crowdfunding exemption, such as Congress has bestowed it.

We can revisit the list when the implementing SEC regulations are written (or develop our list in tandem with that process).

No guarantees - it may turn out that the only crowdfunding under the JOBS Act that will work will be crowdfunding for accredited investors - but here's a start at identifying practices that might help make the equity crowdfunding exemption viable:

1. Don't use lawyers.

Issuers: if you use lawyers, you're going to spend at least 5% of the offering proceeds on them. That's assuming you will succeed in raising the maximum $1 million allowed, and that you haven't raised any money from angels in the past year. If you raise less, the percentage you will pay will be much higher.

Moreover, if you engage lawyers in the process, there will be no end to the discussions and consultations, through the pendency of the offering, and post-closing. If the lawyers take control dealing with your new shareholders, forget it: you will be consigned to spending over 10% of your proceeds on the law firm, within the same year that you raise your crowdfunded round.

Portals: you might use lawyers to write the templates you should require your issuers to use (see below), but you probably shouldn't. You should pool resources with other funding portals and have standard documents and protocols written up. Thereafter you should use lawyers only with regard to issues having to do with your compliance with the regulations that apply to you as a funding portal.

Furthermore, if an issue comes up with an actual or prospective issuer that suggests you need to consult a lawyer, don't; instead, drop the applicant or issuer. Make sure you have terms of service that make it clear that you will cut and run, rather than obligate yourself to spend on legal fees for problems brought into your tent by others.

2. Standardized everything.

Portals: you are charged with first contact with prospective investors. You have to educate them and qualify them; and you will implicitly be assuring them you have done the requisite statutory diligence on the background of the directors and officers of the issuers. (That's not all you have to do; you have to do a ton more, but that's enough for me to reference here by way of setting up the instant point.)

You will have no hope of discharging these duties of education, suitability matching and diligence if each and every deal has its own terms. Preferred stock, common stock, convertible notes; units of stock and warrants; variations on each of the foregoing - forbid it all. Tell all your issuers they must necessarily use a specific security that you will explain, and will explain once, and will explain a thousand times, without variation, to all the investors accessing deals on your portal.

It doesn't stop with the deal terms. Securities are functions of a corporation's charter, so you will have to dictate what the charters of each of your companies look like. If an issuer has already incorporated, too bad, make it re-incorporate or amend and restate its charter in the form you mandate.

And it shouldn't stop with the charter. Make the issuers you list follow the same checklist a good angel group would insist on: assignments of invention from everyone associated with the venture; reverse vesting for founders. Moreover, because, unlike angels, you are not going to have time or resources to vet the variants of corporate documents, publish your approved forms and insist that your issuers use them all without variation. If possible, get industry consensus on what these forms look like.

If the law would permit actual crowdsourcing of information, it would be possible to allow variation on valuations. But the law does not permit that. (The McHenry bill would have, but the McHenry version of crowdfunding was killed by the Senate, and the House Republican leadership, for political reasons of their own, didn't fight it.) So, don't just standardize the legal terms of the deals on your platform; standardize the financial terms, too.

3. Have no directors or officers, other then the founders.

Issuers: the new law does this funky thing with the liability for company misstatements or omissions. It says that, for purposes of liability for such errors, the "issuer" is deemed to include your officers and directors.

It may be that a market for D&O insurance will emerge for equity crowdfunding deals. If and when it does, we can revisit this point 3. But until then, assume that you must have no directors or officers, other than the founders. In fact, it may be best to have just one of the founders volunteer to be the sole director and the sole officer. (But check with the funding portal: they may require you to have a broader responsible team than that.)

Photo: "Give it a try" by Maxim Trudolubov/Flickr.


William Carleton

Bill is a member of McNaul Ebel Nawrot & Helgren PLLC, a Seattle law firm. He blogs every day at http://wac6.com.