Thinking About Crowdfunding? Watch the Fine Print

CrowdfundingMake no mistake about it. If you own a small business or startup company, 2016 is going to be the year of crowdfunding.

For several years now, it has been possible to raise money online for projects such as a new invention, a documentary film or a nonprofit campaign using websites such as KickStarter and IndieGoGo. Basically, you make a pitch for money, take whatever you get and give your contributors goods or services — or maybe just a “thank you” — in return. Nobody guarantees you will get a dime, and (if you’re smart) you don’t guarantee contributors any sort of return on their investment.

Starting May 16 of next year, it will be possible for the first time to raise capital for your company via crowdfunding, and give contributors stock in your company in return for their contribution. You will not be able to raise more than $1 million without jumping through some pretty expensive hoops, you will have to make your crowdfunded offering via a “funding portal” registered with the SEC to make sure everything goes fairly and smoothly, and you will have to comply with about 600 pages of government regulations, but you will be able to raise money from strangers on the Internet.

There will no doubt be tons of books published next year to help companies through the complicated crowdfunding process (including – full disclosure — one by yours truly), and that a number of financially-savvy entrepreneurs will set up consulting firms to help startups navigate the process for a fee or commission

But a number of companies — including, and — are getting a head start on the crowdfunded business by helping companies with so-called “506(c) offerings”. These offerings, which the SEC authorized back in 2013, allow companies to raise funds using “methods of general solicitation and general advertising” as long as each and every investor is an “accredited investor” as defined by the SEC — someone either rich enough or sophisticated enough not to need the protection of the federal and state securities laws.

The main service these companies provide is to ensure that each investor meets the SEC qualifications — as I’ve written in previous columns, if you make one mistake here, it could cost you both your company and your life’s savings.

If you do plan on doing a 506(c) crowdfunded offering before the new rules kick in next May, here are some things you need to look for in the website’s online contract form.

–Non-Exclusivity. Never ever give a crowdfunding website the exclusive right to manage your offering. This is a new and untested process, and it may be years before we learn the “right” way to put together successful crowdfunded offerings. You may sign up with one website only to discover later than another website has a better mousetrap. If that happens, you should have the right to work with both websites, and pay each of them a commission based only on the amounts they raise for you.

Also, make sure you can terminate the contract “for any reason” upon reasonable notice to the website (30 days is customary).

–Fee Calculation. Crowdfunding websites want their fee to be based not just on investments they raise for you, but on the entire amount you raise, both offline and online. That’s more fair than it sounds, as investors who learn about you through the website could do business with you directly and circumvent the obligation to pay fees to the website (I’m not sure how the site would find out about that, but if they did you would be in trouble). Their fee should not, however, include money you raise prior to signing the crowdfunding contract, or from people with whom you have a pre-existing relationship (you will need to identify these before signing the contract).

–Ownership of Intellectual Property.
You will be responsible for the accuracy of all documents, financial statements and other material you post on the site. The website should have the right to use this material as needed to help you with your offering, but watch out if the site asks you to “assign” your copyright to them — this means they own the rights to your content and can use it for other purposes, for example, to help other companies with their offerings. All they should get is a “non-exclusive, perpetual license” to use your material only to help you with your offering and comply with government regulations.

–Post-Offering Paperwork.
Some websites will want you to provide financial information to them for one to two years after your offering is completed. You should not have to do this, however, if the site failed to generate at least one investment for you.

–Government Filings. Some offerings will require you to file documents with the SEC and state regulators. Will the crowdfunding company take care of those? If not, expect to spend anywhere from $1,000 to $10,000 for a lawyer to prepare them.