Guest Post by Law 2050 Student Alex Nunn
As social media membership rates continually push to record heights, an emerging new trend is now seeking to turn your friends list into a pool of potential investors. “Crowdfunding,” as the movement has been coined, is the practice of raising capital by appealing directly to a large group of potential investors via the Internet. While the viability of such a trend might initially be met with skepticism, the equity-raising potential of crowdfunding has proven substantial. For example, in October 2012, Cloud Imperial Games pitched Star Citizen, a space combat video game, to the public and sought to raise the necessary capital for the game’s production through online crowdfunding. The idea quickly went viral, and by August 2014, the developer had raised $52 million dollars for its project, with over five hundred thousands individuals chipping in. On the more comical side, one individual used a crowdfunding site to raise $55,492 to help in his quest to make himself potato salad, while another start-up has raised £8,016 towards its mission to manufacture and sell giant inflatable sculptures of Lionel Richie’s head.
Undeniably, crowdfunding is attracting a significant amount of attention from prospective investors and commentators alike. Recently, however, the trend has caught the eye of a much more influential force – the United States government. Over opposition from the Securities and Exchange Commission, Congress passed the Jump-start Our Business Start-ups Act, or JOBS Act in 2012, which mandated regulatory support for crowdfunding. While the ability to quickly raise capital spurs on the current administration’s drive to bolster small business, the SEC remains wary of the movement due to the certain dangers that accompany crowdfunding.
For one, venture capitalism (the more formal method through which new businesses raise start-up funds) is an extremely risky endeavor for financial experts, with over eighty percent of start-ups failing in their first year. If even these seasoned financial professionals struggle to effectively predict the potential success of future start-ups, how much more vulnerable might crowdfunders be? Despite their enthusiasm, there exists a great potential for loss.
More importantly, crowdfunding is ripe for fraud. Through their crowdfunding campaigns, individuals can raise substantial sums without providing any identification, disclosure, or transparency with their plans. For example, despite its seemingly obvious unrealistic nature, an individual raised over $18,000 to manufacture his proposed “home quantum energy generator.” Predictably, his initial promise of free energy has yet to be fulfilled.
As crowdfunding grows out of its infancy, the movement’s stakeholders will increasingly demand legal aid. As one commentator notes, potential issues include questions over whether a crowdfunded start-up will be required to provide audited financial statements, and whether the funders, or even the funding portal, may share in any potential liability caused by the prospective campaign. Ultimately, the soaring popularity of crowdfunding will see a significant increase in the demand for regulatory compliance, especially as the SEC works towards issuing its final crowdfunding rules. As unassuming individuals find themselves on the receiving end of millions of dollars, their very first need, even before they begin to construct inflatable Lionel Richie sculptures, will be for sound advice on how to manage their funds in a safe, legal manner.