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Crowdfunding and Its Limitations

Companies, old and new, now have the opportunity to raise funds through a unique technique—crowdfunding. Although, this is a twist on the traditional investment model, crowdfunding allows companies and individuals to fund their new ideas and business ventures by seeking investments from the general public. This unconventional approach to the well-known investment structure allows new business to gain financial support. Do you have a new idea that you would like to fundraise? Are you a company that would like to launch a new product? Do you need financial support to help propel your latest venture? If so, then crowdfunding may help your entrepreneurial efforts.

What Is Crowdfunding?

Crowdfunding is the practice of fundraising a new company, idea, project, or venture through large numbers of people. These people typically donate small amounts that add up in the aggregate. Unlike the investment structure that appeals to traditional investors, the general public fundraises projects. Crowdfunding has begun to gain momentum and exposure after the passage of the Jumpstart Our Business Startups (“JOBS”) Act. This law was passed to help small businesses and entrepreneurs jumpstart their business. Both private and public companies may take advantage of this capital-raising model. Crowdfunding is unique because although it does allow for a company to use outside resources to fund a project, however, the company does not have to make an initial public offering, register as a public company, or meet the requirements of a traditional publicly-traded company. Also, unlike a public company, which receives outside investments on an on-going basis, crowdfunding efforts are limited in time. That is, they may not continue forever. An entity must raise its goal amount by a specified end date. Otherwise, the company must offer to return all investments made under that project.

What Are The Limitations To Crowdfunding?

As with all other financial efforts, a government agency regulates the process. In this case, the Securities and Exchange Commission (“SEC”) defines the parameters of crowdfunding. Currently, the JOBS Act and the SEC proposed crowdfunding rules provide some guidance for crowdfunding. First, companies cannot raise more than $1 million during any single year. Companies that require more funds to startup will need to turn to other fundraising efforts for the remainder of the capital. This is limiting because companies will often skip over crowdfunding and turn to the other fundraising techniques. There are also very stringent disclosure requirements that companies must abide by before they raise funds. Satisfying all of these requirements is a costly endeavor for any company, but especially a company that is new and does not have the capital. Additionally, crowdfunding appeals to the common consumer and not necessarily to the experienced investor. Therefore, there are strict regulations in place to ensure that crowdfunders properly educate potential investors about the parameters of their project. These regulations aim to protect the investors if the project does not become successful. Ultimately, in the face of an entirely new form of investment structure, these regulations hope to protect the parties.

You may contact us to speak with an attorney about how this innovative investment tool may help with your next fundraising or startup efforts.