Equity Crowdfunding for Investors. Matthew R. Nutting

yourself time – say, a year or two – to make small angel investments, learn the fundamentals, maybe make mistakes, and acquire investment skills before you commit substantial money to angel investing.

      The following chapters will help you learn the fundamentals, navigate the portals, comply with the rules, make smart decisions, minimize mistakes, and become a skilled equity crowdfunding investor.

      Regulations Will Evolve

      Equity crowdfunding is a new branch of the highly regulated private capital markets. Just as the existing branches have evolved over the decades, with revision and fine-tuning of the laws and rules that govern them, so will this new branch evolve, especially in the next five years or so.

      As this book goes to press, we expect the SEC to issue final rules to implement Title III in 2015, and then equity crowdfunding portals can launch and all investors will be able to participate in Title III equity offerings. It is possible that Congress will pass new legislation to improve some provisions of Title III in 2015 or soon thereafter.

      Throughout the following chapters, we will point out where it is likely that the laws and rules might change. We will post updates on this book's website (www.wiley.com/go/equitycf) and in “refreshed” editions of the book and other Wiley publications.

      Definitions of Key Terms

      Various terms are being used by different people in reference to equity crowdfunding and related platforms, portals, and rules. The variety of terms can get confusing. Because this is a brand-new industry, governed by fairly complex laws and regulations, it will take a few years before everyone settles on a single nomenclature. To avoid confusion, here are the terms we use predominantly in this book:

      Crowdfunding platforms Websites that host crowdfunding campaigns. These include donation, rewards, and Title III securities (debt and equity) crowdfunding sites that are open to participation by everyone (the crowd). They do not include Regulation D securities offering platforms because those are open only to accredited investors, not the crowd. (Some people, nevertheless, might refer to Reg D offering platforms as crowdfunding platforms – we think this nomenclature creates confusion.)

      Equity crowdfunding The offering and sale of equity-based private securities to all investors (including nonaccredited ones), authorized by Title III of the JOBS Act. Equity means ownership, and an investor who purchases equity shares becomes a part owner in the company that issues those shares. Such offerings can be made only through registered intermediaries, whether broker-dealers or funding portals.

      Funding portals One of the two kinds of intermediaries (the other kind being broker-dealer platforms) authorized by Title III of the JOBS Act to host offerings of private equity-based securities via crowdfunding.

      Regulation D offering platforms Websites that host offerings of Regulation D (or Reg D) securities, open only to accredited investors. These platforms, which may feature both Rule 506(b) and Rule 506(c) offerings, look like crowdfunding portals in some respects, but they are not open to all investors (the crowd).

      Title III One of the seven titles in the Jumpstart Our Business Startups (JOBS) Act of 2012. Title III authorizes equity crowdfunding and allows participation by all investors, both accredited and nonaccredited. Title III adds the “crowdfunding exemption” to the list of offerings that are exempt from SEC registration, as set forth in Section 4 of the Securities Act of 1933.

      Title III equity offerings This means the same thing as equity crowdfunding offerings, but we sometimes refer to Title III in order to (1) remind readers of the legal basis for equity crowdfunding and (2) distinguish between equity crowdfunding (for all investors) and Regulation D offerings (for accredited investors only).

      Acknowledgments

      The authors thank Sara Hanks, securities lawyer and CEO of CrowdCheck, for her help in reviewing each chapter and making suggestions for improving the book's accuracy and usefulness.

      Thanks to Harriet Kohn and Paulina Freedman for their love and inspiration. – David M. Freedman

      Total and unqualified thanks to my stunningly beautiful, near perfect wife, Christine, and the perfect God who created her. – Matthew R. Nutting

      About the Authors

      David M. Freedman has worked as a financial and legal journalist since 1978 (www.freedman-chicago.com). He has served on the editorial staff of The Value Examiner (published by the National Association of Certified Valuators and Analysts) since 2005. He is coauthor of the 1987 book Death of an American (Crossroad/Continuum), about the Singer v. Wadman civil rights lawsuit in Salt Lake City. He is also the author of Box-Making Basics (Taunton Press), a bestselling woodworking book.

      Matthew R. Nutting practices corporate law with the firm Coleman & Horowitt (www.ch-law.com) in Fresno, California, where he advises entrepreneurs, early-stage companies, and investors on all facets of business law, including a special emphasis in rewards-based and securities-based crowdfunding. He is a director of the National Crowdfunding Association (www.nlcfa.org), was its National Legal Affairs Director, and cofounder of CrowdPassage (www.crowdpassage.com).

      Chapter 1

      The Foundations of Online CrowdfundingA History of Rewards-, Donation-, and Debt-Based Crowdfunding Platforms

      The emergence of online crowdfunding platforms over the past decade, like the birth of e-commerce in the 1990s, has generated a lot of excitement among entrepreneurs, Web developers, consumers, and investors (and their lawyers) eager to exploit new opportunities. Crowdfunding also threatens to disrupt some existing financial institutions and professions, as e-commerce disrupted the retail landscape two decades ago.

      In fact, some exuberant pioneers and early participants have predicted that crowdfunding will spark a revolution in private capital markets, if not the redefinition of Wall Street.10 At this early stage, nobody can say definitively whether their exuberance is misplaced.

      It perplexes those pioneers, therefore, that so many people still have not even heard of crowdfunding, or have heard of it but barely understand how it works, or don't realize that there are big differences between the various kinds of crowdfunding.

      So we begin with a broad definition. Crowdfunding is a method of collecting many small contributions, by means of an online funding platform, to finance or capitalize a popular enterprise. It is a new, high-tech version of a centuries-old practice. As crowdfunding is so new, there is much confusion in the marketplace about it – for example, many people still think of Kickstarter as the epitome of crowdfunding. Kickstarter may be the prime example of rewards-based crowdfunding (which is the most popular kind today), but there are a few other distinct kinds of crowdfunding, including donation- and securities-based crowdfunding; the latter includes both debt-based and equity-based offering platforms. We will help you distinguish between them and, especially, learn what makes equity crowdfunding different from its ancestors.

      A classic example of old-fashioned (pre-Internet) crowdfunding is Joseph Pulitzer's campaign to finance the construction of a granite pedestal for the Statue of Liberty in 1885. France had donated the statue, designed by sculptor Frederic Auguste Bartholdi, to the United States to celebrate the friendship between the two countries and their mutual respect for republican ideals. After France shipped the statue to America in June 1885, it sat unassembled in a warehouse for a year while the pedestal was being built here. Construction of the pedestal had been delayed because the American Committee of the Statue of Liberty ran out of money for the project.

      The cost to build the pedestal and place the statue upon it was estimated at $300,000, but the American Committee could raise just over half of that. The State of New York refused to help