Should Startups Proceed with Caution Under the New Federal Crowdfunding Program?

Ed Silverstein, Legaltech News

Before moving forward, startups should ask themselves whether they have the resources to adequately prepare their documents.

The new federal crowdfunding program leads to many reasons why start-ups need to be cautious.

Now, the federal framework for equity crowdfunding to non-accredited investors lets startups sell stock to the public. It is sold through Securities and Exchange Commission [SEC]-registered funding portals or broker-dealers.
The SEC's rules implementing the crowdfunding provisions in Title III of the JOBS Act goes into effect on May 16, limiting startups to raising $1 million through this type of crowdfunding every 12 months.

What does this mean for startups? Gary Emmanuel, attorney at McDermott Will & Emery, advises startups to “proceed with caution,” and ask themselves whether they have the resources to adequately prepare documents, noting that there’s a cost to putting together quality disclosure documents.

Emmanuel explained that legal and accounting budgets alone will cost money that may be hard to come by under the financial limitations of this plan. Additionally, lower-price financial statements from accounting firms or lower-price legal work can lead to questions on the quality of work. Lower quality disclosure poses risks, as companies that have made material misstatements in their documents can potentially face future lawsuits.

“It raises the level of scrutiny these kind of companies are exposed to,” Emmanuel said. “It’s all very public.”

If the new framework works out badly, the SEC may get calls from angry investors. The SEC tries to provide investors information in case the investors want to file suit, Emmanuel said. Similarly, state regulators are also concerned that crowdfunding can “open the gates” to fraudulent activity. “They are the ones who get the calls from the widows and orphans.”

There are other concerns about responses that may be made by company officials to comments posted in the portal, including legal risks. Additionally, comments posted by marketing specialists could pose later legal problems. “If you over-promise, you are exposing yourself to very real liability here,” Emmanuel said.

On the other hand, there could be a viable path for start-ups using crowdfunding. It may provide start-ups with enough money to get going – and then during the next stage they can have a serious funding round. But the possibility exists that funding will never make it to that next round.

However, there are service providers and services that offer automated background checks which can address some of these issues. These include such sites as Crowdcheck.com or https://www.startengine.com/.

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