Crowdfunding Legal Issues and Mistakes to Avoid

Crowdfunding may be an effective fundraising technique, but there are a few common legal considerations to be aware of before you get started.

Crowdfunding has aided in bringing the Internet’s power to investment. Since the inception of crowdfunding platforms like Kickstarter in 2009, prominent firms manufacturing market-disrupting technologies

What Exactly Is Crowdfunding?

Crowdfunding may be an effective fundraising strategy in addition to conventional means such as soliciting financial assistance from friends, family, banks, angel investors, and venture capital companies. By creating an account on an online crowdfunding site, a company may raise modest sums of funds from a large number of people in order to launch a new business initiative.

The classic method to crowdfunding is offering a first-run product or some other reward in return for a monetary contribution. Contributors earn no equity and have no right to be reimbursed.

In many circumstances, the procedure is effectively a pre-sale of your product rather than an investment, and it is not governed by the federal Securities and Exchange Commission (SEC).

Equity crowdfunding is a relatively new alternative made accessible by the Jumpstart Our Business Startups (JOBS) Act, which enables you to solicit modest contributions from a large number of individuals. Similar to a regular crowdfunding campaign, you utilise a crowdfunding site to submit a listing, but your funders become shareholders. This contains the shareholder agreement’s voting and dividend rights.

Kickstarter, Indiegogo, and GoFundMe are the main crowdfunding portals for small businesses. MicroVentures and Angel List are two crowdfunding portals aimed more toward investors.

Crowdfunding Legal Issues in General

While conventional crowdfunding (in which no stock is traded) is not subject to federal securities laws, there are a few broad legal problems to consider:

Create a company. There are advantages and disadvantages to each form of company structure, but it is critical for firms looking to crowdfund to establish a business and open a corporate bank account as soon as possible (instead of operating as a sole proprietor by default). Certain company arrangements will also serve to shield the founders from personal liabilities. LLCs are a frequent form for enterprises wishing to raise funds via crowdfunding. If you want to start a potentially significant firm that will seek venture funding, you can learn more about why incorporating in Delaware is the most preferred option here.

Consult a tax professional. Income taxes may apply to money from “rewards” and pre-sale of products. Speak with a tax specialist.

Intellectual property. Entrepreneurs who upload someone else’s copyrighted work without authorization may be prosecuted for copyright infringement. Furthermore, you should consult with an attorney before discussing your innovation online; for example, you may want to submit a provisional patent application to protect your rights. Before you upload particular information on a crowdfunding website, you should also consider registering for a copyright or trademark. Posting your intellectual property online raises the likelihood of it being copied or stolen. More information on how to effectively protect your intellectual property may be found in our simple guide to IP for startups.

State action is required. You might conceivably face legal repercussions if you fail to fulfil your end of the bargain with your supporters or otherwise engage in conduct that violates state consumer protection laws (such as making misleading statements). In Washington State, for example, an enforcement action was taken against a crowdfunded project that did not produce as promised.

Additional Legal Concerns Regarding Debt Crowdfunding

Because debt crowdfunding includes the sale of securities, the legal concerns become significantly more convoluted.

Title II of the Jumpstart Our Business Startups (JOBS) Act of 2012 established an exception from a federal security statute, paving the way for widespread debt crowdfunding. The SEC then issued regulations implementing the JOBS Act, which became effective in 2016.

The following are the major components of the new exemption for equity crowdfunding:

Over a 12-month period, the firm may raise a total of $1 million.

Investors have investment limits depending on their income or net worth. Furthermore, throughout a 12-month period, investors may only contribute a total of $100,000 in all such campaigns.

The offering must be done via a licenced fundraising portal or a broker-dealer.

Companies based outside of the United States are not eligible for the exemption.

The firm must normally file with the SEC a very detailed offering statement (including financials), progress updates, and yearly reports. For many small businesses, the administrative overhead of reporting required for crowdfunding may be too great.

There are restrictions on advertising and marketing the product.

Securities are often not resold for a year.