Skip to content
Link copied to clipboard

The promise and risks of the crowd

I find it impressive that three Philly 50 companies - which tend to be large, established companies - went public in 2012.

I find it impressive that three Philly 50 companies - which tend to be large, established companies - went public in 2012.

Epam Systems Inc., Five Below Inc., and Globus Medical Inc. are fairly young companies that spent years preparing for Wall Street-underwritten initial public offerings that raised tens of millions of dollars for each of them.

If one could have run a crowdfunding campaign to raise money in a matter of weeks, would it have done so?

For those entrepreneurs wildly excited about the possibility of raising equity through crowdfunding, Pepper Hamilton L.L.P. securities lawyer Brian Korn has a cold pail of water for you.

First, while the federal Jumpstart Our Business Startups Act of 2012 included provisions to enable more businesses to tap the power of social media and the Internet to raise money, the rules have not been written yet.

Second, a close look at the JOBS Act should make entrepreneurs think twice before raising equity by crowdfunding, Korn said.

Crowdfunding, in which individuals and organizations can raise money for projects - making movies and art installations - has exploded in popularity. The ability to raise small amounts of money from lots of people online in return for some reward is undeniably powerful. Businesses also turn to the Kickstarter or Indiegogo crowdfunding platforms to run campaigns to finance their own projects.

But when the reward is supposed to be equity, or an ownership stake in a company, regulators are going to err on the side of caution to protect investors, said Korn, who works in Pepper's corporate and securities practice group.

"There will be a train wreck at some point," he said. "That's what regulators are concerned with."

Right now, a small fraction of all crowdfunding activity involves equity investing. Just $116 million, or 4 percent, of the $2.7 billion of crowdfunding dollars worldwide involved equity investments in 2012, according to the research firm Massolution.

It may remain a small fraction because the JOBS Act limits the amount a U.S. company can raise to $1 million in a 12-month period. Any company that does successfully raise money through crowdfunding will have disclosure responsibilities, including filing annual reports with the Securities and Exchange Commission.

To Korn, there are enough legal gray areas that make crowdfunding far less attractive than traditional private placements that can raise far greater amounts of money from a smaller pool of investors - those with a net worth of more than $1 million or income of more than $200,000 in each of the two previous years.

That said, Korn believes crowdfunding has "tremendous potential." It's just that the JOBS Act's restrictions may dissuade entrepreneurs from trading equity for the wisdom of crowds.