Every day I engage with at least one person about how startup investing will change because of the JOBS Act.
Crowdfunders want to know when they can set up platforms and list deals. Angels want to know if new verification rules will mean no more investing in startups unless they turn over tax returns and personal financial statements. And entrepreneurs want to know if it’s okay to start tweeting about the $100,000 still available in an open Series A round.
In most of these discussions, the answer usually involves a caution: wait on SEC rulemaking.
One startup in California, FundersClub, appears to be moving on all fronts above at once, not waiting on anything.
TechCrunch is enamored: “Don’t call it Kickstarter, because on FundersClub you get real equity for your investments in hot startups.” The reporter for VentureBeat at least mentions key legal concepts that, should you chase them down, explain why others are more circumspect about pitching startup deals in such an open fashion.
From what I can tell, no one has yet publicly called out that FundersClub is playing with fire.
I worry about first-time entrepreneurs, those who haven’t raised private money before, who may not have the judgment to weigh the allure of FundersClub’s promise of low-hanging “dumb money” (the phrase was in TechCrunch) against the radioactive risk of violating securities laws.
What’s at stake in getting it wrong? Because Rule 506 is going to include a bad actor disqualification, a great deal is at stake, potentially. Startups and entrepreneurs that associate with a rogue operation for financing are potentially compromising their ability to raise angel money. Betting their future financeability, you might say, on FundersClub’s arbitrage of the shifting regulatory landscape.
It’s possible FundersClub or their attorneys have found something in SEC interpretive releases and no-action letters that the rest of us have missed. If so, more power to them. More to the point: FundersClub should publish any legal opinions they’ve commissioned. That would help other entrepreneurs assess the risks.
There is an FAQ on the FundersClub site, but it’s conclusory rather than explanatory, too thin for something involving public solicitation of other people’s money.
Here are the questions to which I’d want satisfactory answers before I’d list my startup with them:
(1) What permits you to generally solicit for investors before Rule 506 of Reg D has been changed to permit general solicitation and general advertising? If your position is that you don’t engage in general solicitation, then:
- are you making new members wait 30 days before having access to deals;
- what are you doing to clamp down on reports in the tech press disclosing publicly which startups are listed on the site; and
- are you betting that your screening process will satisfy the accredited investor “verification” rules, whatever those may be when published?
(2) You say you’re putting investors into “special purpose vehicles” more like VC or angel sidecar funds, tried-and-true vehicles that aren’t legally suspect. But at the same time you promise investors access to startup founders, and warn that startups may occasionally veto an investor’s participation — indications of a more direct company-to-shareholder relationship. How do you assess the risk that regulators won’t look past the form to the substance of the offering(s)?
(3) Are you relying on the federal broker-dealer safe harbor for online platforms promoting deals restricted to accredited investors, set out in Section 201(c) of the JOBS Act? If so, can you confirm that you do not take possession of investor funds and don’t hold securities?
Bottom line: If this passes muster, great. But tell the world why. For better or for worse, money raising is an industry where mastery of the legal issues has got to be a core competence.
[Editor's Note: GeekWire contacted the founders of FundersClub via email today prior to publication and invited them to answer the questions raised by this piece. We'll follow up with an update if we hear back.]
Attorney William Carleton is a member of McNaul Ebel Nawrot & Helgren PLLC, a Seattle law firm. He works with startups and emerging tech companies, their founders and investors. He posts regularly about tech-related legal issues on his blog.