Last week, a client called to ask what I thought about him raising money through AngelList, or Kickstarter, or any of the other popular online fundraising sites. He has been having trouble raising money recently and was intrigued by the possibility of soliciting funds from the large networks available online. He was also concerned about the possible securities law implications and other unintended consequences he might face, and before he proceeded wanted to know about all the downsides.
I haven’t actually worked with anyone yet who has raised money through AngelList or Kickstarter (or similar platforms), so I didn’t initially appreciate the distinctions between offerings on those two sites. However, there are some significant differences, which I discovered after talking with colleagues and doing a little research of my own.
As I learned, Kickstarter provides a forum through which companies and individuals can raise money in the form of donations. Rather than selling securities, the companies and individuals soliciting funding through Kickstarter offer some type of reward in exchange for the money donated. Usually the rewards increase based on the dollar amount of the donation.
For example, I have a friend who is currently looking for money on Kickstarter for his start-up QONQR. QONQR developed a location based, multi-player, mobile game of global domination. On QONQR’s Kickstarter page, there are at least 10 different levels of rewards for donations of between $10 and $10,000, most of which relate to bonus features that can be deployed as part of the game.
In contrast, AngelList is a site through which companies can make connections with angel investors. Some companies have had good success raising money in this forum.
If you are going to raise money through Kickstarter, or another forum where securities aren’t being sold, then there are no securities law implications. A prerequisite to the application of the federal and state securities laws is that there must be an offer or sale of a security. Essentially, if someone is getting a possible “return” on their money that is contingent on the success of the business, then it is a security.
Any investment made through a connection on AngelList or other online venue, however, definitely has securities law implications. The solicitation of an offering in an online forum is considered a “general solicitation” for purposes of the securities laws. If your offering involves general solicitation, you cannot raise more than $1,000,000 and still qualify for any of the exemptions from federal registration. Even the federal exemption that would permit you to raise up to $1,000,000 is qualified by state law requirements, and may not be available for all offerings or in all states. As always, it’s best to consult with your securities lawyer before offering or selling any securities.
Some of you will recall that the JOBS Act, which was passed in early April, would remove the general solicitation prohibition on Rule 506 offerings. Once that change has been implemented, offerings through sites like AngelList will not be limited to $1,000,000. Technically, Rule 506 has not been changed yet as the SEC still needs to enact final regulations. In my last post, I noted that the SEC missed its deadline in early July to enact regulations implementing the change to Rule 506. The latest update is that the SEC has scheduled a hearing for August 22nd to consider the regulations. Until those regulations are enacted, the general solicitation prohibition technically remains part of Rule 506.
Our client hasn’t yet decided whether either of these online portals will be helpful in raising the money he needs. For companies that are looking to raise relatively little capital to get an idea off the ground, Kickstarter could be a great option. For those who will need significant amounts of “other people’s money,” to launch and build a business enterprise, it probably isn’t the answer.
Given the $1,000,000 limitation, AngelList will also probably not be able to provide the capital our client wants or needs, but it’s a start, and he might make valuable connections in the angel community. At least for his situation, a site like AngelList will probably have more value once the Rule 506 regulations have been enacted and the general solicitation prohibition has been removed.
In any case, these online fundraising sites provide another option to entrepreneurs looking for start-up capital and are the start of what probably will be a growing trend. Before proceeding with any offering in these forums, however, you need to understand the potential implications on your past, current, and future fundraising. I know our client is glad he called first before he decided how to proceed.