Crowdfunding, A New Frontier For Lawyers

By Chris Mondics The Philadelphia Inquirer.

PHILADELPHIA

In early 2012, after plans to raise money through traditional venture capital sources failed to pan out, Silicon Valley entrepreneur Eric Migicovsky and his team at Pebble Technology went in a different direction.

They turned to the Internet site Kickstarter and launched one of the early digital crowdfunding campaigns to finance development of an interactive watch that would display email, text messages, stock quotes and more. Within weeks, Pebble had collected $10.3 million from thousands of Web users who agreed to accept only the promise of a watch in return.

The alternative finance campaign by Pebble caught the attention of investment professionals and the lawyers who advise them.

Though still in its most embryonic stage, such crowd-source financing and the Internet platforms where it takes place have become a target for legal fees for law firms specializing in capital markets. What makes it so appealing to lawyers who focus on transactional work is that, while crowd-sourcing as a commercial funding source now is small, the upside is potentially huge.

Businesses seeking money through crowdfunding websites run the gamut, from commercial real estate companies to high-tech startups and health care firms, said Ellen Canan Grady, a securities lawyer with the Cozen O'Connor law firm in Philadelphia.

"It is really, really broad, everything from technology, to consumer to health care," she said.

The great majority of firms turning to crowdfunding are early stage companies, where tiny investments can grow quickly. What has lawyers excited is that these small companies might grow and become potential sources of even larger amounts of legal work.

"It is a very small portion of the practice area right now, but I love the subject area," said Debbie Klis, a securities lawyer with the Philadelphia firm of Ballard Spahr. "This will become more and more popular over time."

Compared with traditional capital markets, crowdfunding represents only a trickle of the overall stream of investment money pouring into the economy. But according to the research and advisory firm Massolution, which tracks investments through Internet sites, it is quickly increasing. The firm said crowdfunding for real estate projects alone grew by 156 percent in 2014 to a little more than $1 billion. Such financing campaigns ranged in size from $100,000 to $25 million. This year, Massolution projects that crowdfunding for real estate ventures will hit $2.57 billion.

"The basic concept is that now there is much more of an opportunity for average investors to put money into private companies," said David Feldman, a Manhattan-based lawyer for Philadelphia's Duane Morris law firm. "So it is this whole concept of bringing Wall Street to Main Street."

Internet-based crowdfunding has been around for a decade or more, mostly as an alternative vehicle for raising charitable funds, but started to get traction as a commercial funding source with the Wall Street financial markets' collapse in 2008, Klis said.

Then, with traditional credit sources drying up, entrepreneurs borrowed a page from earlier crowdfunding campaigns, such as helping individuals with an avalanche of medical bills or other personal catastrophes.

The most effective form of capital formation, issuing securities in exchange for debt or an ownership interest, remained legally off limits until 2012, when Congress passed the Jobs Act.

Under the Jobs Act, a longtime restriction on solicitation for private placement investments was lifted, effectively permitting companies and people seeking capital to search for capital on the Internet. The law imposed restrictions, however, that have served to temper the enthusiasm of both investors and businesses.

Internet portals that serve as the conduit for such crowdfunding must verify that investors are what the Securities and Exchange Commission describes as "accredited", in other words, sophisticated enough to place their money in a venture that is subject to less SEC oversight than securities traded on traditional exchanges.

That typically means investors must have a net worth of at least $1 million, excluding the value of their primary residence or an annual income of $200,000, and they are required to submit tax returns and W-2 forms.

The SEC is now in the midst of rule-making for a more expansive type of crowdfunding that would permit nonaccredited investors to participate. Many investment professionals and lawyers, however, have panned the proposal, saying that in its current form, it imposes too many restrictions.

"What we got was a very limited and very difficult statutory scheme, so that you cannot raise too much money and it is going to be very expensive," said Michael Harrington, co-chairman of the technology and emerging-business practice at the Philadelphia law firm of Fox Rothschild.

By contrast, Internet fund-raising from accredited investors is on the rise, and that's where there are more and more prospects for legal work from a cross-section of industry sectors.

And that is where Grady of Cozen O'Connor sees most of the opportunity now. For lawyers, Grady said, there are multiple sources of work representing investors and companies seeking capital through crowdfunding, as well as the Internet portals where the two are connected.

"One of the things that I see over and over again is the level of enthusiasm and energy," she said of the investors and businesses using crowdfunding to raise capital. "It is infectious."

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