Where do I sign?

sec-logoIn August, I wrote about passion and pandemic, in a discussion of rewards-based crowdfunding.  Now, as we approach the end of 2016, we’ve had a development in this space that is worth reporting on for the benefit of small companies in the US – including small hooch companies.  Specifically, I’m referring to Indiegogo’s roll-out of equity-based crowdfunding on its site.  This is – or at least may be – kind of a big deal.

As readers will recall from an earlier post, the sale or other transfer for value of an interest in a business (or, really, anything from which the transferee might expect to derive value in the future), is probably the sale of a security under United States federal and state laws.  And every sale of securities in this country is either (i) registered under securities laws, (ii)  exempt from registration, or (iii) illegal.  Option (i) is pretty expensive and option (iii) is prohibitively costly.  So those of us advising companies raising capital (especially smaller companies) tend to focus on option (ii): transactions exempt from registration. Historically, the most commonly used exemptions from registration required that the purchasers be well-heeled.  Specifically, the purchasers needed to be “accredited investors” as defined under the rules of the Securities Act of 1933, as amended [or possibly even “qualified institutional buyers” – a higher standard still under those same definitions].  Under this approach, companies in 2014 successfully raised approximately $1.3 trillion in capital.  So the money is clearly flowing.  But from whom?

To meet the definition of accredited investor, an individual (i.e., a human being) needs to have a net worth of at least $1 million (excluding the value of his or her principal residence), or have individual income of at least $200,000 ($300,000 with a spouse) in each of the last two years along with an expectation of continued income at that level in the future.  To be sure, this threshold isn’t nearly as difficult to meet as it was when the definition was put into place in 1982 – but it is still a relatively high hurdle that the majority of Americans can’t meet.  In fact, by one some estimate households that meet the definition constitute only 8.25% of the households in the U.S.  So just as we’re hearing a lot about wealth and income disparity in the United States we can see (and perhaps shouldn’t be too surprised to find) that the vast majority of private third-party capital investment in the United States is being funded by the wealthy.  The have-nots simply weren’t allowed to participate.

With that as a backdrop, the passage in 2012 of the Jumpstart Our Business Startups Act (the “JOBS Act”) promised to usher in a new era in which Americans of more modest means could legally invest in private ventures.  Specifically, the JOBS Act required the SEC to develop rules to allow equity-based crowdfunding: an exemption from registration that would allow equity investment of smaller amounts by individuals who were not accredited investors.

Of course, given that our securities laws are essentially paternalistic in nature, and the guiding principle embodied in those laws that the less wealth you have the more you need the benefit of government protections, those of us who advise private companies were not surprised to see the regulations – once drafted – take a similar tack.  Regulation Crowdfunding was relatively opaque, required the creation of an entirely new kind of market participant (the “funding portal”) through which all investment must be funneled, and generally made it much more difficult for investment to occur than is the case for the traditional accredited-investor-based exemptions from registration.  But at least the Regulation existed.

Now, one of the primary players in the rewards-based crowdfunding ecosystem – Indiegogo – has partnered with a newly created funding portal to allow for equity-based crowdfunding to occur on its site.  Given the amount of traffic that Indiegogo generates for its rewards-based offerings, this development likely represents the best chance to date for equity-based crowdfunding to succeed.

So how does this impact hooch companies?  Well, in this HoochLawyer’s opinion, the vast majority of spirits companies in the US are simply undercapitalized – some cripplingly so.  And anything that can be done to give companies better financial breathing room will be a welcome change.  Plus, the majority of those companies have relatively little distribution outside their home geographical area.  Conveniently, the majority of small investors prefer to invest in companies they know and which are active in their hometown or region.  If we’re lucky, Indiegogo’s facilitation of equity-based crowdfunding (particularly since they’re more spirits-friendly than their competitor: Kickstarter) will set off a wave of small investment in local spirits companies.

Personally, I’m looking forward to that on three fronts – as a HoochLawyer advising these companies, a spirits geek wanting to see them succeed, and a guy who might like to make an investment or two in the industry.  This should be fun.

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