Last month Digital Currency Magnates wrote about the potential of digital currencies to make their mark in crowdfunding. In a perfect world, digital currencies provide a peer to peer platform for startups to easily sell equity and raise funding for their business from people from around the world. Crowdfunding sites like Kickstarter could also use digital currencies to distribute to their early adopters small equity stakes in their company or rights for future incentives.
While digital currency fueled crowdfunding could be the way of the future for raising money, in the present many questions remain. Possibly the number one question arising around digital currency funding, and an issue at the heart of bitcoin related innovation is how it falls within existing financial regulations. Even for fiat based crowdequity funding, very few jurisdictions have provided guidelines of what is legally allowed to be done, with most countries currently limiting raising of funds to accredited investors.
To learn more about the legalities of crowdequity, Digital Currency Magnates connected with Advocate & Notary Tal Itzhak Ron and Financial Jurist Stephanie Attias of Tal Ron, Drihem & Co. Law Firm, for their opinions on the evolving world of digital based fundraising.
Before discussing opportunities with raising funds using digital currencies, let’s start with an explanation of what startups typically do.
Tal Itzhak Ron, Advocate
There are several different ways to raise funds for startups, it all depends if they are looking for short term cash or a long term investment. The conventional path is to apply for debt financing, which involves taking on a bank loan or private loan. If a business is seeking a long term investment and wishes to cut out the bank as a business partner, the approach is to seek equity financing by issuing stock in the company. This technique will allow businesses with a high growth potential to sell shares of their company to investors, injecting the business with cash and leaving investors with the chance to make a high return.
However, if the business doesn’t succeed, when selling equity, investors have no way out and they may lose all of their investment. For that reason, the Securities and Exchange Commission (SEC) and equivalent regulatory authorities have decided to increase transparency measures to ensure investors are fully protected and informed. The prime concern for regulatory authorities is that investors understand the risks and can afford to lose the investment if the venture doesn't perform as hoped. When selling equity or investing in equity, it is extremely important to seek the advice of a qualified attorney as a slight misunderstanding may put you at risk of fines, shareholder lawsuits, repayment demands, charges of fraud, and may even weaken your ability to raise money in the future.
Equity investment should always be viewed as a long-term solution and a means to inject both cash and experience into your startup.If on the other hand, a business is seeking cash for the short term, offering equity is not the right approach.
Where does crowdfunding fit in the scheme of fundraising for companies?
Another popular technique which plays a large role in the future success of startups is crowdfunding. Through this technique, Entrepreneurs can pitch their ideas to online investors and convince investors to fund their business. Unlike companies offering equity, companies seeking crowdfunding are generally low growth potential companies which cannot obtain funds from Angel Investors. It is strongly advised to provide investors with as much information and disclaimers as possible. Indeed poorly informed investors could easily lose their money by betting on companies that haven’t thoroughly been analyzed.
What are the current legal and regulatory challenges surrounding crowdfunding and crowdequity selling?
Both Equity and Crowdfunding techniques are surrounded by extremely challenging legal and regulatory frameworks. Companies are finding it extremely difficult to conduct correct due diligence, and the reason many firms may not be able to complete a traditional private placement is that they cannot find enough accredited investors.
Under the US Federal law regulated by the SEC, it is illegal to receive a payback on an investment unless the company is approved by the SEC. The SEC limits private equity and crowdfunding investments to crowds of accredited investors, and prohibits solicitation or advertising of the equity being sold.
The solution would therefore be to allow small companies to sell equity stakes to online investors, thereby providing easy access to millions of more potential investors. However, US online crowdfunding platforms are at regulatory risk and we are already seeing changes in the way businesses are run. Recently, Kickstarter amended its terms and conditions to comply with the SEC and stated that it will not participate in equity crowdfunding, primarily because of the extremely high cost of compliance.
Are there any differences of laws for digital vs fiat currency funding?
Due to the fact Cryptocurrencies are not a standard digital representation of money but a decentralized system which is theoretically immune to trusted third parties, some may think that regulators are only targeting “Fiat money”. However this immunity is questionable, investor protection will always be the main concern and Bitcoin based equity offerings have already caught the SEC's negative attention. To that extent, it is extremely important to seek specific legal advice and keep up to date with evolving regulatory requirements.
In June 2014, the SEC fined the bitcoin Entrepreneur Erik Voorhees for $50,000 due to the public offering of unregistered securities in two of his bitcoin-related ventures via online forums and social media platforms. This decision represents one of the most high-profile cases against a bitcoin Entrepreneur for securities violations to date. Until this case, the SEC had hinted that it was only investigating bitcoin related companies in an attempt to warn investors about the dangers of investing in digital currencies but no action was taken. The SEC’s Division of Enforcement director Andrew Ceresney reiterated that “Entrepreneurs need to remember that the agency’s regulations still apply to bitcoin-related ventures. All issuers selling securities to the public must comply with the registration provisions of the securities laws, including issuers who seek to raise funds using bitcoin.” Ceresney added that the "SEC will continue to focus on targeting companies that illegally offer securities for bitcoin investments".
Entrepreneurs and Regulators will eventually need to cooperate to find a long term solution which provides online Crowdfunding to companies in an acceptable regulatory environment.
Are there any existing solutions to selling equity via Bitcoins or using digital currencies for crowdfunding?
Lately, there has been a lot of talk regarding the role of cryptocurrency for the future of crowdfunding and equity creation. Crypto-Equity will be the next "big thing" in raising money for businesses, and Swarm has already established a revolutionary Crypto-Equity Crowdfunding platform that operates on a second generation Bitcoin network to allow startups to raise money by launching their own "Swarmcoin". This "Swarmcoin" will become an equity share in the company, and the Crypto-Equity Crowdfunding process will be carried out through a social network environment for cryptocurrency investors. Swarm's mission is to take the "Blockchain technology" from Bitcoin and transform the way Entrepreneurs raise money by providing a larger access to public funding than current finance models.
By using Crypto-Equity Swarm has the potential to revolutionize early stage equity markets. However, in light of Eric Vorhees' recent fine by the SEC, there is still a strong concern over the legality of making equity offerings in cryptocurrency companies. Indeed Swarm is an inevitable regulatory target as it lies between crowdfunding, equity investment, cryptocurrency, and governments will quickly gain interest in Crypto-Equity thereby creating a legal framework around it.
So the bottom line seems to be that there is very little in concrete guidelines governing equity selling using bitcoins or other digital currencies. As such, what is your current conclusion of the state of affairs for the industry?
As stated by Ben Bernanke, "Digital currencies may hold long-term promise, particularly if the innovations promote a faster more secure and more efficient payment system". Today's technological advancements have made it possible to shift the power to create money from the government to the people by offering decentralized, peer to peer Payments via the Internet. Digital currencies could well be the solution for the billions of people who are unable to get a bank account, the Entrepreneurs who have risked all of their money on a business that went bankrupt in the process, citizens of countries whose banking system has collapsed, startups that cannot afford processing fees or do not qualify for merchant accounts. However, in order to hold in the long term, legal frameworks shall need to increase both security and investor protection.
