For years, entrepreneurs have raised capital from angel investors and venture capitalists through staged financings. In each round of financing, the entrepreneur recruits a lead investor who negotiates the deal terms of the investment on behalf of all investors. From there, the lead investor assists the startup venture by recruiting other investors to join them in participating in the round. This best practice has emerged from investors and entrepreneurs acting in their own bests interests. Interestingly, securities law has not played much of a role in shaping this situation.
Recently, equity crowdfunding has introduced some significant changes to the way some startups raise capital. Issuers choosing to raise capital through Regulation Crowdfunding, rather than a more traditional exemption from securities law, often raise capital from everyday investors who are unaccredited, rather than the traditional group of accredited angel investors and venture capitalists. While congress and the Securities and Exchange Commission have expressly permitted these unaccredited investors to take part in offerings as investors through Regulation Crowdfunding, challenges have emerged with respect to protecting this new group of investors from nefarious behavior by issuers. For example, issuers are permitted to set their own deal terms when launching an equity crowdfunding campaign; there is no investor who serves as an arms-length negotiator on behalf of all investors.
Even worse, equity crowdfunding issuers have imported the term “lead investor” from other investment contexts, without giving the lead investor any of the important powers, responsibilities, and roles they serve in other investment contexts. This presents everyday unaccredited investors with myriad challenges in evaluating investment opportunities through equity crowdfunding. To remedy some of the challenges, this Article proposes reforms to Regulation Crowdfunding that will require issuers to use lead investors in their offerings and, further, require those lead investors to serve the important roles they carry out in other investment contexts.
Author: David Nows
Volume 24, Issue 4