August 09, 2012
Let's Try This One More Time: Crowdsourcing, Securities, JOBS Act and
Posted by Christine Hurt

OK, before we comment on this article about, let's refresh our recollection of the history of selling futures in oneself or one's project over the Internet.  We all understand that if you form a corporation, LLC or partnership and sell profit-sharing interests in that entity, that is a security, and you have to either register it or qualify for an exemption before selling it.  Of course, the fun cases in Sec Reg are the cases where the promoter markets the investment as one not in an entity, but in an asset -- an orchard or building or. . . .themselves.  Or, the cases where the "investment" looks like a "loan," which is not regulated by the SEC.  Throw in the Internet, and you have a carnival of crowdfunding creativity.

2008 blog post on Real Sports Investments, Inc., which was going to sell "investments" in individual minor league baseball players, or at least in Randy Newsom, until the SEC told him it sounded like selling securities and the MLB said it sounded like gambling.  (Newsom is still in the minor leagues.)

2008 blog post on novelist Tao Lin selling fractional shares in his (then) unwritten novel, Richard Yates.  The novel was published and no SEC complaint was filed (though his father was charged with securities fraud at the time in an unrelated matter).

2009 blog post on Kiva, which doesn't really match your "loan" funds to the cute entrepreneur in the picture, but puts it in a pool from which entrepreneurs receive funds.  Your "return" comes from the pool, not directly from the repayment funds.

2009 blog post on Harvard students soliciting $2000 student loans from alumni on Unithrive website.

2010 blog post on Kickstarter, which solicits philathropic funding for individual arts projects and doesn't offer donors any return, making the whole definition of a security not applicable.  However, some artists seem to be offering a return to entice "donations."

2012 ProFounder, started by Kiva founder Jessica Jackley, shut down amid concerns that it violated the '33 Act.  the site allowed individual entrepreneurs to gather funds invested by "friends and family" but without any filtering.

And, of course, the expert on crowdsourcing, Joan Heminway, and her article Proceed at Your Peril:  Crowdfunding and the Securities Act of 1933.

Finally, the JOBS Act of 2012, specifically the CROWDFUND Act in Article III of the Act, seeks to ease restrictions on crowdfunding that meets certain requirements.  Here is Joan's post on those requirements.

So, does Upstart, which appears to be offering investors the ability to encourage innovation by supporting an entrepreneur with anticipation of a return someday, also skirt securities laws like its predecessors (ProFounder, etc.), or does it qualify under either old exceptions or the CROWDFUNDING Act?  Here's the plan:  Backers can choose Upstarts to invest in, $1000 increments, and can also choose to mentor them, provide networking opportunities, make connections, etc.  This doesn't seem to be required, but is encouraged.  Then, Upstarts agree to pay a certain percentage of their income for 10 years, but payments in one year cannot exceed a 14.99% APR for the Backer.  Backers seem to have unlimited downside, but capped upside.  Seems sort of like a debt/equity hybrid security.  And, the site doesn't seem to meet the requirements of the CROWDFUNDING act.  What could save it?  Maybe this mentoring expectation and the sense that the investor's efforts will affect the investor's return.  That would be my argument.  I can't wait to see what others think.

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