Faculty of law blogs / UNIVERSITY OF OXFORD

The First Crowdfunding Investment Contracts in the US


Jack Wroldsen


Time to read

2 Minutes

The first crowdfunding investment offerings in the US include six types of investments: common stock, preferred stock, interest-bearing loans, revenue-sharing arrangements, convertible debt, and future equity. My recent article, Crowdfunding Investment Contracts, analyzes each type of crowdfunding investment, as well as the Kickstarter-style rewards that accompany many of the first crowdfunding investment offerings. The article also argues that the terms of crowdfunding investment contracts may not be investors’ primary source of legal protection. Instead, social media, and the collective voice that crowdfunding investors wield, may be more powerful. This post briefly describes today’s crowdfunding investment landscape and summarizes the article’s findings.

As of May 2016, startup companies in the US may sell stock to the general public through crowdfunding because a new law authorizes the practice for the first time. Though Kickstarter (and others) have succeeded in popularizing rewards-based crowdfunding over the internet, legal rules had previously imposed a severe limitation: no sales of stock through crowdfunding were allowed. But this summer, the CROWDFUND Act began allowing startup companies to use crowdfunding to sell securities (whether stock, debt, or hybrid offerings) to investors via the internet, up to $1 million in any 12-month period. And, in true crowdfunding form, the investors need not be wealthy. Instead, crowdfunding is designed to attract small investments (eg, $100) from numerous (often thousands of) investors in the general public.

To the extent that startups with high-growth potential seek investments from the crowd, the practice can be seen as venture capital for the masses. The idea is that crowdfunding investors can get in on the ground floor and share in the future upside of the next Facebook or Uber. Legal rules previously prevented this scenario because the general public could not invest in startups through crowdfunding. For instance, the virtual reality startup, Oculus, ran a highly successful Kickstarter campaign and offered its early supporters an array of rewards, like T-shirts or developer kits. But when Facebook acquired Oculus less than two years later for $2 billion, the early Kickstarter backers received nothing. Crowdfunding investment purports to solve this problem because early crowdfunding supporters can now own a piece of the creative ventures they support.

My article studies all of the crowdfunding investment contracts offered in the US during the first month of crowdfunding investment becoming legal. For example, the article examines two new contracting vehicles, known as the ‘SAFE’ (or, Simple Agreement for Future Equity) and the ‘KISS’ (or, Keep It Simple Security). As the names imply, both agreements are simplified versions of the types of contracts that venture capitalists typically negotiate when investing in startups with high-growth potential that may go on to be acquired or to attract subsequent rounds of investment.

But not all startups fit in the venture capital box, and for these other types of businesses, a different type of contract is appropriate. Stable lifestyle businesses, for example, are ideal candidates for issuing crowdfunded debt or revenue-sharing securities as a means of fostering a loyal community and gaining social media exposure (like a local brewery). In the first wave of crowdfunding investment contracts, though, equity securities are much more prevalent than debt or revenue-sharing securities. Matching the right type of company with the right type of contract will continue to be a priority for the success of crowdfunding investment practices in the future.

Relatedly, the websites that facilitate crowdfunding investments (known as ‘funding portals’) exert tremendous influence over the nascent industry because the websites typically provide standard form contracts for crowdfunding companies and investors to use. The emergence of standardized contracting practices—from the very first day of crowdfunding investment becoming legal—reveals the potential for path dependencies to develop quickly, which is why it is vital to examine the first available data on crowdfunding investment contracts. In the UK, for instance, where crowdfunding investment practices have in some ways advanced more rapidly than in the US, entrenched contractual arrangements that intermediary websites suggest, or even require, are already the norm. As such, the analysis in my article is designed to help mold crowdfunding investment practices in optimal directions as the crowdfunding industry evolves and matures.

Jack Wroldsen is an Assistant Professor of Legal Studies in the Spears School of Business at Oklahoma State University.


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