Many legal questions come up around the wording of various Crowdfunding opportunities. What happens if the project fails to deliver, what happens if it is wildly successful and sold for 100s of millions? Do the backers have rights similar to investors?
Wake me up before you Indiegogo: legal issues with crowdfunding
May 16, 2014. By Chrissie Scelsi via lexology.com.Have you ever backed a project on a crowdfunding site like Kickstarter or Indiegogo? How did that backing experience go? Were you impressed with the final product, or did the creators hit some bumps along the way to getting the final product made? It seems that for every wildly successful project like the campaign for the “Veronica Mars” movie, which raised almost $6 million dollars on Kickstarter, there is another campaign that draws backlash or has issues, like Zach Braff’s similar effort to raise funds for his film, which drew ire when it was revealed that he also had sold some of the distribution rights to the film in exchange for further financing. As crowdfunding has grown in popularity as a way to raise funds for projects and products, a variety of issues have cropped up, from creators hitting snags that prevented the final product from being made and delivered to backers, to projects becoming wildly successful and the products sold to much larger companies. It is this latter situation and the outrage that has been generated by situations like the sale of virtual reality headset maker Oculus to Facebook for $2 billion dollars that has raised the question of what rights backers have when creators sell the product or company to another company for millions or even billions of dollars.
The answer ultimately comes down to the terms that define the roles of the parties involved. As noted on a recent NPR story, in some cases the terms for the parties in the process seem to be changing from backer and creator to customer and startup. While it may not seem like a big deal, these terms are at the heart of the answer to this question of the rights of backers to crowdfunding projects. In its FAQ, Kickstarter defines “backers” as “folks who pledge money to join creators in bringing projects to life.” It further notes that the project creators on the site maintain full ownership of their works, and that the site cannot be used to offer ownership stakes in the company, financial returns, or to solicit loans for the project. Kickstarter makes this distinction because investors are traditionally defined as parties engaging in activities where money is put at risk for the purpose of making a profit. Investors are also typically protected by state and federal securities laws, which require parties seeking investments to register those securities with the state and federal governments, as well as operate in accordance with those respective laws. By contrast, backers of projects on crowdfunding platforms like Kickstarter are generally contributing money to the project in exchange for a certain reward if the project reaches its funding goal, such as a t-shirt or special experience, without the expectation of making a profit, and once that reward is provided, the agreement between the parties has been satisfied. While Kickstarter and similar sites have policies that are designed to protect backers, and do provide backers with the option of pursuing legal recourse against creators in the event that rewards are not provided as promised, these protections are more a matter of the particular site’s policies rather than state or federal law.
At least this is how things stand for now. The Securities and Exchange Commission (SEC), which governs investment activities, has been in the process of writing the rules for the implementation of the Jumpstart Our Business Startups (JOBS) Act, which includes exemptions to the registration requirements for crowdfunding activities that meet certain criteria. Once these rules are put in place, it may be possible for individuals to invest in projects via crowdfunding, and the policies of such sites will likely change to reflect the new laws. While there is great excitement around crowdfunding, there is also concern about protecting consumers, whether they are backing or investing in such projects. This month, Washington State Attorney General Bob Ferguson filed the first consumer protection lawsuit over crowdfunding against Kickstarter project creator Ed Nash and his company Altius Management for failing to deliver the card playing game and rewards to backers as promised in the campaign. While Kickstarter’s policies give backers legal recourse in the event that project creators do not fulfill their promises, this marks the first time that the government has gotten involved in such matters, and likely will not be the last as this type of fundraising evolves.