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Intrastate Crowdfunding: Why the Red Tape? You Gotta be Able to Kick the Tires

posted Jul 18, 2014, 10:27 AM by David Khorram
Benji Jones is an attorney and partner at Smith Anderson in Raleigh. For young and growing companies, she handles public equity and debt offerings, corporate formation and governance, early stage financing and mergers and acquisitions. She graduated from Columbia University Law School and has a background in writing—she was on staff at the Columbia Law Review.
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I recently received an email from a reader (quite legitimately) lamenting the delay by the NC Senate in adopting the NC JOBS Act (although we are getting closer! And here'sExitEvent's update on the bill ) and the massive amount of red tape that comes with the law. He went on to ask: Why, if he could buy a used car for $2,000 (which would be the cap for many investors under the proposed law) with just a handshake, we needed all of this regulation for small investments in local companies? 
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I understand his frustration and support the general principle underlying his complaint. Our representatives need to create an intrastate crowdfunding process that is efficient and effective. If intrastate crowdfunding is too complicated or too expensive, people simply won't use it.

But the crowdfunding process also needs to provide transparency so that potential investors know what they are getting into. Investing in a company through equity crowdfunding isn't the same thing as buying a used car. Here are three reasons why:

1. A Car is . . . well, a Car. We know what a car is. (It's one of the first words my son uttered as an infant: “Cahhhhhhhhhrr --- VVVRRROOOOMMMM!”) It has a motor, several wheels and a carriage of some sort to transport things. While some models are fancier than others, we know what it is expected to do. You add fuel to it and expect it to help you travel from point A to point B. 
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You can capture the key information about a car for sale in five lines or less:

1998 Nissan Quest - $1,998
Price: $1,998, Mileage: 197,145 miles, Exterior: Black
Interior: Gray, Car Type: Used, Body Style: Minivan
Fuel Type: Gasoline, Stock #: [redacted], VIN: [redacted]
Engine: 3.0L V6 24V MPFI SOHC, Transmission: 4-Speed Automatic, Drivetrain: FWD
Doors: 3

The same isn't necessarily true for investments. Investments take all sorts of forms (debt, convertible debt, common stock, preferred stock, participations, units, interests, contingent value payments, etc.) and the benefit of the investment, including the expected rate of return and the associated management control over the enterprise, varies depending on how an investment is structured. It typically takes more than five lines to highlight the key terms of any investment, and, while I'm not sure how you craft a share of convertible preferred stock out of LEGOS®, I know I can make a toy car with them.
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2. You are in the Driver's Seat. When you buy a car, you control how you expect to use it. You might want it as your primary mode of transportation, or it might be a showpiece or purchased for parts. But once you buy the car, you can do what you want with it. Along with title passes ownership and control. 

Not so with investments. When you hand over your money to a company (whether it is a startup or a publicly traded, Fortune 500 company), you are no longer in the driver's seat. You are giving the company the power to use your money as it sees fit, with the hopes that one day you will get that money, plus some extra, back. You are taking the risk and are giving someone else control. 

3. You Get to Kick the Tires. Although a seller can make promises about how a used car performs, it's unlikely you would buy it without first giving it a test drive. Even if you just want the car as a showpiece or for spare parts, you likely wouldn't fork over a couple of grand without kicking the tires, popping the hood or bringing a mechanic by to check it out.
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Folks typically know what kind of diligence they need to do when buying a used car. There are resources that help buyers not get burned. You can check out the Kelly Blue Book value of similar models or pull up a vehicle history report on the car. Plus, if you are buying a car from a manufacturer, federal and state lemon laws may protect you if the deal goes bad. All of these are resources and regulations that have developed over time to protect purchasers and help them truly know what they are buying. 

Fundamentally, the goal of protecting investors is one of the primary objectives of the NC JOBS Act and all these new related regulations (even the long-delayed enactment of federal crowdfunding under Title III of the JOBS Act). These rules and regulations are trying to establish a level playing field so that investors are given enough information and access to companies so that they can “kick the tires” before they make an investment. Getting it right takes careful consideration (irrespective of all of the politics that might be involved in actually getting something passed).
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Lastly, the same adage rings true whether you are buying a used car or making an investment: “You get what you pay for.” Don't put your money down without doing your diligence – go kick the tires before you invest. There is nothing worse when it comes to investing (or purchasing a used car) than buyer's remorse.

The content contained in this blog post does not provide, and should not be relied upon as, legal advice. It does not convey an offer to represent you or an attorney-client relationship. All uses of the content contained in this blog post, other than for personal use, are prohibited.
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