978-1119563228 Chapter 12

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Wefunder Teaching Note

Overview

The Wefunder case, an example of regulatory entrepreneurship, presents multifaceted

challenges associated with leading the growth of a new industry. Opposite to pursuing an

entrepreneurial opportunity in an established or mature industry, there is far–reaching

uncertainty about the regulatory environment in the equity crowdfunding industry and if

new regulations, which might support the growth of the industry, will ever emerge.

Moreover, Wefunder’s existing success and market leadership, have generated an array of

pressing operational/bandwidth challenges and business model viability questions.

Topics examined in the case include:

• crowdfunding campaign dynamics

• types of crowdfunding, with an emphasis on equity crowdfunding

• new industry creation

• entrepreneurial finance

• operations and scaling challenges of a new venture

Broadly, the case has value in intermediate and advanced entrepreneurship courses which

might examine:

• ambiguity and uncertainty in the face of entrepreneurial action

• the creation (versus discovery) of entrepreneurial opportunities

• challenges educating customers/consumers/users when introducing a new

innovation

• engaging in government relations—and at the extreme, regulatory leadership and

lobbying—to create and enlarge an entrepreneurial opportunity

The case is suitable for both undergraduate and graduate students. However, graduate

students may be more equipped to have far–ranging discussions about the topics raised

above.

The case offers an integrated view of the four types of crowdfunding, painting a broad

picture of this relatively new and developing area of entrepreneurial finance. Moreover, the

case examines vital relationship–dimensions between entrepreneurs who choose to

crowdfund (i.e., Creators) and Backers. Namely, the case analyzes the motivations of

backers to support a given entrepreneur, project or cause, and how community is built

around a campaign. The case is a multimedia case in that it links to several lively

crowdfunding pitch videos and campaigns which animate the topic.

Legalities of Equity Crowdfunding for Non–Accredited Investors

Nick’s frustration with the inability of small businesses to raise money from numerous

small investors was legally justified at the time. The problem stemmed from Section 5 of

the Securities Act of 1933 (the “33 Act”) which in effect requires any company desiring to

sell any of its securities in interstate commerce to go through the process of creating and

filing a registration statement with Securities and Exchange Commission (“SEC”), a process

that can take upwards of 6 months and cost over $1 million. Fortunately, the 33 Act

contained a number of exceptions to this registration requirement.

Possibly the most useful was the exception contained in Section 4(2) of the 33 Act

exempting from the registration requirement “transactions by an issuer not involving any

public offering.” This welcome exception for so–called “private placements” nonetheless

left much to interpretation. Just what exactly is a “transaction…not involving any public

offering?” Over the years, courts have relied on a number of factors to distinguish

qualifying private offerings from public ones, attempting to differentiate investors who

“need the protection of the Act” from others who might have “access to the kind of

information which registration would disclose.” These factors included the identity of the

offerees and their relationship to the issuer and each other, the size of the offering, the

number of investment units (shares) offered, the methods of communication and

distribution employed, and the length of time the securities were held before resale. All of

these factors are at least somewhat subjective so the SEC had issued a safe harbor,

Regulation D.

Under that regulation, as long as all offers were made in states which imposed their own

disclosure regulations, an issuer could raise as much as $1 million by simply filing a one–

page notification with the SEC (“Form D”). If an offering raised over $1 million, further

restrictions applied, including limits on the number and nature of investors, requirements

for disclosure of material information and limits on the manner of solicitation of investors.

One more commonly used exception to the registration requirement which was equally if

not more inapt derived from the SEC’s general exemptive authority contained in Section 3

(b) 1 of the 33 Act. Pursuant to this authority, the SEC had issued Regulation A, which

allowed issuers raising up to $5 million to file a “simplified” form of registration statement

(an “offering circular”), rather than a full–blown registration. However, it was generally

believed that the amount of disclosure still necessary to comply with Regulation A, the cost

of creating such an offering circular, and the amount of time it took to create and gain SEC

approval for such a document made use of Regulation A impractical, especially in light of

the $5 million dollar limitation. 1

Nick was, therefore, generally correct that there was no practical method under the

securities laws as they then existed for a small company to raise a relatively small amount

1 Regulation A has since been amended to, among other things, increase the size of eligible offerings to

$50,000,000.

Zacharakis, A., Corbett, A., & Bygrave, W. (2020) Entrepreneurship, 5th Edition. Hoboken, NJ: Wiley

of money from a relatively large number of small unaccredited investors. The JOBS Act and

Wefunder’s Participation

The efforts of Wefunder’s founders paid off in the form of Title III of the Jumpstart Our

Business Startups (JOBS) Act, enacted on April 12, 2012. That Act created a crowdfunding

exemption from registration under the 33 Act (and from state securities regulation) of

offerings of securities which complied with the following limitations:

a) The aggregate amount raised under the crowdfunding exemption by any offeror within

any 12 month period cannot exceed $1 million.

b) The amount raised from any individual investor within said 12 month period generally

cannot exceed the greater of $2000 or 5 percent of the annual income or net worth of the

investor with some exceptions.for wealthier individuals; and

c) The transaction is conducted through a registered broker/dealer or the newly created

concept known as a “funding portal.” Thus, crowdfunding offerings cannot be conducted

directly by issuers; highly regulagted third party “intermediaries” are necessary.

Further, the JOBS Act imposed significant restrictions on crowdfunding issuers. Including

a) Issuers are required to provide both the potential investors and the SEC with required,

material disclosures ; and b) Following a successful offering, issuers must provide annual

reports to the investors and SEC including financial statements.

Lastly, the JOBS Act provided that any securities purchased under the crowdfunding

exemption could not be resold (with certain limited exceptions) for one year from the date

of purchase.

With this major legislative victory, all eyes turned to the SEC, without whose rulemaking,

the crowdfunding exemption could not go into effect. Unfortunately for those interested, it

turned out to be a long wait. Proposed rules were not released until October 23, 2013, and

final rules, providing all the clarifications required by the JOBS Act, were finally

promulgated on October 30, 2015, with an effective date of May 16, 2016.

Wefunder actively participated in this rulemaking, in the process providing the SEC with a

formal comment letter after the proposed rules were released. The letter praised the SEC

for not requiring investors to prove their net worth and annual incomes with tax returns,

etc. Such disclosure would be a powerful deterrent in context of such small investment

amounts. It also approved of the SEC’s position that the $1 million limit on monies raised

through crowdfunding would not count against any monies raised by an issuer pursuant to

other 33 Act exemptions.

However, Wefunder requested that the SEC reconsider its decision not to allow

intermediaries to take a financial interest in issuers in exchange for its services, thereby

aligning the interests of the intermediaries with that of investors. It further requested the

SEC to allow the “special purpose entities” described erlir in this case. And Wefunder also

requested the SEC to reconsider its stance against allowing intermediaries to “rate” issuers.

Only the request regarding taking a financial interest in the issuer as compensation was

granted, conditioned on full disclosure to the investors and SEC. Otherwise, the final

regulations largely tracked the proposed rules with some further clarifications.

Case Questions

Below are notes to support a discussion and debrief of the five questions presented at the

end of the case. Nonetheless, the case discussion can be taken in many directions.

Question 1: What is regulatory entrepreneurship?

Other prominent examples of entrepreneurial ventures engaging in regulatory

entrepreneurship include:

Arguably, there are ethical questions raised by regulatory entrepreneurship. Namely, is it

ethical to act outside of existing regulatory frameworks in an effort to change those

Zacharakis, A., Corbett, A., & Bygrave, W. (2020) Entrepreneurship, 5th Edition. Hoboken, NJ: Wiley

house/room of the host). On the other hand, the aggressive growth of Airbnb in some cities,

and associated speculation in real estate to offer Airbnb lodging, have worsened the

affordable housing problem. Analogously, the rise of equity crowdfunding arguably has

diluted the protections included in prior law for smaller, unsophisticated investors.

In sum, not all local, regional and national regulations are just, but the entrepreneurial

team is pursuing a unique type of growth strategy when lobbying for new regulations is

central to the entrepreneurial opportunity.

Question 2: Given that equity crowdfunding industry growth is much lower than

anticipated, what should Wefunder’s immediate and longer term strategy be?

Relatedly, in your view, what competitive actions will separate winners from losers

in this new industry?

Clearly, the ability to intake and promote quality campaigns is central to Wefunder’s

strategy, as growth is driven by generating deal flow, commissions and fees. However, as

noted in the case, the desire to cultivate and seize a long–term growth opportunity requires

Question 3: How, if at all, will the emergence of crowdfunding impact angels and

venture capitalists?

Question 4: In what cases should an entrepreneur consider—and not consider—

equity crowdfunding? How should equity crowdfunding be evaluated and compared

to other sources of capital?

Zacharakis, A., Corbett, A., & Bygrave, W. (2020) Entrepreneurship, 5th Edition. Hoboken, NJ: Wiley

Question 5: How are backer motivations similar—and different—when comparing

rewards–based crowdfunding versus equity crowdfunding?

On the surface, there appears to be a significant difference between backers of equity

crowdfunding campaigns and rewards–based campaigns, where equity investors seek

riches, and rewards backers seek only products. The thinking goes that the former

Appendix A. Key Dates and Milestones

2012 – Congress passes the Jumpstart Our Business Startups (JOBS) Act in response to the

2008 economic crisis. Wefunder is invited to the White House Rose Garden to see Obama

sign the bill into law.

2012 – The Wefunder founders raise $530,000 from 60 investors and begin “crowdfunding

for rich people”/accredited investors while waiting for new crowdfunding regulations to be

developed.

2013 – Nick Tommarello, Greg Belote and Mike Norman participate in the business

incubator Y–Combinator in Cambridge, Massachusetts.

Zacharakis, A., Corbett, A., & Bygrave, W. (2020) Entrepreneurship, 5th Edition. Hoboken, NJ: Wiley

2012–2016 – The Wefunder founders offer extensive comments and input to shape the

development of regulations meeting with U.S. Congress members.

May 16, 2016 – Forty months after the Congressional deadline, the SEC crowdfunding rules

go into effect.

May–July, 2016 – 70,000 investors sign up; 5,000 investors commit over $5 million; 29% of

investors put the minimum of $100

October 2016 – Over 77,000 investors are registered with Wefunder; Wefunder has helped

raise funds for 134 companies

October 2016 – Wefunder becomes the first equity crowdfunding platform to accept

Bitcoin

April 2017 – The Wefunder platform accounts for over 80% of all funds raised in the non–

accredited equity crowdfunding space.

May 16, 2017 – One year in, 335 companies have filed offerings on all operating portals, 43

percent of which were funded, 30 percent of which had failing campaigns, and the

remainder were still fundraising; total capital invested is just above $40 million with the

average successful campaign raising $282,000 from about 312 investors, or slightly under

$1,000 per contributing investor. Of the 26 portals registered with FINRA, 9 have already

closed.

October 2017 – StartEngine and Wefunder are neck–and–neck, each with 40% of total funds

raised.

Teaching Note Appendix B. Dollar Volume by Platform

Through March 31, 2018

Funding Portal Amount of Capital Raised (in millions) % as of total

Source: Startengine.com

Teaching Note Appendix C. Platforms Listed with FINRA

As of 11/18/18

Avonto, LLC

Buy The Block

CollectiveSun, LLC

Crowd Ignition, Inc.

CrowdsourceFunded.com

EnergyFunders Marketplace

Equifund Crowd Funding Portal Inc.

EquityBender LLC

First Democracy VC

FlashFunders Funding Portal, LLC

Funding Wonder Crowd, LLC

Fundme.com, Inc.

Fundpaas Inc

Good Capital Ventures

Gridshare LLC

GrowthFountain Capital, LLC

Honeycomb Portal LLC

Hycrowd LLC

Indie Crowd Funder, LLC.

Jumpstart Micro, Inc

Ksdaq Inc.

Merging Traffic Portal llc

MinnowCFunding LLC

Neighbor Capital

NetCapital Funding Portal Inc.

NextSeed US LLC

NSSC Funding Portal, LLC

OpenDeal Inc.

Razitall, Inc.

SI Portal, LLC

Silicon Prairie Holdings, Inc.

Slice Capital

Sprowtt CrowdFunding, Inc.

StartEngine Capital LLC

StartWise, Inc.

STL Critical Technologies JV I, LLC

Thrivera Ventures Fund I, LLC

title3funds.com

Trucrowd INC

Venture Capital 500, LLC

Wefunder Portal LLC