7. Long-term ramifications of having a large number of shareholders
If a company is successful in raising funds through a crowdfunding portal, it may create future issues with the company’s capitalization table. Having 25, 50, or even possibly 1,000 shareholders in a start-up entity can create serious issues for raising the next round of capital as many state corporation laws provide shareholders with protections such as approval rights over certain actions, one of which may be funding through additional investors.
Getting large numbers of shareholders to approve a future round of funding may be so difficult and cumbersome that it may ultimately threaten the long-term viability of the company. Many venture capitalists may avoid crowdfunded biotechs due to the potential problems in getting approval for and funding subsequent rounds.
Aside from crowdfunding, there is one more type of change coming for early-stage corporate funding. Changes to Regulation D’s Rule 506 will loosen restrictions on publicizing private offerings. This will allow companies to advertise more openly for investors—such as on patient advocacy websites or even possibly magazines and newspapers.
Unlike with equity crowdfunding, Rule 506 investors must be accredited investors (for an individual this means having over $200,000 per year in income in each of the two most recent years or having at least $1 million in assets, excluding the value of the individual’s primary residence) who because of the economic situation are better suited for risky biotechnology investments. In addition, unlike the limits placed on equity crowdfunding portals, a Regulation D Rule 506 offering does not limit the amount of equity raised.
Early-stage biotech entrepreneurs should closely watch the development of crowdfunding regulations by the SEC over the coming months and be aware of the significant risks and downsides of crowdfunding.