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The Risks and Perils of Crowdfunding
Crowdfunding could revolutionize fundraising for early-stage biotech companies, but beware of the pitfalls.
Since the passage of the Jumpstart Our Business Startups (JOBS) Act (H.R. 3606) last year, the financial and medical press has been buzzing about the potential for crowdfunding to revolutionize fundraising for early-stage biotech companies. Even more recently, a portal that is exclusively dedicated to crowdfunding biotech and healthcare start-ups launched at medstartr.com. Although there may be reason for biotech entrepreneurs to be excited about crowdfunding, there are significant limitations and risks to this approach as well.
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.
Krist Werling, Bob Cohen, and Michael Pilo work for McDermott Will & Emery.
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