In early 2018, Nick Tommarello could be proud of what he and his partners had accomplished. Their company, Wefunder, Inc., was the acknowledged leader in the equity crowdfunding industry, an industry that he and his partners were largely responsible for creating. Wefunder served as an online portal for crowdfunding investments and had raised more money for more companies than any of their competitors. Yet Nick’s pride and satisfaction with these accomplishments were tempered by the knowledge that neither his company, nor the industry as a whole, had achieved the volume and size he had originally projected. Wefunder’s careful vetting of the companies allowed to raise money on its site had created a reputation for quality, but the labor‐intensiveness of this model was limiting the company’s ability to scale up for growth. And the restrictive conditions imposed by federal law and the Securities and Exchange Commission’s regulations on equity crowdfunding seemed to prohibit models of doing business deemed essential for the growth of the industry as a whole. If these challenges could not be met, Wefunder might well end up as one of many fish competing in an unfortunately small pond.

Short History of Crowdfunding

Since the humble foundings of Indiegogo in 2007 and Kickstarter in 2009, online crowdfunding had exploded to nearly a \($10\) billion dollar industry. Initially a way for hobbyists, artists, and inventors to realize creative projects, the industry spawned disruptive entrepreneurial ventures such as the Oculus Rift in 2012, a virtual reality headset ultimately sold to Facebook for \($3\) billion, and The Pebble in 2013, the first mass market smart watch.
The disruptive power of crowdfunding had arrived, but only for nonequity commitments from backers where a simple product or thank you was promised in return for financial support.
The opportunity to actually invest in these companies was reserved by law generally to sophisticated, wealthy investors (“accredited investors”2) by a legal system founded on the principle of protecting the general public from excessive risk.
Against this backdrop, Nick Tommarello, co‐founder of Wefunder, an equity crowdfunding platform for nonaccredited investors, set out to disrupt the world of entrepreneurial finance.
He remarked, “I don’t feel a sense of meaning when I buy a share of IBM—it’s purely a financial transaction. But start‐ups?
If I could support entrepreneurs trying to change the world and still have a chance of earning a return…well, that’s value beyond money. I could give back. And that’s the key to making crowd investing work.” According to Nick, “Wefunder is predicated upon the idea that anyone, regardless of wealth level, should be able to invest in a company.” He and his co‐founders Greg Belote and Mike Norman wanted to fill the frequent funding gap for start‐ups between angels and that first major round of capital.
In doing so, the three entrepreneurs would be engaging in “regulatory entrepreneurship,” a form of entrepreneurship gaining recognition in the field. As defined by Pollman and Barry, “some companies pursue a line of business that has a legal issue at its core—a significant uncertainty regarding how the law will apply to a main part of the business operation, a need for new regulations in order for products to be feasible or profitable, or a legal restriction that prevents the long‐term operation of the business.
For these entrepreneurs, political activity is generally a major component of their business models. Essentially, these companies are in the business of trying to change or shape the law.”3 For Tommarello, Belote, and Norman, it meant working to shape the original “JOBS ACT,” officially known in the U.S.
Congress as the 2012 Jumpstart Our Startup Businesses Act.
The Wefunder founders actually helped craft the Crowdfunding section of the JOBS Act that President Obama later signed into law. As such, they were invited by the White House to witness the signing of the JOBS Act into law, thus setting the stage for a new age of entrepreneurial finance.
In signing the new legislation in the Rose Garden, Obama stated, “Start‐ups and small businesses will now have access to a big, new pool of potential investors. For the first time, ordinary Americans will be able to go online and invest in entrepreneurs that they believe in” (April 5, 2012).
The JOBS ACT, with rules later released by the Securities and Exchange Commission (SEC), allowed anyone to invest up to 5% of their annual income or net worth, whichever is higher—up to \($2,000\) total per year—in start‐ups, only through an online equity crowdfunding portal such as Wefunder. Those individuals with an annual income or net worth above \($100,000\) could invest up to 10% of annual income in a 12‐month period not to exceed \($100,000\) in total. Securities purchased in this manner would be effectively nontransferable for a period of one year after purchase. Companies would be limited to raising no more than \($1,000,000\) per year in this manner. With the stroke of a pen, the new regulations created millions of new investors with the ability to make equity investments in entrepreneurial ventures but only through crowdfunding platforms.

To temper investor expectations, however, the SEC listed a number of potential hazards with equity crowdfunding (https://www.sec.gov/oiea/investor‐alertsbulletins/ib_crowdfunding‐.html) including the limited disclosure that start‐ups need to share, the possibility of fraud, and the potential that a startup will fail. Equity crowdfunding for nonaccredited investors introduced new possibilities, as well as new potential risks, for investors passionate to support entrepreneurs.

The Global Crowdfunding Industry

Equity crowdfunding for nonaccredited investors was but one of four primary types of crowdfunding driving the growth of the global industry.
Rewards‐based crowdfunding: In rewards‐based crowdfunding (e.g., Kickstarter, Indiegogo) campaign “backers” receive no equity stake in a venture but rather a “thank you,” generally a product, from the campaign creators (“creators” is Kickstarter’s name for an individual or team that launches a campaign on the Kickstarter platform). By aggregating funds on these types of platforms, hobbyists, artists, and inventors alike could know they had both funding and an audience in place for costly projects—in essence preselling new products, music CDs, or even events—before beginning production. The costs to raise funds on such platforms are generally 9% of total funds raised with 5% going to the platform itself (e.g., Kickstarter) and 4% going to a payments processor such as Stripe or Amazon Payments.
Donation crowdfunding: In a donation crowdfunding campaign (such as GoFundMe), backers support a worthy cause or organization with a fundraising need. Donation campaigns have been run to cover the costs of such items as expensive medical procedures for the uninsured to emergency college costs. Costs to raise funds are generally less than with rewards‐based crowdfunding and in some cases free.

Lending crowdfunding: Lending crowdfunding engages crowds to make loans to individuals, offering financial returns (i.e., interest) to backers, leveraging the borrower’s social reputation and network. Examples of lending crowdfunding sites include LendingClub, Upstart, and Funding Circle. The idea is to personalize lending as differentiated from a loan made by bank or professional lender, and costs to the borrower vary. However, since all but short-term loans qualify as securities under the law, prior to the JOBS Act, the opportunities to make such loans were also essentially limited to accredited investors.
Equity crowdfunding: In equity crowdfunding, the focus of Wefunder’s business model, backers acquire an equity stake in the venture raising funds. Portals charge a percentage of funds raised, on average 4–5%, plus a fee to the investors.
The issuer or venture is responsible to disclose a valuation for the company, thus enabling the backer to value his or her investment in the venture. Equity crowdfunding had existed before 2012 JOBS Act but only for accredited investors. Prior to the launch of Wefunder, there were portals serving angel investor networks, or what Wefunder called “rich person crowdfunding,” which Wefunder also offered until nonaccredited investor crowdfunding became legal.
The Global Scope of Crowdfunding
Globally, an estimated 1,250 active crowdfunding platforms (CFPs) compete in the categories of rewards‐based crowdfunding (Kickstarter, Indiegogo), donation crowdfunding (GoFundMe, Patrion), lending crowdfunding (Lending Club, Kiva), and equity crowdfunding (Wefunder, StartEngine, SeedInvest, Republic). According to the World Bank, the global crowdfunding industry is expected to raise \($93\) billion annually by 2025, or approximately 1.8 times the size of the global venture capital industry today, suggesting an opportunity to shake up existing models of entrepreneurial finance. Starting in 2011, Kickstarter raised more money for artists than the United States’ National Endowment for the Arts, or over \($323\) million.
To date, the global crowdfunding industry has transformed notions of how artists, inventors, and entrepreneurs can bring new technologies and innovations to life.
Backer Motivations
Crowdfunding relies on backers—short‐hand for financial backers—who support a particular project, product, person, or passion. While those creating failing campaigns may assume funds simply fall from the sky—a common misconception—
those leading successful campaigns activate, or roll up, a network of fans and followers, including friends, family, and customers.
With rewards‐based crowdfunding campaigns, like those on Kickstarter, backers support the entrepreneurial vision or product development wishes shared by a project’s Creator. More generally, backers support projects that reflect their unique interests and values. Three varied such campaigns are as follows:
Stompy: A successful \($65,000\) campaign to build a giant, truck‐sized, 6‐legged, rideable mechanized “insect” backed by amateur roboticists, science fiction enthusiasts, and engineers.
https://www.kickstarter.com/projects/projecthexapod/
stompy‐the‐giant‐rideable‐walking‐robot‐0/description.
The Pebble Watch: A successful \($10\) million dollar campaign to build the world’s first mass market smart watch, beating companies such as Samsung and Apple to establish this new technology category. The campaign was backed by fans of emerging wearable computing technologies and other technophiles.
https://www.kickstarter.com/projects/getpebble/pebble‐e‐paper‐watch‐for‐iphone‐and‐android/description.

FlowHive : A successful \($13\) million dollar campaign to create an innovative new beehive design/honey‐harvesting process targeting amateur beekeepers who understand the pain and mess of traditional methods of honey‐making. https://www.indiegogo.com/projects/flow‐hive‐honey‐on‐tap‐directlyfrom‐your‐beehive‐environment‐5#/.
Each of the examples above illustrate that successful campaigns target specific target backers and subcultures (e.g., roboticists, wearable computing enthusiasts, amateur beekeepers).
Backers back campaigns because:
• Often they have family and friendship relationships with the crowdfunding campaign leaders.
• They want to see the creation of a new innovation in their particular passion or interest area.
• They value the connection with the project creator and particularly the opportunity to participate—at least vicariously, but sometimes directly—in the journey to realize the innovation, including project updates.
• They want to receive the final product, deliverable or experience promised by the project creator at a discounted or promotional price.
As Yancey Strickler, co‐founder of Kickstarter, once famously said, “Kickstarter is not a store!” The decision to back a project does not guarantee the delivery of a final product two days later as with an order on Amazon. Each project has real risks—which project creators are required to disclose on their project page—and over 75% of rewards have been shown to be delivered late to backers. 5 Backers can show extreme patience and support in the face of delays if the project creator is transparent about unforeseen challenges. Backers can also be merciless and turn on creators taking to comment boards, or even trolling campaigns for years after failure, if creators are seen as inept or deceptive. 6 Crowds giveth and crowds taketh away—which speaks to the deep personal nature of backing and trust between the backers and creators.
Backers most commonly are family and friends, thus the expression “no network, no funding.” Just after Wefunder launched, Nick commented, “Investors who use the site are largely friends or followers of the business itself.” However, certain campaigns break‐out and capture the popular imagination, in some cases raising millions of dollars. At the time of the writing of this case, Kickstarter has seen over 300 \($1+\) million dollar campaigns ( https://www.kickstarter.com/help/stats ).
To date, it is unclear whether the rise of the equity crowdfunding sector threatens rewards‐based crowdfunding by adding the possibility of “earning a return” on backers’ monies. Alternatively, rewards‐based crowdfunding motivators (e.g., exuberance for the projects and the desire for vicarious participation—and even physical rewards) may be equally important in equity crowdfunding, suggesting a likely hybridization of motives and methods.
Wefunder’s Planning forGrowth
Nick and his co‐founders knew all too well the potential risks of bringing equity crowdfunding to the masses. Investors would have to be educated about very real risks and their expectations would need to be managed very carefully. Equity crowdfunding could not be promoted as a get‐rich‐quick scheme for investors, but instead as a new way to make small investments in businesses you know and love —ones launched by your friends or right in your own neighborhood.
As seen on the company’s home page, Wefunder’s managed this message carefully:

Participation with the potential for profits—but not wealth—was the value proposition. Your fellow engineering Ph.D. student developed a new technology—support her to commercialize it.

Your favorite small‐batch whiskey distillery wants to expand regionally—support the founder’s dream and let others know how amazing the whiskey is.

However, there were broader ambitions too, as stated on the Wefunder website:
“Let’s revitalize capitalism and keep the American dream alive. GDP is slowing. Wealth inequality is rising.
Entrepreneurship is dying across America; falling from 10.6% to 3.6.% among those under 30 since 1989. We aim to reverse these trends by funding more deserving businesses. Our goal is to build a new type of stock market (a NASDAQ for riskier ventures) that lets markets allocate capital to a wide range of businesses more efficiently than banks or VCs.”
Wefunder Does aWhistlestop Tour Across America With a priority to drive entrepreneurial community—not just financial returns—Nick and his team sought to build deal fl ow and identify high‐quality initial campaigns for the platform.
The conviction was that strong campaigns and demonstrablycapable entrepreneurs would distinguish Wefunder from other equity crowdfunding platforms with little personal interest and research into their first issuers.
Wefunder co‐founder Greg Belote commented, “Our vision was always to help fund a cross‐section of the economy in ‘real America’—not just Silicon Valley—so our entire company hopped on a train and met hundreds of business owners across America, 12 cities in two weeks, coast to coast.” The message was fairly straightforward: “Out‐of‐touch bankers on Wall Street don’t take any risks for Main Street! Let’s recreate a world where friends and local communities can invest in their neighbors.”

Wefunder website Fellow Wefunder co‐founder Mike Norman summed it up, “The majority of entrepreneurs are not web‐tech focused businesses in the Bay Area, so it was important for us to get out there, meet folks on the ground, hear people’s issues and challenges and what they’re building in places like Fargo and Chicago and Pittsburgh and Providence…. We found some great companies to feature for our big launch.”
When the launch date finally came, Wefunder launched with 20 companies, which ultimately raised nearly \($3\) million, including a donut shop, whiskey maker, a biotech company, and a Chicago entrepreneur looking to launch an African American culinary district. Nick told Crowdfund Insider, “People are going to be surprised by the quality of companies that decide to use Regulation Crowdfunding on May 16 [2016],” the first day that the new type of equity crowdfunding became legal.
Fast forward to the date of the writing of this case, and Wefunder has raised over \($31\) million for 90 different companies through equity crowdfunding, and was the most successful portal in the industry, “leading the pack both in the number of deals and total dollars raised” 7 (see Appendix A: Sample Wefunder Offerings). It is almost overwhelmed by the number of companies seeking to be listed on the portal and the challenges of scaling the high‐touch vetting and listing process, which has led to its success. Yet, the number of companies using equity crowdfunding and the amount of money raised through equity crowdfunding portals are significantly less than initial projections.
Nick and his partners recognized that the new industry was becoming crowded with other platforms entering, so it sought to differentiate Wefunder by encouraging and enabling investors to build relationships with entrepreneurs, and as Nick stated, “help start‐ups beyond the funding moment.” Equity investors could provide vital product feedback and network contacts, comment on a venture’s overall strategy, and even evangelize. As Nick’s co‐founder Mike Norman explained, “Wefunder really wants to build long term relationships between founders and investors.”
Wefunder also sought to differentiate itself from other platforms by enabling investors to become part of investment clubs and follow lead investors. One of the founders’ key values driving the creation of Wefunder (beyond giving everyone the opportunity to invest in start‐ups) was that the idea that informed experts make better investment decisions than investors alone. “We believe in the wisdom of the crowd guided by industry experts,” said Mike Norman. He continues, “If we allow crowd investors, experts, and fans to collaborate effectively we can allocate capital to deserving new businesses more efficiently than traditional investing.” But, there were also legal obstacles to such an approach (captured in the discussion of Special Purpose Vehicles below), so some further regulatory entrepreneurship would be needed.
Challenges Remaining with the JOBS Act and Equity Crowdfunding Industry Although the JOBS Act and the subsequent SEC regulations went a long way toward facilitating this new method of crowdfunding ventures, in the view of Nick and others in the industry, the law still contained key shortcomings, which would have the effect of drastically limiting the potential for growth. The most serious of these shortcomings is derived from a failure to address the problems inherent in ventures with a large number of small equity holders. These problems fall into two main categories.
The first set of problems result from the provisions of Section 15 of the Securities Act of 1934 (“the 34 Act”). Although the Securities Act of 1933 enacted a comprehensive system of disclosures for companies issuing securities, it did not require any follow‐up disclosures for the benefit of any secondary market, which might arise in such securities. Thus, without additional follow‐on disclosures, investors buying and selling securities on a stock exchange would be essentially flying blind.
The 34 Act remedied this by requiring publicly traded companies to register with the SEC and create and file a series of regular disclosure documents, including quarterly reports, two types of annual reports, and proxy statements, as well as reports and press releases for any of a series of significant events. It also established serious penalties for failure to disclose and misrepresentations.
This, of course, begs the question of the definition of a publicly traded company. Section 12(g) of the 34 Act includes any company that has done a registered public offering but also, in its present form, any company with 2,000 or more shareholders (or 500 or more unaccredited shareholders) and more than \($10\) million in assets. Obviously, a company successfully completing an equity crowdfunding offering quickly risks exceeding the 500 unaccredited investor limit, exposing itself to the highly complex and expensive reporting requirements of the 34 Act as well as its potential liabilities.
The SEC’s crowdfunding rules attempted to address this problem by exempting issuers from registering under the 34 Act, even if they exceed the allowable number of shareholders, so long as they have less than \($25\) million in assets. Once a company exceeds the \($25\) million dollar limit, they will have a two‐year grace period before having to register with the SEC.
Thus, a successful crowdfunded company could be on track for 34 Act registration and its attendant liabilities and disclosure obligations. As such, Nick and most of the crowdfunding industry would prefer a clean exemption under which crowdfunded shares simply do not count against the Section 12(g) limits. Such an exemption is included in the omnibus Financial Choice Act (designed mostly to address alleged shortcomings in the Dodd‐Frank Act) passed by the U.S. House of Representatives in June of 2017 and sent to a very uncertain fate in the Senate, as well as in standalone bills previously passed in the House and in a bill proposed to the Senate. But, this problem remains unresolved as of this writing.
Second, the existence of potentially hundreds or thousands of individual small stockholders presents a legal and recordkeeping nightmare for most issuers. Under various state corporate laws, stockholders may have rights to inspect records, attend stockholders’ meetings, receive distributions, etc. Without incurring the expense of a professional transfer agent and establishing a stockholder services infrastructure, most crowdfunded companies would be unable to keep up with their obligations in this regard. Just keeping up with securities transfers and address changes could be overwhelming. And this, in turn, would likely scare off potential later round investors who much prefer “clean” cap tables.
Nick and much of the crowdfunding industry advocate the use of Special Purpose Funds (or Special Purpose Vehicles, “SPVs”) to solve this problem. An SPV would be an entity formed for the purpose of investing in one crowdfunded company and would be managed by its officers or, in some cases, the relevant funding portal. Investors would invest in the SPV, not the crowdfunded company, so the crowdfunded company would have only one additional stockholder of record (the SPV). The manager of the SPV would handle the crowdfunding compliance and recordkeeping requirements of the SPV. Unfortunately, such an SPV would likely qualify as an investment company under the Investment Company Act of 1940, which regulates companies whose assets are largely securities of other companies. The cost and complexity of compliance with the Investment Company Act are substantial. And worse, the SEC regulations prohibit investment companies from using crowdfunding to raise money, thus making the SPV solution to this problem illegal.
Legislation exempting crowdfunded SPVs from the Investment Company Act is viewed as essential by the industry, but as of this writing, no such legislation has been passed. It is not included in the (likely doomed) Financial Choice Act but was included in standalone bills passed by the House and a bill proposed to the Senate.
In the meantime, many crowdfunding portals advocate the offering of alternatives to formal equity, such as debt. One increasingly popular form of crowdfunded security is the Simple Agreement for Future Equity (often misleadingly referred to as “SAFE”). This is an instrument that converts into actual equity at the time of, and on the same terms of, a future round of investment such as venture capital deal or upon a liquidity event such as a sale of the company or IPO. It addresses the administrative and state law issues created by having large numbers of small stockholders, but doesn’t address the remainder of the challenges described above, such as the registration requirements of Section 12(g).
Finally, notwithstanding the careful management of investor expectations contained in most equity crowdfunding websites, it is fair to assume that some portion of crowdfunding backers (those motivated mainly by hope of return on investment) will become frustrated and angry upon discovering that they are effectively locked in to an uncertain, long-term investment in the absence of any meaningful secondary market for their shares.
Such frustration might be directed against the issuing company and its founders, or even the portals themselves. This problem, it seems, can be addressed only by creation of a secondary market once the one‐year holding period for crowdfunded securities has expired, but the question is will Wefunder or any of its competitors see this as one of the ways to increase the size of their business? In summary, a complex and uncertain legal landscape complicated the overall growth and development of the equity crowdfunding industry.

The Road Ahead

In a round‐up of the first year of equity crowdfunding, one analyst wrote, “Wefunder got out of the gate strong, but can it stand up to the portals that have deep‐pocket VCs behind them?”
Nick and his co‐founders grappled with strategic questions such as how to lead and grow the industry overall, how to enlarge the current entrepreneurial opportunity by lobbying Congress and the SEC, how to scale their currently labor‐intensive business model, and how to maintain a commanding lead in the industry, which was seeing new entrants. The prospect of welcoming millions of people to fund innovative, entrepreneurial ventures and help reboot the U.S. economy in the process was enticing but there were several high hurdles ahead.

Discussion Questions

1. What is regulatory entrepreneurship?

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?

3. How, if at all, will the emergence of crowdfunding impact angels and venture capitalists?

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?

5. How are backer motivations similar—and different—when comparing rewards‐based crowdfunding versus equity crowdfunding?

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WEFUNDER FAS Invest in Startups You Love Keep the American Dream alive Back founders solving the problems you care about and help their startups grow