3. Beware the glut of crowdfunding portals.
Once funding portals become sanctioned, they will be a large and entirely new industry that will need to be closely scrutinized. According to the Wall Street Journal, there were 8,800 web domain names registered in the U.S. and Canada in November 2012 that used some form of the term "crowdfunding," up from 900 in January 2012. According to a recent article in The New York Times, several proposed crowdfunding businesses have either set up shop or already moved on from the space.
"In an impending market of hundreds of crowdfunding portals covering all manner of business verticals," Cork says, there will be hundreds of thousands of opportunities for investors. "In that paradigm, it’s a buyer’s market, and the investors will end up where they have access to the best deals," he says.
The funding portals will need to be registered by the SEC and monitored by FINRA or some other similar regulator to keep them honest. But how much will they actually be regulated? Is too much better than not enough? In any case, the specific nature and requirements of the portals remain a mystery.
"Who will be allowed and who will not be allowed?" wonders Indiegogo CEO and co-founder Slava Rubin, who intends to be part of the new crowdfunding paradigm. "I'm somewhat concerned that the SEC is going to stamp a few sites and say, ‘these are the sites that are allowed to be used.’ But if they do that, it's going to damage competition. No one said Amazon.com was the only online retailer that you could use and X.com is one that you can't use. The free market figured it out."
4. Beware the unsophisticated investor.
"Unsophisticated" doesn't necessarily mean stupid — but it could. Many industry insiders agree that the biggest potential problem that will arise as a result of the JOBS Act is the rise of the "non-accredited" or "unsophisticated" investor, which means someone who doesn't have a lot of experience with equity investments.
"Even prior to the SEC ruling on the JOBS Act, raising money from people you don’t know and who are unsophisticated can cause enormous problems down the line," says Cork. "When sophisticated investors lose money on a deal they think, 'What did I miss?' and move on to the next opportunity with greater awareness and insight. When unsophisticated investors lose their money they think, 'Who can I blame?'"
Rubin agrees. "Unsophisticated investors might not understand what it means to invest in a movie. If they do invest in a movie, they might expect their money back in two weeks or two months. But lots of movies don't even get made, and even the ones that are successful, there is sometimes no money back. And that can lead to a lot of frustration, where people get upset."
In this new financing world, it will require lots of due diligence from both filmmakers and investors to avoid those kinds of outcomes. Fledgling investors will have to educate themselves to understand the risks involved, and filmmakers and producers will have to make it clear to those investors what those risks are as well as make sure financiers and funding portals are on the level.
"There will be lawsuits, and there will be fraud, on both sides of the table," adds Cork. "And not necessarily when a film loses money. Headline-grabbing Hollywood lawsuits usually happen when a film makes money. So taking investments from an unsophisticated investor for a high-risk/high-return/high-profile investment, such as film, should be a very calculated and careful decision by the filmmaker."
5. The rules remain in flux. Stay on top of them, and work with experienced lawyers and accountants to know what is required.
"There are a lot of moving parts inside these rules," says Rubin. For example, the JOBS Act currently calls for a maximum limit on investors of $10,000 per person and $1 million per entity. "But how is the SEC going to track the $10,000 per limit per person? Is it going to be self-reporting? Or is there going to be a real-time database that is going to see if you've gone over your limit? The difference between the two is massive," says Rubin. "One takes no work; one takes years of work to implement."
Rubin also notes that investor perks could present challenges for both filmmakers and funding portals. If film productions are offering investors credits on a film, such as "executive producer," or tickets to a premiere or advanced copies of a DVD, will this perk-based fundraising be handled by a portal separate from an equity-based funding portal?
"Can you offer an equity share of the profits in a movie and a movie download at the same time?" asks Rubin. "That's hairy, nitty-gritty stuff we're talking about."
According to the currently proposed rules, film productions seeking more than $500,000 through crowdfunding must also provide audited financial statements, which is a costly process for filmmakers, and could prove "very onerous, almost a deal-breaker," says Rubin. "That's real money and a dent into your crowd-fundraise. You'd probably have to be raising money just to get audited statements."