Good News for Small Developers: Crowdfunding in the JOBS Act

As we discussed recently, today’s gaming market has ample opportunities for independent developers. There is distribution across multiple consoles, personal computers, and smartphones. Development costs for a top-tier title on the Xbox360 may prevent a start-up company from competing, but you do not have to push the graphics to the limit to find an audience. While indie game development might be cheaper, it is not free. If you do not have money to finance your project, what are your options?

Many people have been looking to the crowd. “Crowdfunding" is a variation on crowdsourcing. The idea is elegant, simple, and well suited for the internet. Rather than taking inputs from just a few sources, crowdsourcing casts a wide net. By receiving feedback from many individuals, you are more likely to arrive at a better solution. As internet connectivity has proliferated, people have taken this basic concept and applied it to many different situations.

It has been used in public safety. In the aftermath of the devastating Haiti earthquake, geographic information systems experts and programmers pooled their efforts to build working maps of ground level conditions. During the recent civil unrest in the Middle East, journalists looked to the crowd on sources like Twitter to place their coverage in context. Tracking the crowd is also being applied to global development, as experts hope it can forecast shifts in commodity prices and economic conditions.

Crowdfunding works by gathering funds by receiving smaller amounts of cash from many people rather than big contributions from just a few. President Barack Obama famously looked to the crowd for a significant portion of his 2008 campaign financing. Comedian Louis C.K. made $1.1 million from a stand up special financed by the crowd, and other creatives are following his lead. For those without an established audience, there are sites like Kickstarter where people with ideas can propose a project and receive crowdfunding. Recent successful proposals have included REM dreaming sleep masks, an encyclopedia of Golden Age Superheroes, and a side-scrolling adventure game. There have been some very famous projects in both the game and tech space.

While Kickstarter and similar sites offer incentives for funders, such as a personalized copy of the project, post cards, or exclusive content, they do not offer ownership. By opening your e-wallet to an idea that looks good to you, you receive no share or stake in their success, other than a name in the credits (which brings no financial benefits). With the recent passage of the JOBS (Jumpstart Our Business Strength) Act, that could change. The new law has numerous regulatory adjustments meant to help small businesses get access to capital. It works to make private capital formation simpler, and reduce the administrative burden for a fledgling business looking to go public.

A particularly exciting portion of the law shows that Congress has been watching crowdfunding, and believes it could provide the economy a shot in the arm. The JOBS Act amends the Securities Act, allowing a company that does not register with the SEC to raise up to $1 million in a year. There are a few requirements to qualify. First, if the interest sold exceeds $1 million, the company no longer qualifies. Second, there are limits to the amount a company can receive from individual investors. If a funding party has a net worth or annual income less than $100,000, they cannot provide more than $2,000 or 5% of their annual income or net worth. If an investor earns more than $100,000 a year or has a net worth above that number, they cannot invest more than 10% of their income or net worth.

The JOBS Act also requires that a company seeking investment through this exemption to use a broker or funding portal, similar to Kickstarter, and has a series of basic guidelines for the broker or funding portal. They have to register with the SEC, provide necessary disclosures to investors, and perform due diligence on companies seeking investment. They may only provide funds once the target is reached. They must protect investor privacy, avoid conflicts of interest, and make sure any individual investments do not exceed the limits described above. The Act also requires that companies seeking investment limit their advertising, file a disclosure document with the SEC, avoid undisclosed compensation for promoting the offering, and provide the SEC with an annual report. (This is a brief digest, but the law firm Akin Gump has released a much more detailed explanation.)

Why does this matter? Looking over these regulatory adjustments, the law recognizes the potential of crowdfunding and shifts the burden away from the company seeking investment and towards the processor of investments, be it a broker or a funding portal. For a small company looking to get the ball rolling, this is a big deal. Companies will still have to make sure they are keeping their financial statements in line and being very careful with investor funds: that does not change. But by relaxing these registration regulations, a growing company can let a broker or funding portal do the heavy administrative lifting. This makes sense. As a company that handles investments for a lot of different companies, a broker or portal will already be familiar with how to navigate the SEC and can remove a lot of anxiety, stress, and time for someone who needs crowdfunding. It also gives creators an alternative to bootstrapping or asking friends and family for investments. It may be an intermediate step before seeking angel funds, or a viable alternative to traditional angel investors. It is a much needed step for early entrepreneurship to have access to this kind of capital.

These regulations could support a huge variety of crowd-funded projects, including games. As long as a company was looking for under $1 million within 12 months and obeyed the individual investor limits, they could receive support from many different everyday investors instead of a few big ones. This also creates an incentive for investors. Kickstarter is great, but what if the rewards such as a copy of a game are not interesting to you? The JOBS Act means you could end up with a stake in the success of a particular project, or the company as a whole. There will likely be a lot of flexibility in what is crowdfunded and how these opportunities are structured and offered by the crowd portals. See a proposal for a game you think is the next big thing, and believe that the developers can make it a reality? By getting in on the ground floor, you could see a financial return if the project succeeds.

There are caveats. Although this law has passed, it still needs to be interpreted by the SEC in light of its current regulations. There is strong bipartisan support for the law, so it is unlikely the SEC will throw any curveballs. Still, always better to wait for the agency to make a statement before plowing ahead. Also, anyone who chooses to invest in a project should do their homework and make sure they are not over committing themselves. Investments of all kinds have risks, and crowdfunding does not change this fact. Funding portals will need to decide whether they are comfortable crossing into the area of providing a real public offering. Some companies might think it is too much trouble and stick with the Kickstarter “reward" model.

Still, it is exciting to see legislative acknowledgement of a technological tool that has been applied in fascinating ways around the world. The crowd has come to the rescue many times over the last few years, and now it could be used to finance the next great indie game.



Zack Bastian is an official contributor to Law of the Game. A third year student at George Washington University Law, Zack works at the Woodrow Wilson Center's Science and Technology Innovation Program and is a member of the American Intellectual Property Law Association. The opinions expressed in his columns are his own. Reach him at: zack[dawt]bastian[aat]gmail[dawt]com.

Megaupload Shut Down, Provides Basic Lessons on Bad Business

It’s been a crazy week with many crazy stories. Fears about the Stop Online Privacy Act created a massive online response, thrusting copyright reform into the national conversation. But while people were speculating on the future of intellectual property, the Department of Justice shut down Megaupload. Over the last five years, Megaupload had grown in popularity as an online “cyberlocker”. As broadband use explodes, the value of these companies is obvious. They are a user-friendly FTP where anyone can place files on a central server, to access them from a different locations or share them with others. When use a cyberlocker to store your baby photos or send a song you wrote to friends, there is no legal issue.

There might have been pictures of a two-year-old’s birthday party or basement demos somewhere on Megaupload, but review of the indictment made public this week shows the site knew their bread and butter was piracy. Although they had disclaimers on their site that users could be punished for uploading copyrighted content, the indictment claims that there was little, if any, enforcement. Instead, Megaupload acted to encourage infringement, primarily by creating an Uploader Rewards program that offered cash payments to the users who provided the most popular files. This, along with many more bad decisions detailed in the indictment, made the shutdown seem like an inevitable event.

There are many layers to this situation. It is a fascinating and frequently entertaining story, complete with outsized characters. One of the defendants Kim Dotcom (formerly Kim Schmitz) was living in China and New Zealand, and drove luxury cars with “GOD” license plates. Megaupload had an internal search engine to pluck whatever they liked from the servers, and one exec e-mailed another complaining his stolen copy of the Sopranos was in French. Employees described themselves as a modern day shipping service for pirates. In the wake of the shutdown, many have expressed concerns that this might signal an aggressive stance towards other sites that serve as cyberlockers. While it is unclear if that is the case, there are some lessons we can take to heart.

The federal government is very serious about delivering heavy blows to electronic money laundering, and are out to discourage anyone (including foreign companies) supporting it. Poker Stars, Full Tilt Poker, and Absolute Poker all tried to avoid the Department of Justice by operating offshore, but were sunk last year. The Treasury’s new Prepaid Access rules have enhanced company obligations to verify customer data, collect information, and comply with law enforcement. This is a sustained pattern that has continued with Megaupload, as the third count in the indictment is for money laundering. It appears it has again been proven that doing your due diligence on your customers and making sure that you do not let suspicious transactions go unnoticed will always be a good investment of money and time.

This case seems uniquely egregious, and it may be that worries about a wider crackdown are exaggerated. Most companies are not going to present such an obvious case for prosecution. Megaupload’s border hopping executives built a business model around attracting stolen content by offering cash incentives to users whose uploads produced traffic. They reveled in their criminality and invited the attention of law enforcement. There is a push to address copyright law and make broad, substantive changes, but most companies offering cyberlockers are not going to be waving a giant flag saying “SHUT US DOWN” like Megaupload did.

As we recently discussed on BitTorrent, the struggle of the government and the courts with file-sharing is part of a broad pattern. There is no widespread agreement on how to deal with these issues, as the hue and cry over SOPA proved. But it is hard not to be encouraged by the emergence of technology law in the national conversation. Last week, the two biggest stories were a piece of legislation that had yet to make it to a vote, and the shutdown of Megupload. If it gets people thinking critically on how to help the law catch up with modern technical realities, everybody benefits. Except Kim Dotcom. He is (probably) in big trouble.

Zack Bastian is an official contributor to Law of the Game. A third year student at George Washington University Law, Zack works at the Woodrow Wilson Center's Science and Technology Innovation Program and is a member of the American Intellectual Property Law Association. The opinions expressed in his columns are his own. Reach him at: zack[dawt]bastian[aat]gmail[dawt]com.