The Social Network and the Crowdfund Act: Zuckerberg, Saverin and Venture Capitalists' Dilution of the Crowd
By virtue of Title III of the JOBS Act, signed into law on April 5, 2012, crowdfunding could become a powerful, even revolutionary, force to finance start up companies. It democratizes entrepreneurs' access to seed capital and converts the masses of Internet users into potential retail venture capitalists. Many have cautioned, though, that crowdfunding poses serious investment risks of start up companies failing, committing fraud, and being mismanaged. Accordingly, the JOBS Act includes numerous disclosure obligations designed to mitigate such downside risks. But what has been overlooked, and what this Article analyzes from a venture capitalist perspective, is that even if a crowdfunded start up company is successful, crowdfunding investors can lose the value of their investment if they lack venture capital legal protections. When successful start up companies raise additional funds from professional venture capitalists, the value of ground floor investments can be severely diluted, as colorfully dramatized in The Social Network. In addition, when crowdfunded companies are acquired in private transactions, crowdfunders are at risk of being left out. Therefore, under a "qualitative mandates" regulatory philosophy that moves beyond securities law's status quo disclosure requirements, this Article proposes substantive venture capitalist protections for crowdfunding investors, such as down round anti dilution, tag along, and preemptive rights, to help safeguard the value of early stage investments in successful start up companies. Especially because many crowdfunding investors are likely to be inexperienced and unsophisticated in start up company investing, crowdfunding laws and regulations should go beyond disclosure requirements that warn investors of danger (to the extent investors even read or understand the disclosures) to help crowdfunders obtain market based economic protections characteristic of venture capitalist investment contracts.