Far from the Madding Crowd: Crowdfunding a Small Business Reorganization

• Publication year: 2018

Far from the Madding Crowd: Crowdfunding a Small Business Reorganization

Anthony Tamburro

FAR FROM THE MADDING CROWD: CROWDFUNDING A SMALL BUSINESS REORGANIZATION

Abstract

Crowdfunding, the act of raising small sums of money from a large pool of people over the internet, represents a new way for small businesses to raise capital. Thousands of entrepreneurs have used online portals such as Indiegogo.com or Kickstarter.com to fund their business ventures. While the results of those campaigns vary wildly, the market itself has thrived, and currently sees an annual investment of $90 billion. As more businesses turn to crowdfunding, the likelihood that crowdfunding will come into conflict with the Bankruptcy Code increases.

This Comment proposes a framework by which bankruptcy courts can analyze cases involving non-equity crowdfunding and small business debtors. The framework is best described in the context of four questions likely to be raised by the creditors of a crowdfunding debtor. First, creditors may seek to cancel a crowdfunding campaign once the debtor has filed for bankruptcy. Section 365, and the concept of contingent interests, will both allow the debtor to overcome these objections and incentivize debtors to withhold them in the first place. Second, creditors may object to the use of estate property in the campaign itself. Section 363 provides courts with a means to evaluate these objections and debtors with a means to defeat them. Third, creditors may seek to prevent a debtor from taking on new debt by fulfilling its post-petition crowdfunding obligations. Section 364, however, suggests that those obligations should be considered administrative expenses. Finally, creditors may oppose confirmation of a reorganization plan predicated on a successful crowdfunding campaign. If such a plan is carefully designed, however, it can satisfy § 1129(a)(ll)'s feasibility standard.

Bankruptcy Courts can and should evaluate these cases with an eye towards promoting trust in the crowdfunding sector. By explaining the proposed framework through the eyes of a fictional small business, this Comment argues that courts can answer creditors' questions in a way that both satisfies the twin aims of bankruptcy and protects the integrity of the crowdfunding system.

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Preface

Debt, as a general rule, is undesirable. Nevertheless, as the economy continues to grow in unexpected directions, debt remains a constant part of almost any market.¹ Small businesses treading water in that oft-raging sea of equity often discover that, as Ralph Waldo Emerson wrote in 1860, "money often costs too much."² Failure to raise capital, then, becomes the breaker upon which so many entrepreneurs ultimately crash.

Crowdfunding represents one means by which individuals and businesses can avoid the pitfalls of debt-based capital formation.³ Crowdfunding is, in its simplest form, "a financing model that relies on collecting small sums of money from many people over the Internet."⁴ The process is straightforward. Instead of giving up equity to a bank or encumbering more of their property with liens, entrepreneurs can tap into their consumer base for needed capital. Using online portals such as Kickstarter.com or Indiegogo.com, the entrepreneur, and thousands like her, simply lists her project online for the masses to evaluate. If an individual likes the project, and wishes to see it thrive, he can contribute funds and become a "backer." In addition to knowing that they have contributed to something they are passionate about, backers are often rewarded with special access, recognition, or items to commemorate their benevolence.

These contributions are flowing in at unexpected rates. According to Forbes, the crowdfunding sector will see investment of $90 billion per year by 2017, and has likely already overcome venture capital in terms of average yearly investment.⁵ Small businesses are playing their part in this surge because "[c]rowdfunding addresses a well-known gap in financing for companies and projects with prospects too uncertain to qualify for bank loans as well as business plans too small or esoteric to attract angel investors or venture capital funding."⁶

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On Indiegogo, the "small business" category is filled with well over 250 campaigns⁷ crowdfunding for everything from opening a hot yoga studio in Richmond, Virginia ($5,750 raised)⁸ to relocating a modular "co-living space" in Los Angeles ($29,307 raised).⁹ The allure of tapping into the crowd for capital has also been felt in larger corporate circles. In 2015, Sony, an international company with $148 billion in assets, announced that the third installment of its long dormant video game series Shenmue would be funded via Kickstarter.¹⁰ Despite some intense media skepticism and criticism, Sony raised $800,000 in the first half hour of the campaign.¹¹

Unfortunately, small businesses often have a rough go in today's economy—in 2016, for example, an average filing-day saw 151 businesses file for bankruptcy.¹² As the amount of businesses using crowdfunding platforms grows, so too will the amount of crowdfunding businesses that fail. More failed businesses funded by crowdfunding campaigns will logically lead to more businesses filing for bankruptcy that still owe promises to backers. These failures will ultimately bring crowdfunding into conflict with chapter 11 of the Code.¹³

Introduction

Legal scholarship has only recently addressed crowdfunding from a bankruptcy perspective. In a 2013 American Bankruptcy Institute (ABI) Journal feature titled "Crowdfunding" a Chapter 11 Plan, one commentator wrote that while "[c]rowdfunding has the potential to create new options for small business debtors . . . if and when these new options arise in the context of bankruptcy cases, they will inevitably raise a host of questions."¹⁴ This Comment will address four of those questions, each likely to be brought by creditors of a small business debtor. It will not suggest how a court should rule in any particular

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case; as will be discussed, such inquiries are rather fact intensive. The Comment will, however, propose a framework for how a court can decide (1) whether the campaign should be cancelled outright upon filing, (2) whether a debtor can use property of the estate to crowdfund, (3) whether promised rewards can be paid without upsetting eventual distribution, and (4) whether a chapter 11 plan can be confirmed if it relies on crowdfunding as a means of capital formation.

This Comment will suggest that, with regards to crowdfunding, the Code need not be reinvented, and the tools to analyze these four questions are already present in the judge's toolbox. The threshold question of the crowdfunding campaign's continuation is addressed by § 365, which concerns executory contracts, and § 541's allowance of contingent interests as property of the estate. As discussed infra in parts III (B) and (C), these two sections should allow debtors to continue their campaigns after filing for chapter 11. Part III (D) discusses how § 363 will authorize debtors-in-possession to use property of the estate to crowdfund.¹⁵ Part III (E) proposes that, because rewards promised to backers are post-petition burdens, § 364 can allow debtors to satisfy those obligations. Finally, part III (F) suggests that crowdfunding can satisfy § 1129(a)(11)'s feasibility requirement, and that reliance on such a campaign need not be fatal to a plan's confirmation. That such a framework is already present in the Code means that courts do not need to react impulsively in response to crowdfunding ¹⁶

Broadly speaking, there are two types of crowdfunding: equity crowdfunding and non-equity crowdfunding. While this Comment concerns the former, the latter will be discussed by way of comparison, especially in part II (A), with regards to the 2012 "Jumpstart Our Business Startups" ("JOBS") Act.¹⁷ Equity crowdfunding platforms are akin to virtual stock exchanges. Both individual and institutional investors can log in to an equity crowdfunding portal, such as Microventures.com or Equitynet.com, and purchase shares in

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companies.¹⁸ Backers on these platforms become shareholders, and because they represent a wide swath of the investing community, companies seeking their investment can cater to a wider set of interests than they would in a traditional investment setting.¹⁹ In bankruptcy, these backers would fall behind secured and unsecured creditors in chapter 11 proceedings.²⁰

This Comment focuses on non-equity-based crowdfunding, which represents a more attractive proposition to many entrepreneurs because, as the name would suggest, it does not require a business owner to give up equity or shares.²¹ As described in Part II (B), a business using a non-equity crowdfund can theoretically raise capital by trading on nothing more than the goodwill of its customers. Further, non-equity campaigns on platforms that do not allow securities offerings, such as Kickstarter.com²² or GoFundMe.com,²³ are governed by general contract law, which is more accessible to small business owners than securities law.²⁴ As non-equity crowdfunding contracts are governed by contract law, they are simpler to evaluate in bankruptcy. For example, in a non-equity crowdfunding case, § 1145's securities law exemptions need not be considered.²⁵

When a business involved in crowdfunding files for bankruptcy, three unique qualities of crowdfunding schemes may pose challenges for bankruptcy courts.²⁶ First, many platforms use an "all or nothing" system wherein funds are not released to project organizers until their "goals," as filed with the platform

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and advertised to prospective backers, have been met.²⁷ If the goals are not met, the campaign receives nothing. One could imagine a scenario where a debtor has raised 90% of its goal on the date of filing for chapter 11. Should the court force the campaign's cessation to appease risk averse...