A new capital raising mechanism, called crowdfunding (or crowd funding), will create additional D&O (Directors & Officers) liability insurance exposures, and underwriters are already responding. Are you prepared to assist your D&O clients with this new exposure?
As it is used today, crowdfunding allows a company to raise capital by selling small amounts of equity to many investors via the internet. The JOBS Act goes into effect in 2013 and specifically provides for crowdfunding. Crowdfunding is expected to be a strong source of capital for entrepreneurial companies. The objective of the JOBS Act is to ease access to capital for small and startup companies, but the process is new and their will likely be some hidden costs and exposures that your clients should know about.
There is already speculation among underwriters and other industry experts that the legal hurdles and director/officer exposures are not quite as simple as hoped. We have been discussing this exposure with underwriters, and have found that they are beginning to evaluate the exposures and ask questions regarding companies' crowdfunding capital raising intentions. Approaches vary, but we anticipate that underwriters will initially exclude capital raising activities via crowdfunding outright, or will charge an increased premium to cover this activity.
Underwriters’ concerns include:
- Potentially increased SEC oversight of and liability for issuers’ material misstatements and omissions in the offering
- New regulations that the SEC might promulgate
- Exposures associated with outdated state regulations
- Increased claim frequency from more (smaller) investors in each investment
- Fraud, from relaxed distribution controls
- Complexity and lack of knowledge may lead to errors and higher transaction costs
Your small startup and growth clients will want to understand the exposures and D&O implications before pursuing crowdfunding to ensure they are properly protected. In addition, they will need to be reminded that some of these exposures are personal – their personal assets are at risk. A strong D&O program is essential in protecting the directors & officers.
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