At least one high-volume Crowdfunding portal is using a series LLC as a crowdfunding vehicle. It’s a terrible idea.
A “series LLC” is a relatively new concept. Rather than form a new limited liability company for a business, you can form a “series” of an existing limited liability company. Think of the parent LLC as a building and the series as a cubicle in the building. If you do everything right, the assets and liabilities of each series are segregated from the assets and liabilities of every other series.
EXAMPLE: A company wants to conduct two businesses, one an asbestos business and the other an auto dealership. It creates Series X to conduct the asbestos business and Series Y to conduct the auto business. Under Delaware law, if the company does everything right, maintaining separate books and records, creditors of the asbestos business can’t get at the assets of the auto business and vice versa.
That’s great in theory. But there are two problems.
The first is that while Delaware law is clear, as far as I know the series structure has never been tested in a bankruptcy court. Bankruptcy courts have enormous power to achieve equitable results and often use that power aggressively. Suppose the asbestos company has caused 57 children to develop a rare but deadly form of cancer and the assets of the asbestos company aren’t sufficient to pay the economic damages. Will a bankruptcy court allow the parent company to walk away with the auto business intact? Maybe, maybe not.
The second problem is that some states simply disregard the Delaware law. Arizona is one of them. Its statute provides:
A foreign limited liability company, its members and managers and its foreign series, if any, have no greater rights and privileges than a domestic limited liability company and its members and managers with respect to transactions in this state and relationships with persons in this state that are not managers or members. A foreign series is liable for the debts, obligations or other liabilities of the designating foreign company and of any other foreign series of that designating foreign company, arising out of transactions in this state or relationships with persons in this state and a designating foreign company is liable for such debts, obligations or other liabilities of each foreign series of that designating foreign company.
That means if the kids got sick is in Arizona, the court is going to ignore the series and take the assets of the auto business, no question.
Now let’s think about a crowdfunding vehicle.
Suppose the funding portal has created crowdfunding vehicles, or SPVs, for three issuers, Company A, Company B, and Company C. It’s created each crowdfunding vehicle as a series of one limited liability company.
Two years from now a bankruptcy court somewhere in the United States declines to respect the separateness of the series structure. Immediately, the crowdfunding vehicle of Company A is subject to all the liabilities of the crowdfunding vehicles of Company B and Company C, and vice versa nine different ways. When the investors in Company B lose all their money because of a lawsuit involving Company C they’re going to sue, and because Company B didn’t even tell investors about that risk, its founders are going to be sued personally – and successfully.
Now let’s say someone from Arizona invests in the crowdfunding vehicle of Company C. Later, it’s revealed that Company C failed to disclose material information in its offering. Under the Arizona law that investor can sue the crowdfunding vehicles of Company A and Company B. The investor wins that lawsuit and now investors in Company A and Company B have claims against their own company and their founders.
It’s a legal disaster.
And for what great benefit did the funding portal take that risk, using a series LLC rather than a separate LLC as the crowdfunding vehicle? To save about $150 in filing fees. Really.
That’s why using a series LLC as a crowdfunding vehicle is such a terrible idea. If a funding portal tells you to use a series LLC as your crowdfunding vehicle remember Nancy Reagan’s famous slogan: Just Say No! And if you already have a crowdfunding vehicle formed as a series LLC, change it right away.
And for that matter, remember that you don’t need a crowdfunding vehicle in the first place.