SEC ALLOWS START-UP INVESTING VIA CROWDFUNDING UNDER TITLE III OF THE JOBS ACT

The SEC recently voted on and passed the final rules to implement Title III of the JOBS Act, allowing non-accredited investors to invest in startups and other small companies via equity crowdfunding.  Before the new rules, private companies could seek money only from “accredited investors,” defined as individuals who own more than $1 million in assets, excluding their primary residence, or have received an income of more than $200,000 for at least two years.

The Jumpstart Our Business Startups Act or JOBS Act, is a law intended to encourage funding of small businesses by simplifying various securities regulations. While it was signed into law by the President in April, 2012, Title III of the JOBS Act could not become effective until the SEC passed rules to implement it. The SEC finally did that on October 30, 2015.

Entrepreneurs raising money through crowdfunding campaigns have typically rewarded their backers with early access to products and with T-shirts and coffee mugs.

But under new rules the entrepreneurs will be able to offer something that could potentially be more lucrative: an equity stake in their business.

The rules will allow small investors to buy shares of private companies under the provisions of the JOBS Act.

The new rules allow companies to raise up to $1 million in a 12-month period through a crowdfunding campaign. Companies will need to provide their potential investors with financial statements, but some first-time issuers and those seeking less than $500,000 will not be required to have the statements audited. Since the cost of audited financials can be substantial, this exception can be of big help to a start-up. However, it also poses risks for the investors since they must invest in an unaudited company.

Companies will be able to advertise their offerings in a variety of ways, including posting them on Kickstarter-like portals for investors to inspect.

The amount of money backers will be allowed to invest depends on their income. Those with an annual income or net worth of less than $100,000 will be allowed to invest up to $2,000 in a 12-month period, or 5 percent of the lesser of their income or net worth, whichever is greater. Those with an income and net worth of more than $100,000 will be permitted to invest up to 10 percent of the lesser of their annual income or net worth.

This is great news for both entrepreneurs who now have easier access to capital and for regular investors who can invest and acquire equity in the next Facebook or Google.

However, it should be noted that the equity shares that one may buy under Title III are risky investments. The entrepreneurs offering these investments do not run established, tested business. Instead, they run start-ups and companies at the beginning of the road who can go out of business without much notice of recourse for the investors.  Additionally, these are illiquid investments. Investors will generally be required to hold on to the shares for at least one year, and there are not yet many marketplaces for those seeking to sell shares in private companies, which are difficult to value.

With this latest development, private companies can now raise money from non-accredited investors in a number of ways. In June, new federal rules took effect allowing companies to raise up to $50 million through a provision known as Regulation A. Those deals carry stricter disclosure and compliance requirements than the crowdfunding process outlined on in this post, which is intended to be much cheaper and faster for issuers.

Taken together, the new rules give entrepreneurs a much wider set of options for raising money from a diverse pool of investors.

Title III Summary

  • Equity crowdfunding expands to include non-accredited investor participation
  • Startups and small businesses can raise up to $1M in a period of a year
  • Investors making less than $100,000 per year can invest the greater of $2,000 or 5% of annual income
  • Investors making more than $100,000 per year can invest up to 10% of their annual income
  • Offerings must be made via Broker-Dealer or Portal Intermediary
  • Significant disclosures are required for companies to help provide transparency