November 16, 2016 marked the six-month anniversary of Title III of the JOBS Act of 2012 being fully implemented. Title III and the rules promulgated by the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) allow businesses to raise capital through “equity crowdfunding.” This is the act of raising capital from others via the internet, by seeking small investments from a large number of potential investors through the use of licensed broker-dealers or internet funding portals. These investments are exempt from the traditional security registration requirements.
People are generally familiar with existing “crowdfunding” platforms such as Kickstarter, Indiegogo, and GoFundMe which have been in existence since at least 2008. These platforms practice rewards-based crowdfunding. Backers give a “campaign” money, and the backer gets back a “reward,” i.e., a thank you note or the first edition of a product.
Title III, however, allows for “equity crowdfunding,” which is the ability to buy ownership in an early-stage company and hopefully reap a monetary return on that investment. Instead of getting that thank you note or new product, the investor is getting a piece of equity in the company he or she just invested in.
Many industry professionals and commentators expected “equity crowdfunding” to be a “slow burn” due to regulatory hurdles, a lack of infrastructure, and public skepticism. But after six months to kick the tires, should businesses and investors be looking to “equity crowdfunding” to accomplish their goals? Here is some critical information to know before taking that step.
- Title III is designed for smaller start-up businesses to raise capital. There is a $1 million limit on how much a company can raise in a twelve-month period. Businesses looking to raise larger sums of capital should consider other vehicles, namely Title II of the JOBS Act (known as 506(c) offerings) which allows an unlimited capital raise from no more than 2,000 accredited investors.
- Title III does not allow a business to sell equity shares directly to the general public. The business must use a registered broker-dealer or a registered funding portal to act as an intermediary.
- Funding portals are extremely limited in the scope of what they can do. In essence, the funding portal acts as an intermediary for the transaction between the investor and the offeror. A funding portal cannot offer advice on the investment and cannot solicit, sell, or purchase securities.
- Unaccredited investors (which are most of the general public) need to know their investment limits. Over a twelve-month period, Title III allows unaccredited investors with an annual income or net worth of up to $100,000 to invest five percent of the lesser of their annual income or net worth, but no more than $2,000. Unaccredited investors with an annual income and net worth above $100,000 can invest up to 10 percent of their annual income or net worth, but no more than $100,000.
- Offerors of investment opportunities must be ready to disclose their financials and business structure. The level of disclosure changes based upon the amount of the offering, but it generally includes a Form C filing (basic business and details on the offering) and financial statements certified by the executive officer or an independent auditor.
- Investors have up to 48 hours prior to the end of the offering period to change their mind and retract their investment for any reason. Once the offering period reaches its final 48 hours, all investments are final (including those made within the 48 hour period). Therefore, investors should think critically about their investment well before the close of the offering period, and offerors are wise to remember Yogi Berra’s famous statement, “It ain’t over till it’s over.”
These are just a few of the key issues for businesses and investors to consider before participating in “equity crowdfunding.” If your business is interested in seeking to raise capital through this method, or you are an investor considering investing through a funding portal, the attorneys at Gibbons P.C. can assist you in navigating this new and evolving marketplace.