Four years after Congress passed the Jumpstart Our Business Startups Act —also known as the JOBS Act—equity crowdfunding for non-accredited investors finally arrived on May 16. But the regulations are so complex that Congress is already working to simplify them.
In the meantime, given that the regulations are here and no one knows for sure if and when they will change, advisors should be aware of the regulations so they can decide whether crowdfunding is a viable investment for their clients.
Equity crowdfunding allows relatively small investments online to fund new ventures. While traditional crowdfunding provides prizes ranging from film credits to free CDs in exchange for contributions, equity crowdfunding provides equity to investors.
By freeing up this new potential source of capital, businesses are theoretically more likely to grow and hire more workers. While crowdfunding is having significant success in countries such as the United Kingdom and Australia, like the companies it’s designed to fund, crowdfunding is still in the start-up stage in the U.S. The top 50 crowdfunding deals from 18 leading portals are listed on the CNBC Crowdfinance 50 Index and range from $82,500 to $8,506,897.
Alternative investments have doubled in size since 2005, “with global AUM growing at an annualized pace of 10.7%, twice the growth rate of traditional investments,” McKinsey reported. As investors seek non-correlative selections to hedge against traditional volatility, that growth may continue and, as a new alternative investment, equity crowdfunding may enjoy significant growth.
Crowdfunding Regulations
JOBS includes three “titles” pertaining to crowdfunding, according to “The Crowdfunding Curriculum,” which was developed by Equity Institutional, which provides alternative asset custodial services. Title II permits general solicitation of accredited investors under Rule 506(c) of Regulation D. Title III allows funds to be raised from non-accredited investors, but the amount raised cannot exceed $1,000,000 in a 12-month period. Regulation A+, which replaced the underutilized Regulation A in Title IV, enables entrepreneurs to raise larger amounts from either accredited or non-accredited investors, but the regulations are far stricter and more costly to comply with than Title III or Reg D.
Title III
According to The National Law Review, other important facts about Title III include:
• Non-public U.S. companies may raise funds on the Internet from both accredited and non-accredited investors.
• Crowdfunding must be conducted through Securities and Exchange Commission-approved portals managed by registered broker-dealers.
• Investors with annual income under $100,000 are limited to investing the greater of $2,000 or 5% of their net worth. Investors with annual income of at least $100,000 are limited to investing 10% of their annual income or net worth, whichever is lower, up to a total limit of $100,000.
• Prior to fundraising, the company must file Form C, which requires a detailed disclosure of corporate and financial information, with the SEC.
• The public filing must include financial statements certified by a company officer if less than $100,000 is being raised, reviewed by public accountants if $100,000 to $500,000 is being raised and audited if more than $500,000 is being raised.
Regulation A+
Reg A+ allows non-accredited investors to participate in two types of offerings:
• Tier 1 offerings may raise up to $20 million in a 12-month period, including up to $6 million of securities sold on behalf of security holders. The issuer is required to provide only reviewed, unaudited financials. A state-level qualification is also required.
• Tier 2 offerings may raise up to $50 million, including up to $15 million of securities sold on behalf of security holders. The issuer is required to provide two years of audited financial statements. State-level qualification is not needed.
Through a Regulation A+ investment, a “testing-the-waters” provision permits communications to prospects prior to SEC approval for information purposes only, as long as communications include no implied or direct obligations. This allows companies to determine the level of interest for their business before finalizing legal and accounting commitments. “Testing the waters” is allowed without prefiling, but solicitation materials must be filed with the first solicitation statement and an offering circular must be filed 48 hours before the first sale.
The North American Securities Administrators Association (NASAA) has opposed Regs A and A+ due to concerns about investment fraud. NASAA is especially critical of allowing companies to bypass state review, considering the high risk of crowdfunding.