Following the SEC’s approval of rules that address Title III of the Jumpstart Our Business Startups (JOBS) Act, some advisors may find themselves vetting crowdfunding investment opportunities for their more risk-tolerant clients. What exactly should they be looking for?

The Securities and Exchange Commission adopted final rules on Oct. 30 to allow companies to offer and sell securities through crowdfunding.

“There is a great deal of enthusiasm in the marketplace for crowdfunding, and I believe these rules and proposed amendments provide smaller companies with innovative ways to raise capital and give investors the protections they need,” SEC Chair Mary Jo White said in a statement announcing the decision to permit crowdfunding.

The rules allow companies to raise a maximum of $1 million through crowdfunding in a 12-month period. Some companies are excluded from using crowdfunding to raise capital, including non-U.S. companies and Exchange Act reporting companies, among others.

Individual investors with an annual income or net worth less than $100,000 may invest a total of $2,000 across all their crowdfunding ventures, or 5% of the lesser of their annual income or net worth. The limit for individual investors with more than $100,000 is 10% of the lesser of their annual income or net worth.

Furthermore, during the 12-month period, the aggregate amount of securities sold to an investor through all crowdfunding offerings can’t go over $100,000.

Philip Racusin, CEO of EnergyFunders, a crowdfunding platform that focuses on oil and gas opportunities, says there are three things advisors should keep in mind as they evaluate a potential deal for their clients.

“For investment advisors, this is opening a new asset class,” Racusin told ThinkAdvisor. “Where the investment advisor can really add value is filtering deals down to the ones that they feel are legitimately good deals, have good fundamentals, have lots of information that will allow the investment advisor to evaluate the terms of the deal and understand the risk factors involved so they can present it to their clients.”

He said advisors and their clients should approach crowdfunding opportunities with an understanding that they have a “higher risk-reward profile, so they should balance their portfolio accordingly.” He suggested: “They might put 5% of their portfolio in it, or maybe 10% depending on their risk tolerance. They should probably cap it at 10%.”

The most important factor in evaluating a crowdfunding opportunity is transparency: Are the terms of the deal clear and easily understood?

“If they’re shrouded in mystery then stay away,” Racusin warned. “You have to understand exactly what you’re investing in and how you will make your money back, how you will make your return, why this is worth it to the originator to seek investment. There needs to be a clear path to that [information].”

The second factor is the reputation of the issuer, according to Racusin. As the new crowdfunding rules open up new ways for firms to raise capital, many opportunities may be with companies that don’t have a long track record to study.

“It may be the first time they have started such a business, or maybe this is a new type of opportunity for them, but they should have translatable experience, and they should have a clean background,” Racusin said. He suggested advisors approach researching the investment originator “probably the same way that a city does when they’re background checking people and giving them licenses.”

The third thing advisors should look for is whether the investment originator owns or has the right to use the assets required to make the investment successful, Racusin said. For example, in the oil and gas industry, which is the sector EnergyFunders works in, advisors need to make sure “the person making the offering has identified assets. They have drill site locations. They have the leases. They have the title opinions, or they’re going to obtain them. They have real-world, realistic economics.

“Really, that applies to any investment opportunity,” he continued. “You want to make sure the one making the offering has the title or owns the assets they claim to have developed or will develop, or has the right to utilize them. You want to see that the economics make sense and are tied to real factors that are based on realistic scenarios.”

Advisors also need to cross-check the numbers, according to Racusin. Are the assumptions made by the originator realistic for the industry, the part of the country — or foreign country in the case of oil and gas — they’re operating in?

Potential for Fraud

The SEC recently froze the assets of oil and gas firm Ascenergy and its CEO, Joey Gabaldon, that was trying to raise capital on multiple platforms. The SEC claimed that Ascenergy made “multiple, material misrepresentations” about the company and its offerings, presenting itself as a “credible energy company” that was offering a “novel and extremely low-risk” investment.

“In reality, Ascenergy is, at best, offering a high-risk investment in undeveloped and unproven conventional oil and gas wells,” the SEC wrote in its complaint.

Racusin said it can be hard for advisors and investors to identify investments from offerers who are intentionally misleading investors from those who are merely inexperienced or unrealistic, which he said is “almost as bad. […] Most of the time you probably wouldn’t know for sure whether something was fraud or just a shady deal — maybe somebody’s inexperienced or maybe it’s a half truth, but you should stay away either way.”

Racusin said that exposure to a large number of other investors is a benefit of investing in crowdfunded opportunities.

“When you present something with lots of information to a lot of different people, some of those people are experts,” he said. “They will speak up and say things about the investment opportunity or the project the funds are being raised for. They’ll make their opinions known and those opinions never would have seen the light of day if this information hadn’t been presented to the crowd, which is also why it’s so important that opportunity has a lot of real information related to it.”

In oil and gas opportunities specifically, he said there’s a lot of “very, very good publicly available information that’s been aggregated over the last 80 years or so and is held at the state level most of the time. You can do a very good check to see whether the assumptions are realistic.”

He stressed that evaluating these opportunities is a big commitment in time for advisors. “It takes some work; it really does, but the payoff is that you can find a deal you really like, run by somebody you trust that could offer you a very good return for your time and money.”

— Check out 11 Cool Crowdfunded Products on ThinkAdvisor.