Investors of any wealth level can now invest in startup ventures, ushering in what industry officials say is a watershed moment that “democratizes” angel investing.
In mid-May, the last of the Securities and Exchange Commission’s three-pronged measures under the Jumpstart Our Business Startups (JOBS) Act took hold when the agency’s Title III crowdfunding rules became effective, allowing startups to raise capital from non-accredited investors via crowdfunding.
Under Regulation Crowdfunding, as it is being dubbed, “almost anyone will be permitted to invest” in these offerings, said Jim Dowd, managing director of North Capital Private Securities, “which will ensure that a broad universe of companies will, for the first time, have access to new sources of capital.”
The JOBS Act of 2012, which created an exemption for securities-based crowdfunding transactions that meet certain requirements, directed the SEC to adopt rules to implement those requirements.
With the equity crowdfunding rules now in place, companies will be able to start raising capital through what SEC Chairwoman Mary Jo White called a “new regime” in recent comments at a meeting of the International Organization of Securities Commissions. The May 16 effective date, White said, “has been anxiously awaited by many small entrepreneurs and the advisors who help them.”
Dowd agreed that he’s been anticipating the Regulation Crowdfunding rules for nearly four years, noting that “the market may not take off with a bang,” but neither did general solicitation under Regulation D. However, Dowd said he believes Reg CF “will quickly become a critical source of capital for small businesses.”
Other than the repeal of Glass-Steagall, Dowd argued that “the JOBS Act is perhaps the most important change in securities laws in over 80 years.”
During his 30 years in financial markets, Dowd said, he’s “been lucky enough to be involved in three developments that have been transformative for the industry: the start of the derivatives market in the ’80s, the rise of the hedge funds in the ’90s and the JOBS Act,” which he maintains “will have a far-reaching impact for years to come.”
As of press time in mid-May, FINRA — which is charged with regulating broker-dealers that intend to develop internet funding portals — had approved five funding portals. The SEC’s Office of Compliance Inspections and Examinations is responsible for helping oversee those portals.
The two other capital-raising options that were opened under the JOBS Act before Title III finally kicked in enable private companies to engage in general solicitations of investors for exempt offerings under Rule 506 of Reg D, and also raised the cap on certain Regulation A (Reg A+) offerings to $50 million, up from the previous cap of only $5 million.
Since Reg A+ became effective in March 2015, issuers have publicly filed over 85 offering statements, while others have taken advantage of provisions in the rules that allow for non-public staff review of draft offering statements before publicly filing, White said. The SEC has also qualified over 30 offering statements from companies seeking to raise approximately $500 million.
Raising Capital; Building Vibrant Markets
White told IOSCO members at the event held in Lima, Peru, a few days before the Title III rules took hold, that there’s “significant interest and excitement” in the U.S. about the use of securities-based crowdfunding, which she said the SEC hopes will give small businesses “another tool for raising capital and building vibrant markets.”
Companies have many options for raising money to fund their businesses, White said, “and those seeking capital will ultimately be in the best position to decide whether crowdfunding or another capital-raising option will work best for them.”
White conceded, however, that the agency is — and will continue — to monitor the risk inherent in crowdfunding.
Indeed, Vincente Martinez, chief of the SEC Enforcement Division’s Office of Market Intelligence, said at an event in Washington in February that the SEC is “giving special attention” and devoting separate agency staff to crowdfunding-related initiatives set in motion by the JOBS Act. The SEC’s enforcement division as well as other agency divisions, including the Division of Economic and Risk Analysis, is “taking a close look” at Rule 506(c) private offerings as well as Reg A+ offerings, Martinez said.
The industry will have a “learning curve” when getting up to speed with the capital-raising measures under the JOBS Act, especially crowdfunding, Martinez added.
White said during a recent discussion that in relation to the SEC’s lifting of the ban on general solicitation under Rule 506(c) private offerings, “on the fraud/misconduct front,” the SEC already has “some open investigations in several categories.”
Dowd acknowledged that while there will be some “dog deals” that get done under Title III, and that “investors will lose money along the way […], that’s no different from any other market.”
Regulation Crowdfunding, he argued, “is going to open up entirely new pools of capital, with different criteria and investment objectives from traditional venture investors.” Dowd also maintains that despite naysayers, “real estate is a natural market for crowdfunding. I think there will be a lot of sub-$2 million deals that are funded through crowdfunding — deals that are too small for institutional investors and too large for most individuals to consider on their own. We are already seeing a ton of interest from small developers.”
The Crowdfunding Rules
Advisors should be sure to remind clients — as the SEC did in February — of the net worth and income limits placed on those participating in Title III crowdfunding:
If either your annual income or your net worth is less than $100,000, then during any 12-month period, you can invest up to the greater of either $2,000 or 5% of the lesser of your annual income or net worth.
If both your annual income and your net worth are equal to or more than $100,000, then during any 12-month period, you can invest up to 10% of annual income or net worth, whichever is lesser, but not to exceed $100,000.
Crowdfunding investments can only be made through a broker-dealer or funding portal’s online platform, such as a website or a mobile app; companies will be prohibited from offering direct crowdfunding investments.
Amro Albanna, CEO of ieCrowd, a startup that’s been around for six years and raised more than $17 million, said that “many questions remain” regarding how equity crowdfunding will play out, and “a steep learning curve” in such offerings is “inevitable for both investors and entrepreneurs.”
IeCrowd has two innovative products coming to market: Kite, a natural mosquito repellent that blocks mosquito carbon dioxide receptors from detecting human blood, and the Nuuma air pollution sensor to create a “digital nose” in smartphones.
Albanna said that investors — as well as their advisors — should consider investing in startups that have already raised capital because it allows them to “rest assured they have already learned some of the hard lessons of starting a business.” Also, having already raised capital means a company “knows how to deal with investors,” he argued.
Another plus is a startup that has a board of directors. “Single entrepreneurs can have a one track mind,” but companies with “a solid board of directors can demonstrate that professionals have done their due diligence and are on board to help with strategic direction.”
Another tip: look for startups with an exit plan, he said. “A startup that already has plans for an IPO or a purchase has more potential for a successful exit where everyone makes money.”
— Read “SEC Pegs April for Fiduciary Rule Release” on ThinkAdvisor.