On February 16, 2016, the SEC posted an investor bulletin relating to equity crowdfunding intended to educate the public about the process for investing in equity crowdfunding and some of the risks involved. On May 16, 2016, Regulation Crowdfunding will become effective, allowing non-accredited investors to invest limited amounts in private offerings conducted through an online platform.
The bulletin provides some good background regarding equity crowdfunding and includes some helpful tables designed to assist a potential investor in understanding the net worth and investment limitation requirements of Regulation Crowdfunding. The bulletin also includes risk factors that the SEC believes investors should consider before investing in a crowdfunded offering. In addition to risk factors relating to the illiquidity of the investment, limitations on disclosure, the high degree of speculation, and untestable valuations, which are typical start-up risk factors, the bulletin also includes some risk factors that are non-standard or unique to crowdfunded start-ups, such as (quoting here):
- Investment in personnel. An early-stage investment is also an investment in the entrepreneur or management of the company. Being able to execute on the business plan is often an important factor in whether the business is viable and successful. You should also be aware that a portion of your investment may fund the compensation of the company’s employees, including its management. You should carefully review any disclosure regarding the company’s use of proceeds.
- Possibility of fraud. In light of the relative ease with which early-stage companies can raise funds through crowdfunding, it may be the case that certain opportunities turn out to be money-losing fraudulent schemes. As with other investments, there is no guarantee that crowdfunding investments will be immune from fraud.
- Lack of professional guidance. Many successful companies partially attribute their early success to the guidance of professional early-stage investors (e.g., angel investors and venture capital firms). These investors often negotiate for seats on the company’s board of directors and play an important role through their resources, contacts and experience in assisting early-stage companies in executing on their business plans. An early-stage company primarily financed through crowdfunding may not have the benefit of such professional investors.
For more information, you can refer to our prior four-part series covering Regulation Crowdfunding:Capital Raising and Investment Limitations; Issuer Requirements; Intermediary Requirements; and Additional Funding Portal Requirements.