HIGHLIGHTS:

  • The U.S. Securities and Exchange Commission (SEC) recently approved Title III of the JOBS Act, a significant development because the new regulations allow non-accredited investors to participate in equity crowdfunding.
  • The new Title III rules permit an issuer company to raise a maximum of $1 million through crowdfunded offerings in a 12-month period.
  • The new rules and forms would be effective 180 days after they are published, except that new forms enabling funding portals to register with the SEC would be effective Jan. 29, 2016, thus giving portals time to figure out the rules and how to comply.

The U.S. Securities and Exchange Commission (SEC) recently approved Title III of the JOBS Act, a significant development because the new regulations allow non-accredited investors – those making less than $200,000 a year in income or having a net worth of less than $1 million, excluding the primary residence – to participate in equity crowdfunding. Previously, under Title II, only accredited investors could invest in online private placements that raise capital for issuer companies.

It is estimated that there are 10 million accredited investors in the United States, which accounts for approximately 8.25 percent of the population. While a small number, these 10 million investors hold about 70.28 percent of all private wealth in this country, or a whopping $45.5 trillion. Nonetheless, the point of the JOBS Act, in part, was to stir economic development and create greater access to capital for small businesses. As such, there was a strong desire to allow the balance of the population to invest in high-growth, early-stage companies. Title III makes that goal possible.

The original goal of the JOBS Act, signed into law on April 5, 2012, was to encourage funding of small businesses by easing various regulations that would otherwise limit how these businesses could fundraise. Essentially, the change in the rules makes it easier for small companies to either go public or raise capital privately so that they can stay private longer. The most groundbreaking change in the Title III regulations was the addition of exemptions for crowdfunding, allowing companies to engage in the general solicitation of investors for capital. Many articles have discussed the Regulation D Rule 506 offerings and the impact the rule changes are having on private placements, especially in the real estate industry. Here, we focus on the most recent changes set forth in Title III of the JOBS Act, which now gives non-accredited investors the opportunity to invest in start-up companies.

Rules Overview

The new Title III rules, adopted on Oct. 30, 2015, permit an issuer company to raise a maximum of $1 million through crowdfunded offerings in a 12-month period. In addition:

  • Over a 12-month period, individual investors are permitted to invest in the aggregate across all crowdfunding offerings up to:
    • if either their annual income or net worth is less than $100,000, than the greater of:
      • $2,000 or
      • 5 percent of the lesser of their annual income or net worth
    • if both their annual income and net worth are equal to or more than $100,000, 10 percent of the lesser of their annual income or net worth
  • During the 12-month period, the aggregate amount of securities sold to an investor through all crowdfunding offerings may not exceed $100,000
  • Securities purchased in a crowdfunding transaction generally cannot be resold for one year

Greater Burden for Intermediaries

Importantly for crowdfunding portals, if the portal acts as an intermediary, the portal must register with the SEC using a new form called the Form Funding Portal and become a member of the Financial Industry Regulatory Authority (FINRA). An issuer company can raise money through only one crowdfunding portal at a time, giving the portals exclusivity for that particular capital raise.

With a larger audience from which to raise capital, intermediaries have a greater burden under the new rules and must undertake the following:

  1. Provide investors with educational materials that explain, among other things, the process for investing on the platform, the types of securities being offered and the information an investor can expect from the issuer company
  2. Make information that a company is required to disclose available to the public on its platform throughout the offering period and for a minimum of 21 days before any security may be sold in the offering
  3. Provide communication channels to permit discussions about offerings on the platform
  4. Provide disclosure to investors about the compensation the intermediary receives
  5. Accept an investment commitment from an investor only after that investor has opened an account
  6. Have a reasonable basis for believing an investor complies with the investment limitations
  7. Provide investors notices once they have made investment commitments and confirmations at or before completion of a transaction
  8. Comply with maintenance and transmission of funds requirements

Comply with completion, cancellation and reconfirmation of offerings requirements

Another important part of Title III for portals is a change to the compensation system. Platforms can now earn compensation with a financial stake in the issuer companies. Essentially, platforms can take a carried interest, which may enhance their attractiveness to investors so that platforms are only earning profits when investors do. This change aligns the interests of the investors, the platform and the issuer companies. It also helps the issuer companies, as it relieves them of the upfront cost component of raising money.

The new rules and forms would be effective 180 days after they are published, except that the forms enabling funding portals to register with the SEC would be effective Jan. 29, 2016, thus giving portals time to figure out the rules and how to comply.

Additional Amendments

The SEC also proposed amendments to existing Securities Act Rule 147 to modernize the rule for intrastate offerings to further facilitate capital formation, including through intrastate crowdfunding provisions. The proposal also would amend Securities Act Rule 504 to increase the aggregate amount of money that may be offered and sold pursuant to the rule from $1 million to $5 million. It would also apply bad actor disqualifications to Rule 504 offerings to provide additional investor protection.