The Status of Title III Crowdfunding

The culture around crowdfunding is rapidly maturing. Over the last several years, crowdfunding websites in the United States have been a popular way for artistic enterprises like films or musical products to obtain charitable support. Under recently adopted rules, the general public will have the opportunity to participate in a broader range of early capital raising activities for start-ups and early-stage companies.

The evolution of crowdfunding has followed a pattern of increasingly opening up the practice to less wealthy investors.

This form of investment is regulated under the JOBS (Jumpstart Our Business Startups) Act. The latest version of the act, Title III (adopted as Regulation CF), loosened the tighter restrictions (under Title II) as to who can make crowdfunded investments.  Unfortunately, while it loosened standards for investors, it also imposed burdensome obligations on companies that utilize Title III.  Title II, which was adopted as Rule 506(c), required that companies only make offerings to "accredited investors".  Typically, these are individuals with substantial net worth or high income, or companies that have strong assets or sophistication.  In addition, Title II stipulated that companies must take "reasonable steps" to insure that investors are really "accredited."

Starting in May, 2016, companies have been able to use crowdfunding to offer and sell securities to the investing public. Anyone can invest in a crowdfunded security offering, even if they were not accredited investors. However, the U.S. Securities and Exchange Commission (SEC) has been very careful to introduce a number of safeguards to protect people from over-investing in unsafe or high-risk ventures.

Because crowdfunded investment offerings are less tightly regulated, the size of investments that may be made under Title III in a twelve-month period is limited by the income or net worth of investors.

If your annual income or your net worth is less than $100,000, you can invest up to the greater of $2,000 or 5 percent of lesser of your income or your net worth.  Note that there is a $2,000 floor so anyone can invest up to $2,000.

If your annual income and your net worth are equal or greater than $100,000 then you can invest up to 10 percent of income or net worth (whichever is less), but not to exceed $100,000.

You can calculate your annual income or net worth jointly to include your spouse's income or net worth.

The value of your home is not included in your net worth calculation.

The maximum capital that an issuer can raise using Title III in twelve-month period is $1 million.

The non-accredited crowdfunding investor is regarded as a naïve investor who has to be protected against the higher risk of investment. Accordingly, these investments must be made through a registered broker-dealer or a registered funding portal website, serving as an intermediary. These must be registered with the SEC and be a member of the Financial Industry Regulatory Authority (FINRA). Companies may not solicit Title III crowdfunding investments by themselves.  All communications regarding your investment must be electronic.

In the early days of crowdfunding, according to Forbes, nearly every artistic endeavor made a crowdfunding effort, nearly all of which was doomed to fail because the artists had no idea how to prepare one.

Title III of Jobs can be an enormous opportunity for entrepreneurs and investors because it allows "non-accredited" investors into the equity marketplace. The impact of this change has not yet been assessed. for small start-up companies an investment of one million dollars can be a tremendous help. Larger companies can site the range of smaller donations simply to prove that their company is of interest to a large audience, so to win larger donations.

One of the drawback of Title III for entrepreneurs may be the amount of information their companies must disclose in order to raise money. The SEC regulations say a company must disclose to the public:

·        Information about the officers and directors'

·        A description of ways the company will use the crowdfunding proceeds.

·        Details about the price of the securities being opened, the target amount, the closing deadlines.

·        Certain related-party transactions.

·        A description of the financial health of the company.

·        Financial statements and tax returns.

Even as onerous and impractical as it is, Title III crowdfunding is growing and provides a source of capital to companies that are a good fit for Title III.  In the meantime, Title II is where the action is at.  While tens of millions of dollars have been raised via Title III, tens of billions of dollars have been raised via Title II.