Less than 1% of all companies in the United States finance their operations through venture capital. For the other 99%, the Securities and Exchange Commission (SEC) and many state regulators are loosening the rules and regulations regarding raising money from accredited investors and the general public.
An Introduction to the JOBS Act
Congress approved the Jumpstart Our Business Startups (JOBS) Act with tremendous bipartisan support on April 23, 2012. The act provides a framework for public solicitation and advertising of a company’s securities offering via equity crowdfunding platforms. Over the following three and half years, the SEC began to put into place rules and regulations that will enable companies to raise money from people who may find out about a company’s security offering through an ad on Facebook, an e-newsletter or an outdoor billboard. Some states also implemented their own rules and regulations in response to what the SEC was—or wasn’t—doing.
Titles II, III and IV of the JOBS Act and intrastate crowdfunding initiatives allow entrepreneurs to raise money more easily from friends, family, customers, vendors, people united by similar characteristics (such as gender or ethnicity) or a community (such as video gamers, mothers, sufferers of a specific disease, etc.) that cares about having access to products and services that better meet its needs.
“This significantly increases the pool of capital from which entrepreneurs can raise money,” says Douglas Ellenoff, a partner at Ellenoff, Grossman & Schole, a leading securities and crowdfunding law firm. “However, its impact may be the greatest on underrepresented groups, such as minorities and women, who tend not to have connections to wealthy investors.” An overwhelming number of these investors want to put money into startups and small businesses run by minorities and women, according to research conducted by Mattermark and Quire,who provide data on and connections to investment-ready private companies.
Entrepreneurs can offer an equity stake in their businesses or borrow money, which they pay back with interest. “These investors may not be looking for the really big returns angel and venture investors look for,” says Ellenoff. “They may just be looking to do better than the stock market or to make the American dream come true for an entrepreneur.”
Depending on the source of the money, rules for the different investment crowdfunding options may limit the amount of money you can raise, require you to disclose certain information about the business and have the SEC or a state regulatory body review your offering.
Below are highlights of the different options.
Title II – Smoothing the Way for Accredited Investors
When it went into effect on September 23, 2013, Title II became the first option to allow companies to more easily raise money from accredited investors via crowdfunding platforms such as AngelList, CircleUp andCrowdfunder. “Prior to Title II you could only invest in a deal if you had a prior relationship,” says Kim Wales, founder and CEO of Wales Capital and CrowdBureau and a pioneer in the crowdfunding industry. “Now any accredited investor who reads a Tweet or ad in a newspaper can invest.”
Title II is shortening the time it takes companies to raise money from accredited investors. What would normally take seven to 12 months—or sometimes even longer—in a conventional “offline” fundraising round may only require four to six months on online crowdfunding sites, according to Luan Cox of Crowdnetic, which aggregates data from 18 equity crowdfunding platforms. These platforms centralize, streamline and simplify the process for both the entrepreneur and investor.
Just as if you were raising money offline from accredited investors, you can raise an unlimited amount of money from accredited investors online under Title II. These investors are most likely to invest at the startup stage, but also are able to invest at the seed and early growth stages. Under Title II, you need to file a Form D, but you do not need to have your offering reviewed by the SEC. Nor do you have to provide annual or financial reports, though that is a good practice. If you’re raising money online, you do need to verify that your investors are accredited, which you do not have to do offline.
I recently took a look back and ahead at Title II on its second birthday. Misconceptions regarding Title II are being overcome, and best practices are emerging. For more detailed information, read Stand Out In the Crowd: How Women (and Men) Benefit From Equity Crowdfunding. It is especially exciting that some crowdfunding platforms are raising funds to invest in some of the companies raising money on them.
Most importantly, the lack of problems to date with Title II appears to have given the SEC confidence to move ahead with Title III rules.
Title III – A Gateway to Investors of All Income Levels
The SEC approved Title III on October 30, 2015, allowing companies to raise $1 million over a 12-month period. Nonetheless, Title III rules will not become effective until 180 days after approval, which is April 30, 2016. Once they come into effect, a company can raise money from anyone, including those earning less than $100,000 per year.
These individuals can invest $2,000 or 5% of their annual income in a 12-month period. People with greater earnings can invest 10% of their annual income. No individual investor will be able to purchase more than $100,000 worth of securities through this option. “Title III is so exciting because it opens a gateway to investors of all income levels for entrepreneurs seeking capital,” says Wales.
Title III will require companies to disclose certain information about their offerings, including:
- Information about the officers and directors
- A description of the company’s business
- Information regarding the use of proceeds from the offering
- The company’s valuation
- The company’s financials
Startups are the companies most likely to benefit from Title III.
Title IV – Enabling Mini-IPOs
As of June 19, 2015, companies are allowed to do a Reg A+ offering, or what’s known as a mini-IPO (initial public offering). This allows you to raise money from everyone, including the general public, via platforms like SeedInvest and StartEngine. There are two tiers for soliciting investment:
- Tier I allows companies to fundraise up to $20 million within a 12-month period. Tier I offerings do not have “state preemption,” which means that the security has to be registered in the state in which it will be sold. Formal audits and annual reporting is not required for Tier I fundraising, nor is a review of the offering by the SEC. Potential investors can invest as much as they please into Tier I offerings.
- Tier II allows companies to fundraise up to $50 million within a 12-month period. These offerings enjoy “state preemption,” meaning that they do not have to register in each state in which the securities are sold, thus saving the issuer time and money. Tier II requires more robust initial and ongoing reporting. For their own protection, less-experienced investors are limited to investing a maximum of 10% of their income or net worth per year. Legal and accounting fees for Tier II offerings can run in excess of $100,000. To date only one company, Elio, has been approved by the SEC to do a Tier II offering.
At either tier, preparing filings requires effort and money, which is another reason a mini-IPO is not appropriate for very early-stage companies. These companies are focusing on developing the product and bringing in customers, and simply don’t have the resources to devote to raising money in this way. Learn more about whether raising capital with a mini-IPO under Regulation A+ is right for your company.