More than two years ago, President Obama signed the JOBS Act into law. Among its provisions were several significant changes to the way small private companies could find potential shareholders.
In a nutshell, the act did two major things. First, it allowed private companies to openly solicit investors, on the Web and elsewhere. Secondly, the act paved the way for unaccredited investors (basically, people who aren't professional investors, don't have more than $1 million in assets, and don't make more than $200,000 a year), to take part in these private placements.
The first part of this, known as Title II, overturned 80 years of Securities and Exchange Commission regulation, opening the door to the creation of numerous equity crowdsourcing platforms in operation today. The second provision, known as Title III, has gotten bogged down in rulemaking proceedings with the SEC, and has never come to pass. Although that has left small-time investors out in the cold, many crowdfunding platforms and the companies they serve are perfectly fine with it.
"I don’t anticipate Title III to be adopted any time soon," says Rory Eakin, co-founder and chief operating officer of equity crowdsourcing platform CircleUp. "We are following this closely, and in touch with people around the Hill, and our view is that it's not likely to come to pass." CircleUp is a licensed broker dealer whose platform, for accredited investors, sells equity in consumer product companies. Since 2012, it has helped 50 consumer products companies raise more than $50 million.
There are upwards of 9 million accredited investors in the U.S. And many equity crowdfunders say they would prefer to focus on them. Accredited investors have a lot more money to invest. And companies that take funding from them aren't required to undergo audits or make as many public disclosures about operations.
Although the SEC has yet to issue rules on how small-time, unaccredited investors would buy into private companies, what's being formulated isn't all that desirable to crowdfunders. Among the things the SEC is likely to require when raising funds from unaccredited investors: audited company financials; increased scrutiny (and potentially greater liability) for directors and company officers; and public filings of company financials after the financing round, not unlike what public companies are required to produce now. All that could slow down the funding process--and possibly a company's prospects for growth.
Perhaps an even greater restriction for equity crowdfunding platforms would be limits on what non-accredited investors could invest--generally between 5 percent of income for those with a net worth of up to $100,000, and 10 percent for those with more. And the private companies raising money via Title III would be limited to raising no more than $1 million through such platforms.
As a result, some experts expect that a two-tiered system will emerge, with accredited investors getting access to the better, less scrutinized deals, and unaccredited investors potentially buying into less lucrative deals due to the number of hoops the companies that want financing will have to jump through.
"There is no question a funding platform [for Title III investors] has to be regulated and licensed, with SEC limits on how much can be raised by entrepreneurs, and how much unaccredited investors can put into deals," says Douglas S. Ellenoff, a securities and crowdfunding expert and partner at law firm Ellenoff, Grossman and Schole in New York.
But that will make it a less attractive option for companies, Eakin says: "We don’t believe [Title III] provides the right structure for raising capital."
Microbrewery Fireman's Brew can testify firsthand to the limits of working with unaccredited investors. Based in Woodland Hills, California, one of the few states that allows for general solicitation of non-qualified investors, the brewery recently raised $1 million over the course of 12 months, in small chunks--primarily from firemen who found out about the brewery's equity drive through ads in local publications. But Fireman's Brew is growing rapidly, and it wants to bolster its sales team to expand beyond California and further into the 15 states where it's currently sold.
It launched an equity campaign with Flashfunders this week, and hopes to raise up to $5 million over the next 90 days from the platform's accredited investors. Flashfunders is a newly-launched equity crowdfunding platform, which, like CircleUp, is registered as a broker-dealer and allows accredited investors to buy directly into startups.
"Flashfunders will open us up to a much wider pool of people we can raise money from," says David Johnson, who is co-founder, COO, and CFO of Fireman's Brew. "Now we can raise money from all over the world."
As for opening the platform to smaller investors, Vincent Bradley, co-founder of Flashfunders, says he's taking a wait and see approach. "The current outline for Title III Crowdfunding isn't appealing to most," Bradley says.