Small business owners will have a shiny new financing tool available to them in just a few days.
Starting Monday, entrepreneurs will be able to offer equity stakes to non-accredited investors for amounts of up to $1 million, as a result of new crowdfunding rules put into place by the Securities and Exchange Commission in October.
The new rules, known as Title III, come from the Jumpstart Our Business Startups (JOBS) Act, which President Obama signed into law in 2012. Title III was meant to help businesses raise money when banks pulled back from lending in the aftermath of the financial crisis. It got held up for years though as the SEC tried to figure out the best way to protect investors and businesses from potentially reckless speculation. The SEC issued its final rules in late March following a public comment period, and set May 16 as the start date.
While the additional fundraising resource could prove useful, not everyone thinks there will be a rush to use it, and some legal and financial experts say they think the hassle and costs will outweigh the benefits.
"It will not be a significant tool, although I can see some companies wanting to use this to give them access to investors they might not have access to otherwise," says Stephen Wink, a partner in law firm Latham and Watkins' New York City office.
Here's a brief summary of what's new:
1. How much you can raise.
Small businesses will be able to raise up to $1 million during a 12-month period from non-accredited investors. (A non-accredited investor, generally, is one who has less than $1 million in liquid assets and earns less than $200,000 annually.) They will, however, have to submit to an informal audit and produce documentation that describes investor and financial risks, legal experts say.
2. What investors can invest.
In any 12-month period, non-accredited investors will be able to invest the greater of $2,000 or up to 5 percent of their income if they make less than $100,000, in company shares. Investors with annual income or a net worth of more than $100,000 can invest up to 10 percent of their income, up to $100,000.
3. How to sell shares.
Sales will be handled via registered broker-dealers or funding portals that will act as gatekeepers, vetting investments and providing critical investment information to investors. The intermediaries will collect fees for the service, which the SEC will require them to disclose as a dollar amount or percentage of the deal.
Ten broker dealers and 50 companies that plan to run portals have applied to the Financial Industry Regulatory Authority to become official Title III intermediaries, the The Wall Street Journal reports, and five portals have been approved so far.
In a related move, last summer the SEC altered something called Regulation A, which previously allowed private companies to solicit funding of up to $5 million from wealthy investors. The change, called Regulation A+, allowed private companies to raise much larger amounts of money in two tiers, up to $20 million and up to $50 million. Non-accredited investors also could invest in those deals, as long as they limited investing to no more than 10 percent of either their annual net income or net worth, whichever is greater, in offerings up to $50 million.
Automobile startup Elio Motors was one of the first companies to use Regulation A+, raising $17 million from nearly 7,000 non-accredited investors using the crowdfunding portal StartEngine. The Phoenix-based company listed on the OTCQX Market exchange in February.
Wink says Title III is likely to be costly for small business owners, running into the tens of thousands of dollars, as the SEC will require them to perform an audit of their financials. Assembling the intermediary broker dealer or funding portal to sell shares will also add cost, he says.
"These are not trivial matters in terms of risk exposure," Wink says. "And the intermediaries will charge issuers something [to offset the risk]."
Rory Eakin, the chief operating officer of equity crowdsourcing site CircleUp, which works only with accredited investors to fund new consumer products companies, foresees other problems. Among them, companies that raise money under Title III may run the risk of exposing too much of their inner workings--for example their revenue size, margins, and profitability--too early on.
In short, soliciting non-accredited investors via Title III might put them at a competitive disadvantage.
"Emerging companies in our market, and many others, value keeping this information private," Eakin says.