Historically, investing in startups and small businesses has been reserved for accredited investors, or just the wealthiest 2% of America. Now, after three years of anticipation, investing in pre-IPO companies will be opened up to the other 98%. Title IV of the JOBS Act which kicks on Friday, June 19th upgrades Regulation A and enables the fastest growing private companies in America to conduct Mini-IPOs and raise up to $50 million from everyone.
Although the sweeping changes hold enormous potential, the investment options for retail investors will initially be limited and will not open up all private investment opportunities to all investors. Individual private companies which choose to conduct fundraises with all investors will need to prepare and file a registration statement with the SEC and receive SEC approval prior to launching a Mini-IPO.
There are a few points which new potential investors should keep in mind as they begin to navigate this new asset class:
1. Testing the Waters
In most cases, companies will "test the waters" prior to undergoing the full SEC registration process. This means that they will start talking to investors, marketing the opportunity, and collecting "Indications of Interest." Essentially companies will solicit expressions of interest from potential investors and see whether investors are interested before they spend time and money pursuing a full-blown Mini-IPO. You should be aware that these "Indications of Interest" are non-binding and do not compel you to make a future investment.
2. Investment Amounts
For new investors, there will be a cap on the amount you can invest, generally up to the greater of 10% of your annual income or net worth. So if for example you make $75,000 of income per year with little savings, you will be able to invest up to $7,500 in a given opportunity. Regardless of the congressionally imposed investment limits, it's not prudent for investors to allocate greater than 10% of their overall portfolios into private companies. Furthermore, like the old saying goes, "don't put all your eggs in one basket." Diversification is critical so make sure you are building a portfolio of at least 10 private companies.
3. Everyone Can Participate
This is the most meaningful change related to Regulation A+. Essentially all private companies which have raised capital historically have done so through a securities exemption called Regulation D, 506(b) which only permits accredited investors (ie. the wealthiest 2%). Although there are limits on what individual retail investors can invest, anyone in America will be able to finally invest in private companies. As a reminder, companies will ultimately decide whether to open up to all investors, so investors will only have limited selection initially.
4. Unrestricted Shares
Unlike typical private investments, there are no restrictions on the resale of Regulation A securities so theoretically investors will be able to sell their shares the next day. However, in actuality, secondary markets for these securities are currently very limited. Eventually a robust secondary market will develop, but in the meantime, investors should plan on investing and holding for 5-7 years (until an acquisition or IPO occurs). Additionally, shares could also be subject to contractual transfer restrictions from the company itself. Pay careful attention to these transfer restrictions for any securities that you purchase.
5. The Nitty Gritty
Consult your legal and tax advisors prior to making any investments so that you fully understand the terms of the offering. You should be wary of investing at a different valuation than institutional or larger investors investing around the same time. In addition, each company will be required to file a detailed disclosure document called a Form 1-A with the SEC. You should read this document carefully prior to making an investment. Finally, most of these offerings will be conducted by broker-dealers, including those that operate online platforms like SeedInvest. You should do diligence on your broker-dealer and/or platform prior to making an investment through them.
In summary, this change marks a key development in the democratization of the private capital markets. 240 million Americans will now have the opportunity to enhance their portfolios of stocks and bonds by adding alternative assets, just like sophisticated institutional investors. However, with new opportunity comes new risks and it's critical that new investors educate themselves before taking the plunge.