Soon, investing in startups will be an opportunity, and a risk, available to nonaccredited investors. On Friday, the Securities and Exchange Commission (SEC) adopted rules for how securities could be sold to small-time investors, finally implementing Title III of the Jumpstart Our Business Startups (JOBS) Act.
Restrictions on the sale and marketing of securities to the general public were instituted in the Securities Act of 1933 in the wake of the discovery of widespread fraud on Wall Street after the crash of 1929. Since then, the expansion rights of unaccredited investors have been enlarged on a state by state basis, and was set for a nationwide comeback by the JOBS Act in 2012.
Nonaccredited investors are defined by the SEC as those who don’t make $200,000 a year or have a net worth less than $1 million.
Under the new rules, companies are able to crowdfund $1 million from unaccredited investors on an annual basis, and the SEC is debating whether to lift that cap to $5 million.
The primary form of protection afforded to investors are strict limits on how much equity they can purchase: those making less than $100,000 can invest up to $2,000 or 5 percent of their income in crowdfunding ventures, whichever is more; if both their income and net worth are above $100,000, they can invest up to 10 percent of the greater number.
The company offering the securities is required to make basic disclosures such as the fundraising target, description of the business, and shareholders who own more than 20 percent of the company.
For companies offering between $500,000 and $1 million in securities, financial documents will only need a review by a independent public accountant, and will not have to undergo a formal audit, for cost constraint reasons.
A more extensive set of rules is reserved for online crowdfunding portals, which have blossomed in the past decade. In addition to donation-based crowdfunding websites like Kickstarter and Indiegogo, equity crowdfunding websites for accredited investors like Crowdfunder, RockThePost, and CircleUp have emerged, and will likely be the biggest venue for large-scale crowdfunding efforts.
These types of crowdfunding intermediaries will be required to register with the Financial Industry Regulatory Authority’s (FINRA) new Form Funding Portal; companies seeking to raise funds are only allowed to work through one platform at a time.
It’s also stipulated that intermediaries cannot hold stakes in companies that are selling securities on its platform, and they cannot pay individuals for personally identifiable information on potential investors.
Intermediaries will also have to furnish investors with educational material on different types of securities, resale restrictions, and investment limits as well as offer tips on how to avoid fraud, such as how to assess whether companies are complying with Regulation Crowdfunding or have the means to accurately track shareholder records.
Platforms are also required to make public disclosures made by an offering company available for at least 21 days before securities are sold, and must have a reasonable basis for facilitating investments that comply with the caps for individual investors.
“An inter-divisional staff working group will begin immediately to keep a watchful eye on how this market develops and will evaluate the types of issuers using the new crowdfunding exemption, how issuers and intermediaries are complying with the rule, and whether the exemption is promoting capital formation and effectively protecting investors,” SEC Chairman Mary Jo White said in a statement.
It’s uncertain how much of an effect the relaxation of investor requirements will have. Earlier in 2013, the JOBS Act loosened restrictions on general solicitation, widening the ways in which companies could advertise their securities to investors, but the reform was criticized as doing little to change investment practices because of the burdens it places on the solicitors.
“If you want to use General Solicitation … you must undertake some specific efforts to make sure that your investors are in fact accredited. This is above and beyond what is typically required in a securities offering where General Solicitation is not used,” venture capitalist Fred Wilson wrote in a blog post.
The new rules will go into effect 180 days after they are published in the Federal Register.