The Dawn of Equity Crowdfunding

Throughout the last year, JOLT has covered crowdfunding in various iterations several times. From funding plaintiff’s cases to the Ant Simulator disaster story, the new form of capital-generation has continued to push new legal boundaries. As a brief re-cap, crowdfunding to date has been characterized by websites such as Kickstarter.com, allowing entrepreneurs to solicit donations to help get their great ideas off the ground.
However, crowdfunding has been criticized for being poorly regulated, not guaranteeing “investors” any return, and encouraging fraud, as in the Ant Simulator case examined by JOLT earlier this month. Until recently, it seemed as if it was crowdfundings destiny to stay obscure and insecure.
In 2012, the Jump Start Our Business Startups Act (JOBS Act) was passed, and contained some ambitious provisions. Among them was Title III; the Equity Crowdfunding section of the JOBS Act. Title III was viewed with much skepticism, as initial SEC proposed regulations were so stringent that they were expected to completely suffocate the provisions. Additionally, other JOBS Act provisions such as the Regulation A+ funding provisions seemed to fill the gaps envisioned by Congress in passing Title III.
However, in late October of this year, the SEC finally published its final rules for Title III, breathing life into a provision nearly four years after Congress initially enacted it. These provisions have just gone into effect, and are currently in use by crowdfunding pioneers such as Crowdfunder.com.
So what does Title III do?

The idea behind it was to bring early-investment opportunities to the general public, or the “crowd”, rather than reserving them for only the ultra-wealthy “accredited” investors such opportunities are generally limited to.

 
Traditionally, the SEC has prohibited companies from soliciting early-stage equity investments out of fear of fraud. However, with the success of sites such as GoFundMe.com and the sluggish economy of the early 2010’s, Congress felt pressure to attempt to modernize traditional capitalization techniques for startup companies.
The result is Title III. Companies seeking funding under Title III can solicit up to $1 million per year from the “crowd” or unaccredited investors. These “crowd” investors can invest up to 5 percent of their annual income or net worth if said numbers are <$100,000 per year, and 10% if greater than $100,000. No single investors can invest more than $100,000 in a single Title III offering. Securities purchased through Title III are generally illiquid, and cannot be sold for one year after purchase.
Additionally, companies have stringent reporting and disclosure laws they must abide by in order to file for Title III funding, including financial statements, rough pricing estimates, and a detailed business plan. If the company does not reach its fundraising goal, it must return all funds raised through Title III.
Further, any Title III transactions will take place in an online marketplace very similar to Kickstarter. The biggest difference, however, is that these crowdfunding platforms are charged with a duty to take steps to prevent fraud. As a result, any company hoping to list on a Title III platform will likely be very carefully vetted by the offering platform. A website using older regulations (allowing a type of crowdfunding only for accredited investors) has stated it accepts less than one percent of all applicants.
It is also worth noting that the SEC has allowed these platforms to accept an equity share of the offering company in lieu of their owed filing fees, the SEC expects will range in the tens of thousands for most companies. This author suspects that as a result, equity crowdfunding websites will function less to provide the “crowd” access to a broad variety of start-up companies, and instead only offer those carefully vetted and assured of some moderate degree of success, ensuring the platform company profits.
The strengths of this system are of course obvious; if the very portal the company must use to solicit investors carries a stake in their success, said platform will be much more interested in reducing fraud (compared to Kickstarter, which isn’t particularly invested in the success of its’ projects). Nonetheless, in the next few years it will be interesting to see what types of success can be had via equity crowdfunding. Will new companies be able to break into capitalization markets never before accessible? Or will low capital caps and stringent platform enforcement bar all but the most desirable companies from the market, essentially shifting the vetting burden of angel investing to the platform and using public funds to fuel these startups?