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The SEC's historic approval of Title III means everyone can play venture capitalist
It's a big day for the average investor and for many young businesses that are looking to tap new sources of investors.
The Securities and Exchange Commission Friday, as expected, voted on and approved Title III, the last crowdfunding rule mandated by the JOBS Act, which was signed into law in 2012. This portion of the JOBS Act, however, is probably the biggest landmark change as it significantly broadens the investor base to this asset class called: startups.
What this means is that startups that have raised or are looking to raise a Regulation D offering (which is the kind of offering all venture-backed startups use), can now also have hundreds of non-accredited investors, according to Chance Barnett, Founder and CEO of Crowdfunder. Heretofore, private businesses that also raised money from VCs were limited to 35 non-accredited investors.
At the same time, startups will have to be mindful that if they get 2,000 investors, they're required to file with the Securites and Exchange Commission and essentially go public.
Here's some rules around what, who and how these investments can be made. Keep in mind that there is currently a 60-to-120 waiting period for the rules to be reviewed and commented on before any activity can happen under Title III.
- Startups can only raise $1 million a year.
- Only registered broker-dealers and funding portal may intermediate purchases or investments.
- If your income is under $100,000, you can invest a maximum of $2000 or 5% of your income, per year.
- If your income is over $100,000, you can invest 10% of your income or net worth, up to $100,000 a year.
- If you make an investment, you cannot sell the equity for at least a year.
- Businesses must offer total disclosure to all investors, such as financial statements, use of proceeds, terms of the fundraising, deadline, etc. and information about any officer or director with more than 20% ownership.
- Businesses must also file an annual report with the SEC.
Here's a big challenge for businesses or startups that want to do this, however. All of those investors will be on their cap table. Imagine raising $1 million by collecting $2000 checks from 500 individuals. That means ensuring all 500 have appropriate documents and disclosures, which could be an administrative nightmare. But $2000 is the maximum. Imagine taking in $100 checks.
Crowdfunder's Barnett believes, however, that startups will be fine dealing with hundreds of investors.
"I can imagine that we'll see 300 to 400 non-accredited investors in each deal," said Barnett, whose platform already sees around 25 investors per deal. "They’re [fundraising startups] are required to provide an annual report. What we’d like to see is a quarterly report. But that’s not a lot of work, the larger conversation is: What are the rights these investors have?"
Indeed, startups such as Glowing Plant, plan to be among the first companies to use Title III offerings.
"We have 8000 backers on Kickstarter," said Antony Evans, Founder and CEO of Glowing Plant, a venture-backed company. "I don’t see why there would be a dramatic different in managing equity investors vs crowdfunding backers. There’s time you have to spend communicating with them but it’s part of the job."
And, another ruling is that for companies raising over $500k, they will have to have an audit and that could cost $30,000 to $40,000, estimates Barnett.
Still, he and others don't believe these obligations will be cost-prohibitive.
"I definitley see more startups getting funded from this," said Bill Clark, Founder an CEO, at MicroVentures, which calls itself a "venture capital investment bank" since it operates venture funds around startups they want to invest in, and they also can also raise money for startups and get an investment banking fee since Clark and his team have all the required licenses.
MicroVentures has seen $82 million in investments across140 different raises on the platform. The average investor puts in $10,000, and the average raise per company is $300,000, Clark said. There are 32,000 investors on the platform, of which only 12,000 are accredited.
"I see a lot of local companies that aren't tech startups that will raise money from their community using a Title III model," said Clark.
But what about liquidity? Investors in a Title III startup will not be able to sell their investment for one year after they make a purchase. According to Barnett, there will be "Venture exchanges" that will help accommodate investors who want to get liquidity. "The SEC is interested in reducing risk by creating secondary markets that helps provide liquidity options," Barnett said. "Venture exchanges would allow people to trade shares."
Interestingly enough, the Nasdaq recently bought SecondMarket to accommodate secondary trades of companies that are opting to stay private longer.
Looks like the venture market has become very public.
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