Crowdfunding: Are you the Right Investor?

If you have always wanted to invest in a start-up business, whether a high tech emerging growth company or a low tech products company, you have no doubt heard of the new SEC rules allowing crowdfunding. Part of the excitement comes from being able to make investment opportunities available through crowdfunding internet portals, and part of the excitement comes from more relaxed investor standards. Let’s take a look at the new regulation, which the SEC has title “Regulation Crowdfunding”. You can find it at https://www.sec.gov/rules/final/2015/33-9974.pdf. My last blog regarding crowdfunding ( click here to read) focused on the requirements for an issuer. In this blog, I’ll focus on the requirements concerning investors.

Crowdfunding is generally thought of as the use of the Internet by small companies to raise modest amounts of funds from investors. The new regulation allows investments to occur online. Only a broker-dealer or online portal registered with the SEC and a member of the Financial Industry Authority (“FINRA”) or other national securities association registered with the SEC, however, is allowed to offer and sell securities to the investing crowdfunding public. A company can’t offer a crowdfunding opportunity directly. To see if a broker-dealer is properly registered with FINRA, check http://brokercheck.finra.org/, and to check if a portal is properly registered under FINRA, check http://www.finra.org/about/funding-portals-we-regulate.

Although Regulation Crowdfunding relaxed investor suitability standards, some still exist. The standards limit the amount that can be invested. During any 12 month period, an investor can invest up to:

  1. the greater of either $2,000 or 5% of the lesser of the investor’s annual income or net worth IF the investor’s annual income or net worth is less than $100,000; or
  1. up to 10% of the investor’s annual income or net worth, whichever is less, but not to exceed $100,000, IF both the investor’s annual income and net worth is each more than $100,000

There are some important caveats when looking at these limitations, and investors should familiarize themselves with these limitations through their own research or discussion with their advisors. First, net worth can NOT include the positive value of an investor’s personal residence. An investor can, however, include the income or net worth of an investor’s spouse even if the income or net worth is not jointly owned. Second, if the investor consolidates his or her spouse’s income or net worth to satisfy the above criteria, the investment amount limitations are still determined based on the individual investor’s income or net worth.

Investors need to be careful. Crowdfunded securities are not like public company stock. There are limits on reselling crowdfunded securities. An investor may not sell these securities for one year after purchase except to the original issuer, to an accredited investor, as part of a registered public offering, to a family member or trust created for the benefit of a family member, or in connection with the death or divorce of the purchaser. Each of these classes of persons have specific definitions under the securities laws. Although Regulation Crowdfunding doesn’t state this, transfers of the crowdfunded securities after the one year holding period can’t be done unless the transfer complies with applicable federal and state securities laws. Because of this, crowdfunding securities will be extremely illiquid. Investors will have to be prepared to hold the stock indefinitely, or at least until the issuer goes public or is sold to another company in exchange for cash or publicly tradeable securities.

Crowdfunding provides opportunities for both issuers and investors. Investors needs to carefully evaluate the risk of investing in the issuer, and need to be prepared to hold their investment for a long period of time, or lose it altogether.

The information appearing in this blog does not constitute legal advice or opinion. Such advice and opinions are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to Strategy Law, LLP.

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