How Title III of the JOBS Act Impacts Startups

By Katie Sullivan at VentureApp

This post originally appeared on the VentureApp blog.

The JOBS Act (Jumpstart Our Business Startups Act) has been around since 2012 when it was signed in to law by President Obama, ultimately requiring the SEC to write rules on capital formation, disclosure, and registration requirements.

In November 2015, the Securities and Exchange Commission (SEC) approvedTitle III of the JOBS Act, which ultimately opens up opportunities for startups to receive equity crowdfunding from unaccredited investors. Cut to almost a year later…. the rules are finally taking effect on May 16, 2016.

According to the SEC, Title III implements “a regulatory framework for intermediaries that facilitate crowdfunding transactions, including specific registration requirements for a new type of intermediary called a funding portal, and rules that impose obligations on all crowdfunding intermediaries — both broker-dealers and funding portals.”

Yikes. Let’s break that down into simpler terms for startups.

With Title III of the JOBS Act, startups can take investments from ANYONE in exchange for equity. Before 5/16/16, startups could only consider exchanging equity with accredited investors, or those individuals with more than $1M net worth (there were some exceptions if your net worth is higher when including spouse’s earnings, or if you made more than $200k over the last two years and will continue to make it in the current year).

What you need to know:

  • This only applies to private companies — you can’t be registered to sell stocks publicly
  • You can raise up to $1M over a 12-month period (note: if you might need more than that to get through a year, this is not the option for you)
  • While you can raise from anyone, those looking to invest in you with a net worth of less than $100,000 can only invest up to $2,000
  • Those that make between $100,000 and $200,000 per year can only invest up to 10% of their annual income in your startup
  • We’re not talking Kickstarter, GoFundMe, or Indiegogo operations — investors don’t get early access or discounts to your product when it’s ready — they own a piece of your business
  • Crowdfunding still must happen through broker dealers or authorized funding portals — sites like FlashFunders, StartupValley, Crowdfunder,EquityNet, SeedInvest, and others

OK, so it seems pretty cool. Does it really impact your startup, though? It depends.

Similar to why crowdfunding sites like Kickstarter are popular, many early-stage businesses are too early to raise the traditional VC route. This presents another viable option.

But some folks are skeptical. Tanya Privé (the CEO of 1000 Angels, a venture investing platform, and CEO of CoFoundersLab, a platform to meet cofounders for your startup) contributed a post to Fortune, which brought up some really important points.

While it’s pretty cool that just about anyone can get involved in the startup ecosystem by investing even $200 in a company, there are some drawbacks to the process — for both sides.

For startups, the process of working through the authorized portals or broker dealers can be very time-intensive, and that’s because just about anyone can get involved. The SEC has to protect investors with more stringent due diligence, which means it takes longer for the money to hit the bank for startups.

You’ll need a lawyer and founders will pay anywhere between $30,000 — $100,000 to prepare documents to raise via Title III. Additionally, those brokers or portals take a fee off the top of the total investment — which according to Privé, is typically 7%. Woof — all that adds up.

Reporting doesn’t get any easier either. Most startups send monthly or quarterly update emails to their more traditional investors. For Title III investments, the SEC will require pretty structured documentation from the startup, which Privé expects will require a lawyer, as well.

So, should you investigate equity crowdfunding from unaccredited investors once May 16 rolls around?

It’s hard to say. For investors, it’s definitely a high-risk game as private company investments rarely boast a return, and when they do, it’s multiple years later. For startups, it seems like a lot of work and equity goes into incremental capital.

Is the intended result and idea better than the reality? It might be too soon to tell. Either way, it will be interesting to see how this plays out over the next few months and years.