The JOBS Act, four years later.

President Obama and the US Congress passed the JOBS Act on April 5th 2012. The new law promised to allow startups and small businesses to start using crowdfunding to raise money online from regular investors, which was previously not allowed under US finance rules.

To be clear, we’re not talking about pre-ordering a product or contributing to a project you support the way you do on Kickstarter. We’re talking about actually investing, buying an equity piece of a company, the way you do on the stock market.

The next step was for the US Securities and Exchange Commission (SEC) to create all the specific technical rules governing exactly how the new law would be implemented. This ended up taking an absurdly long time. The original mandate in the JOBS Act was for the SEC to draft the rules by the end of 2012. Instead the SEC released the final rules three years late in October 2015. They are finally scheduled to go into effect on May 16th 2016.

Behind the scenes this long delay was caused by larger controversy among industry and government stakeholders between a pro-business side which wanted rules that were open enough to be used widely and effectively, versus an investor protection side that wanted to avoid a new era of online investment scams at the expense of normal investors. Many have accused the SEC of intentionally dragging their feet for these political reasons. In their defense, the SEC made a herculean effort to listen to a massive amount of feedback from both sides of the argument and to carefully weigh the pros and cons of all the technical details of the rules. Congress might not have appreciated just how complex and subtle the legal process of equity fundraising is. The final Equity Crowdfunding rules came out to be 686 pages long.

Before the JOBS Act, investing in private companies was available to “Accredited Investors” only, defined as individuals earning above $200,000 annually, or $300,000 with their spouse, or with a net worth above $1million excluding their home. Private companies (As opposed to public companies which trade on the stock market.) were also not allowed to publicly state in any way that they were raising money from investors, and instead needed to be introduced to investors via a registered broker dealer or have a substantial pre-existing business relationship. This created a world in which well connected rich people invested very differently than the rest of us. High income and net worth individuals had access to private investment startups, hedge funds, venture capital, and other alternative asset classes, while regular investors benefited from SEC protection, making sure that the publicly traded companies they were allowed to invest in were well audited and regulated.

The New Rules

The Equity Crowdfunding rules, dubbed “Regulation CF”, allow small companies to raise up to $1million online annually through equity crowdfunding portals registered with the SEC, which will have to comply with various investor protection measures.

We can expect a flurry of activity and press in May as new platforms come online and companies start to raise money with fundraising using the new rules.

But wait, there’s more!

The JOBS Act actually has seven separate sections, called titles, each creating new sets of rules. Crowdfunding is just one of those seven titles.

Titles 1, 5, 6, and 7 were enacted immediately when the law passed in 2012. They deal with technical matters such as how many shareholders a private company is allowed to have before reporting to the SEC, streamlining the SEC disclosure process, defining a new class of “emerging growth companies” that these new rules will apply to, and a mandate for the SEC to focus more on businesses owned by women, veterans, and minorities.

JOBS Act Titles 2, 3, and 4, or as they are referred to in the industry, Title II, Title III, and Title IV, each create a whole new process by which private companies can raise money from investors online. These are the big ones. Title III is the one enabling Investment Crowdfunding we’ve talking about so far.

Surprise! We’re Already Here.

With all the buzz around final implementation of the long delayed Title III Equity Crowdfunding rules, a lot of people have missed the more subtle fact that Title II and Title IV have already been enacted, are being used, and that each has the potential to be much more impactful than Title III Crowdfunding. They are a bit more complicated and haven’t gotten as much media attention, but they’re rapidly becoming popular in the world of startup investing. Let’s walk through the details:

Title II Accredited Investor Crowdfunding

Title II, often referred to as Accredited Crowdfunding, created a new set of rules called Regulation D rule 506(c), which went into effect in September 2013.

These rules allow companies to advertise publicly that they are raising money, including by listing themselves as an investment opportunity on online equity crowdfunding portals. This public advertising of a private offering is called “General Solicitation”, and was previously not allowed. This means that if someone wants to invest they can go out and hunt for investments themselves from a much larger pool of options, instead of relying on introductions their broker and existing business relationships.

Companies using rule 506(c) are allowed raise an unlimited amount of money this way, but only from Accredited Investors, and issuers have to go through extra effort to make sure that their investors actually are accredited by reviewing their personal financial documentation such as tax returns and bank statements.

Top accredited investment crowdfunding portals include:

(You can see the details of each and many more on the CrowdExpert.com Investment Crowdfunding Platform Directory.)

These top platforms have already raised hundreds of millions of dollars online for private companies from accredited investors. CrowdExpert.com estimates total 2015 US equity crowdfunding volume at $2.1 billion.

These accredited-investor-only portals have further confirmed with the SEC that they can also host companies raising money under the old rules, which are now called 506(b), by simply requiring the companies raising money to stay hidden behind a login-required area of the platform which is accessible only after an investor has self-certified their status as an accredited investor. As long as they stay behind this wall companies using the 506(b) rules do not need to rigorously confirm that their investors are actually accredited. So even though these platforms were largely created to take advantage of the new JOBS Act rules, the majority of offerings still use the 506(b) framework to raise funds.

In practice the difference between 506(b) and 506(c) isn’t that meaningful now that they’re both listed on the same platforms. Some companies prefer to do the extra work of verifying their investors accreditation status in exchange for the ability to advertise more widely, and some don’t want to deal with that. Some have no intention of advertising but choose to use 506(c) just to be safe in case any of their investment materials do accidentally slip into a publicly facing medium.

Title IV “Mini-IPO” Equity Crowdfunding

Title IV, sometimes referred to as Mini-IPO crowdfunding, allows companies to raise up to $50million per year from both accredited and now finally also from regular old public Non-Accredited Investors using a new set of rules called “Regulation A+” (an update to an old under-utilized set of rules called Regulation A). These rules went into effect in June 2015.

We have not yet seen as much usage of these new Title IV Reg A+ rules as we have with the Title II Accredited Crowdfunding because the companies raising money with Reg A+ need to first register with, submit detailed offering materials and financial statements to, and be approved by the SEC. This process takes at least six months, and costs $50k-$100k. (Though somehow the first company to use Registration A+ managed to spend almost $500,000 preparing their offering, which is still much less than the $3.7million average cost for a company launching traditional IPO.)

CrowdExpert.com tracks the few platforms that have managed to navigate the new process for raising investment money with Regulation A+ so far:

StartEngine has had one successful raise of $16million for an automotive startup, and is currently raising funds for an aviation and medical cannabis startup, plus has several more startups in the “Testing the Waters” phase of using the platform to gauge investor interest.

SeedInvest has one Reg A+ equity raise currently live for a fashion company, and two more testing the waters.

GroundFloor and FundRise have both made crowdfunded real estate investment available to unaccredited investors using Reg A+.

WR Hambrecht + Co just listed a few upcoming Reg A+ offerings on their site.

Banq.co says that they also have some Reg A+ offerings currently in the pipeline.

In short, Regulation A+ investing is just now getting started. Keep an eye on our Investment Crowdfunding Platform Directory as more platform bring Reg A+ offerings online.

What do you get?

When investors put money into a company via one of these accredited investor only Title II crowdfunding platforms, they are buying into any one of a variety of different investment structures. Sometimes it’s direct equity in the form of common shares. Sometimes it’s a convertible note, which is a loan contract that converts to equity on a future funding round, when a large investor comes in and the valuation of the company is determined. Sometimes the investor buys an ownership share in a Special Purpose Vehicle (SPV) LLC, which exists to represent a group of investors that own a piece of a company or asset together. Because these investments are only made available to accredited investors, the SEC allowed a lot of flexibility in how offerings are structured. They are expected to understand the risks and technicalities of what they’re getting into.

When investors put money into a company on regulation A+ platforms they usually receive direct equity in the form of common shares in the company they invest in, though the rules also allow for debt and convertable-note issuances.

There is a limitation on the amount of securities non-accredited investors can purchase in a Reg A+ offering that raises above $20 million, called a “Tier 2" offering. In a Tier 2 offering a non-accredited investor can invest up to 10 percent of the greater of the investor’s annual income or net worth.

How do you make money on these crowdfunding “investments” ?

So much of what is written about Equity Crowdfunding is from the perspective of the companies raising money. It’s as if as if issuers assume that the world is just lining up to give them free money with no expectation of ever getting something back. We make a startup, they think, and investors will somehow appear to give us money, as a rainbow appears between the clouds, a law of nature. And they’re right. In a world with negative interest rates, commodity prices collapsing and then collapsing again, a giant housing bust still lingering in recent memory, China going nuts, the Eurozone fighting with each other, currencies plummeting, zero inflation, and a manic depressive stock market, tech startups have been the one way anyone has made any money in the last decade. So the big money is already there.

The accredited and institutional investors putting billions of dollars into Regulation D Rule 506 offerings know what they’re doing. These investors (should) have a long time horizon and these investments (hopefully) represent a small part of their overall portfolio. When investing in tech startups their plan is to sit on a portfolio of companies and wait for them to grow and for one or two to eventually go public or be acquired at an order of magnitude larger than when they invested. When Facebook decides to buy silly little companies like Whatsapp and Instagram for $3 Billion out of nowhere, investors like this get their payday.

Regulation A+ offerings are also a long bet on an eventual exit, but so far the few that have gone through have shown an additional trend of using Reg A+ as a quick stepping stone to trading openly on the OTC Markets, as a normal stock. For Example Elio Motors, a company developing a new kind of small urban car, raised $17million recently on the StartEngine platform via Reg A+, and is currently trading on the stock market with ticker symbol ELIO. Anyone call log into their brokerage account and buy or sell shares. Investors that bought into the Reg A+ offering at $12 per share are probably pretty happy that it’s currently trading in the $30 range just a few weeks later. (Though share prices on OTC Markets are based on very little trading volume. It’s not quite the same as a real stock.)

In General though there isn’t much liquidity for startup private shares. Larger more successful startups, the kind you’ve heard of, do sometimes allow early investors and employees to sell shares on secondary markets such as Equity Zen, and Dream Funded.

Mostly though, if you’re investing in tech and internet startups you’ll be sitting on shares waiting years for something to happen, and for most companies, it won’t. These are still startup investments, and they’re risky. Most don’t pan out. That’s why the SEC was so hesitant to let un-accredited investors play in this space. Normal investors are unaccustomed to the idea that they will probably lose all their money, and that that doesn’t mean it was a scam. Investing in a startup is buying a really big lottery ticket, with somewhat better odds.

But there’s more to life than startups. Investors seeking more reliable returns have figured out there just as many real estate crowdfunding platforms as there are those specializing in startups, a few of which including FundRise and GroundFloor are open to unaccredited investors. Because real estate is a relatively stable income generating asset, investors can assume a pretty steady 5–15% return rate, and an easy diversification away from the stock market.

Peer-to-Peer Lending, or Marketplace Lending as it’s becoming known, has also offered very regular returns by allowing individuals and institutions to build portfolios out of slices of many individual small consumer and business loans, graded using big data on their payback quality. Again, this offers pretty reliable 4–12% returns, and has proven so popular that huge institutional investors have largely taken over the space. Still, as an unaccredited individual investor you can easily create an account on LendingClub or Prosper and start your own portfolio.

It’s almost silly for Real Estate Crowdfunding and Peer-to-Peer Lending to be included as a minor note in this article, because US Real Estate Crowdfunding is already a bit larger at $1.4 Billion in estimated 2015 volume than startup crowdfunding at volume at $1.2 Billion. And Peer-to-Peer lending is an order of magnitude larger at an estimated $23 Billion in 2015.

Why don’t we hear more about this?

Confusingly, the platforms using Title II and Title IV often seem to go to great lengths to not refer to themselves as “crowdfunding”, perhaps embarrassed that over thanksgiving dinner a well-meaning aunt might compare their sophisticated financing activities to a cute project they saw on Kickstarter.

Instead of calling it Investment Crowdfunding, Equity Crowdfunding, or CrowdInvesting, you’ll often see terms like: Direct Public Offering (DPO) ,Private Offering, Private Placement, Private Issuer Publicly Raising (PIPR), Alternative Finance, Alternative Investment, or FinTech.

Most financial activity in the world goes on behind the scenes. The SEC is already tracking 506(c) fundraising volume at $33 Billion as of 2014 according to these two studies, only a small fraction (about 3%) of which could be accounted for by the activity on investment crowdfunding platforms. Even the $33 Billion is only an itty-bitty part (2%) of the $1.3 Trillion volume raised in that time via all Regulation D private offerings. The hidden world of private investing is huge. Comparatively public IPO Volume in that same period was about $140 Billion.

Potential Downsides with Title III Crowdfunding

I‘m excited for May. It’s going to be very interesting to see what happens when the new Title III Investment Crowdfunding rules go live. I bet we’ll see some really cool new projects this summer. On the other hand, there is also a lot to be concerned about.

The biggest limitation is that companies will only be able to raise one million dollars. That might be enough for opening a local business or manufacturing the first run of a new product, but it doesn’t set up a company for the kind of a growth an investor would be looking for. We already have rewards-based crowdfunding like Kickstarter and Indegogo to support projects we like, and many projects have raised over $10 million using those platforms, so why should investors be limited to one tenth that amount?

Investors are also limited in how much they can invest. Someone earning less than $100,000 per year or with net worth below $100,000 is only allowed to invest the lesser of $2,000 or 5% of their annual income or net worth per year. Investors making more than $100,000 per year or with net worth above $100,000 can invest up to 10% of the lesser their annual income or net worth. Any investor, no matter how high their income or wealth, may only purchase a maximum of $100,000 in Regulation Crowdfunding securities over the course of any 12-month period.

The companies raising money will have to file with the SEC, and provide financial statements, and information about their business and their investment offering.

Most of the limitations and rules rest on the shoulders of the investment crowdfunding portals. Portals will be regulated by both the SEC and FINRA. Portals won’t be allowed hold investor funds, offer investment advice, or highlight particular offerings. Portals will be required to provide educational materials to investors, police issuers, keeping out bad actors, provide an online communication platform between investors and issuers, and ensure that investors don’t exceed their investment limits.

I think the SEC made the right choice by putting the bulk of the regulatory burden on the Portals. They have the most to gain from investment crowdfunding, and the most opportunity to learn the process and build their businesses around it. Crowdfund investors and the companies raising money with crowdfunding will be doing it for the first time, and often be inexperienced with investing and fundraising in general, so excessive regulation would push a lot of them out of the space altogether. The portals on the other hand are all fighting to become the leading platform, a lot of these companies have raised a lot of real money for themselves on the pitch of becoming the next big thing, kickstarter meets e-trade. Let them deal with the details and fight it out. Whoever figures it would will have built a billion dollar company and be fighting off acquisition offers. (Interestingly, portals are also allowed to take an equity stake in issuers as payment. I wonder how that will be used.)

The primary concern of many of the smarter people in the industry is a more technical one. A rule called 12(g) will put companies on the path of full reporting to the SEC once they exceed 500 unaccredited investors or $25Million in assets. A low bar for companies planning on growth.

These rules combine to make Title III crowdfunding unappealing to startups. Why go through all this bother, and learn all these new rules, work under all these limitations, just to raise a measly million dollars from a bunch of novice unaccredited investors?

The answer is like water to a fish, so obvious and overwhelming that you don’t even notice that it’s all around you. Investment Crowdfunding, as it’s set up under Title III isn’t for tech startups.

If you’re building the next big app, or big data machine learning algorithmic advertising platform, or bitcoin-only flying car sharing marketplace, then there is a huge industry of venture capitalists and angel investors all fighting to give you their money. If you really hit on something good you can walk into the right meeting with a private investor and walk out with one check to carry your business through the next few years. Crowdfunding takes months and months of planning and marketing, talking to investors and keeping track of paperwork, all under the strict rules of the SEC.

In fact I would be extremely wary of any tech startup that does choose to raise money this way. Unless they’re doing it out of a true and deep love of their community, they’re doing it because all the smarter money said no. Venture capitalists make their money by investing in ten companies, assuming nine will fail and one will grow 20x. So anything left over has above a 90% chance of being a total failure.

What Title III Crowdfunding seems to actually be for is normal, non tech, non internet businesses. A million dollars would be great for opening a new kind of summer camp, launching a new beverage, expanding a small clothing brand, or turning a local restaurant into a franchise. Venture Capitalists mostly don’t want to have anything to do with these sorts of businesses and these companies will most benefit from having a group of super-fan investors that have a financial and an emotional investment in what they’re doing.

In an era where Google and Apple have quickly become the most valuable companies in the world, it’s easy to forget about all the parts of life that don’t happen on your phone, and all the businesses that would be happy to raise a mere million dollars. Maybe Crowdfunding will help take us into a more balanced future, and hopefully some people will even make a bit of money investing in it along the way.