April 29, 2020
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The SEC is expected to pass Title III – otherwise known as retail crowdfunding – sometime this Fall, nearly three years since the 2012 passing of the Jumpstart Our Business Startups (JOBS) Act. With Title II (Regulation D) and Title IV (Regulation A+) already defined by the SEC, Title III is the final piece. Title III has been a long time in the making; since it will open up early stage investing to a much larger swathe of the investing public, understandably investor protections needed to be thoroughly thought-through.
The JOBS was the legislation that opened up hitherto unavailable channels (stipulated by the Securities Act of 1933) for private companies to raise capital. More specifically, beyond access to accredited investors (Regulation D – 506(b) offerings), the SEC has opened doors for “generally solicitation” (Regulation D – 506(c) offerings) as well as access to non-accredited individuals and much higher funding cap up to $50 million (Regulation A+).
So why the great anticipation of Title III?
Why Title III is a Big Deal
Known as the retail crowdfunding component of the JOBS Act, Title III added the new Securities Act Section 4(a)(6), which provides an exemption from the registration requirements of Securities Act Section 5 for certain crowdfunding transactions. Under this exemption, startups can solicit and include an unlimited number of non-accredited investors.
To qualify, issuing startups need to follow several provisions in a 12-month period to remain eligible :
- Amount raised must not exceed $1 million
- Individual investments of up to $2000 or 5% of annual income or net worth, if the investor’s annual income and net worth are both under $100,000
- Individual investments of up to 10% of annual income or net worth, if the investor’s annual income or net worth is above $100,000
- Transactions must be intermediated by either registered broker-dealers or funding portals
- All investors must be offered total disclosure
It’s not hard to postulate that the pool of capital that will be made available to fundraising companies will grow dramatically from the current population of accredited investors (estimated at 1% of the U.S. population .) This is a market that has grown from ~$100B under the pre-JOBs Act market to ~$340B with the adoption of Title II, and up to $1T+ when Title III is implemented. Even more fundamentally than Reg A+, Title III will make it easier for startups to tap main street investors who previously had no access to early stage startups. Imagine the number of eligible investors in an asset class growing 50x overnight! That’s what makes Title III a big deal.
Investor Education a Must
Here’s the big “BUT.” Investors need to go into angel investing with their eyes wide open. Angel investing as we know it is a highly risky proposition. And beginner investors new to the space need to be armed with information and tools to evaluate companies to avoid being blindsided. The huge potential influx of new capital into angel investing can easily lead to a bubble, especially if beginner angel investors’ first instinct is to be “part of the herd”. For Title III not to undermine retail investor protection – SEC’s raison d’être in the first place – helping investors thoroughly assess potential investments needs to be a cornerstone of angel investing.
As I described in my blog on Reg A+, Propel(x) is well positioned to service and nurture this new class of non-accredited investors. To start, our curated deal flow focuses on startups built around innovation and breakthroughs under protectable IP – these are fundamental value drivers that will become increasingly crucial for investors in an environment of speculative investing.
More importantly, Propel(x) assists investors in making informed decisions via our diligence infrastructure – something we developed to instill the “tire kicking” spirit in every angel investor.
So it’s clear we at Propel(x) believe angel investors should put in the work to form their own investment decisions. What does that mean practically for an individual, do-it-yourself angel? There is a much more in-depth blog coming soon on the topic of conducting diligence. In the meantime, my colleague Ralph Turlington published an excellent primer on becoming an angel investor. In his “Being Diligent” section, he outlined a process which begins with initial evaluation – “Is there a market,” “What does the playing field look like,” and continues with more substantive diligence – “How much runway does the company have,” “Is the technology or innovation a breakthrough,” and ends with considerations around deal terms and documentation.
There are a lot of questioning involved with Ralph’s process. And the Propel(x) diligence infrastructure is here to streamline and automate that for investors, especially if they are just venturing into the high-risk world of angel investing.
The Bottom Line
No one knows precisely when Title III will be finalized; it could be a matter of weeks or months. Chair White of the SEC declared that final rules will be revealed in the “very near term” while outgoing Commissioner Gallagher recently told Crowdfund Insider, “it’s going to happen … no one on the Commission is opposed to it” .
Regardless of when, we at Propel(x) are super excited to welcome non-accredited investors who will gain pre-IPO access for the first time to technologies that could cure cancer or solve the world’s energy crisis. And as the angel investing world continues to hold its breath waiting on the ruling, we will continue to work hard on capabilities that will help individual investors discern diamonds from duds.
(Disclaimer: This article is meant to provide a simplified overview of a complex regulatory topic. It involves some interpretation and by no means should this material be considered regulatory advice.)