New regulation allows everyone to invest in private companies
By Daniel S. Fabiano
Until now, private businesses were banned from soliciting the public for equity investments. At the same time, individual investors were barred from trying their hand at investing in private businesses unless they were accredited investors (making $200,000 per year or possessing $1 million in personal assets) or had a relationship with the owner.
This system underwent a major change May 16 with the Securities and Exchange Commission’s implementation of Title III of the Jumpstart Our Business Startups Act. Generally speaking, this new regulation allows for broad equity crowdfunding or the purchase and sale of equity through registered websites.
For businesses seeking capital, this democratizes access to investors in a major way. However, there is a legal framework to be followed.
The sale must be performed through a registered crowdfunding website and is capped at $1 million per year. As part of the sale, the business must make significant disclosures, including the identities of the owners and directors, financial statements that have been reviewed or audited depending on the size of the offering, business and shareholder risks, and anything else that an investor would need to know.
This reporting requirement is ongoing — the business must file annual documents with the SEC and post them publicly. Next, the owner, officers and directors could all potentially be personally liable for misinformation or omissions.
Finally, the business must be careful not to advertise the sale until it begins on the crowdfunding website, and any advertisements thereafter should be limited to the terms of the offer and the website address (no marketing fluff).
For investors, this allows them to get into the game and try their hand at investing.
Investors must self-regulate to ensure that they do not cross the investment limits. Investors that make under $100,000 per year may only invest the greater of $2,000 or 5 percent of their annual income, while investors that make over $100,000 can invest up to 10 percent of their annual income, though they are capped at $100,000 in aggregate investments per year.
Absent a fraud situation, the investor’s primary risk will be that of a bad investment.
On the other hand, a business faces much more risk: it can damage its capital structure or intellectual property portfolio if the crowdfunding offering is poorly executed, which would limit the ability to grow the business or gain future investors.
If you would like to make a crowdfunding investment or sale, we encourage you to contact an attorney familiar with corporate laws and the crowdfunding regulations beforehand to ensure that the transaction is in compliance with all applicable laws.
• Daniel S. Fabiano is an attorney with Buynak, Fauver, Archbald & Spray of Santa Barbara.