By John Lion
Waiting on Title III of the JOBS Act? Join the rest of the nation including equity crowdfunding platforms like 1000 Angels, the private investor network that connects startups with investors, where currently only accredited investors are allowed to invest. Accredited investors are only 1% of the US population.
The SEC seems quite okay with postponing finalization until October 2015. Better late than never: an October implementation would be over 600 days since Congress's initial deadline.
Garnishing media attention since before 2012, the JOBS Act's Title III is among the most important landmarks in the history of modern crowdsourcing. It significantly broadens investment opportunities and a startup’s potential to raise capital through only a few legislative provisions. So why the hold up? More importantly, what can we expect if the SEC decides to pass Title III?
The JOBS Act and Title II
Startups are great for U.S. tax collectors and consumers alike. Even 2012's Congress agreed, passing the JOBS Act with bipartisan support through both the House and Senate. Otherwise called the Jumpstart Our Business Startups Act, the legislation modifies a series of laws that enable startups to seek funds using methods that have been illegal since FDR's Securities Act of 1933.
The Securities Act does many things, but one quite significant for startups is the classification of who can invest, how much they can invest, and where they can invest. Specifically, the act works within a broad, pre-existing distinction of potential investors.
Accredited investors have at least $1,000,000 in net worth (excluding primary residence) or an income of at least $200,000, annually, in the past two years
Non-accredited investors have a net worth of less than $1,000,000 or earned less than $200,000 annually in the last two years
Paying reverence to the age-old understanding that those good at making money and keeping it typically make sounder investments, the Securities Act severely limits startup businesses' ability to solicit funds in exchange for equity or debt. Only companies that fit within the Securities Act's exemptions, as defined in Regulation D, can accept funds without oversight (typically only from accredited investors partnering with the exempted business). There is some wiggle room, however, as organizations can include up to 35 non-accredited investors if offering full disclosure.
The JOBS Act refines Regulation D by progressively allowing more circulation, advertising, and inclusion of all manner of investors. The legislation itself has its advocates but also its detractors, with old guard unions and consumer protection groups particularly concerned about transparency and legitimacy. Still, a large number of outside investors and economists support the bill, as do younger folk less reverent towards the New Deal.
Divided into seven titles, the SEC is progressively introducing the JOBS Act section by section. Only Titles I, V, and VII went into action immediately after the bill's passage. Title II was not instituted until September 2013, a little more than a year after the SEC's deadline assigned by Congress.
Title II modifies Regulation D's 506(c) exemption to allow startups to solicit accredited investors and accept funds from them prior to being in "a substantial and pre-existing relationship," opening front doors that would otherwise require back entry. SEC official Keith Higgins announced that after six months of its implementation, $10 billion went into about 900 companies. Those numbers were actually a tad disappointing to Keith, but since then startups have continually managed to find accredited investors.
Title III: Potential Manifest
Title III, meanwhile, allows startups to solicit and include as many unaccredited investors as they wish. They still need to follow a few provisions to remain eligible:
Organizations may only solicit $1 million annually
Only registered broker-dealers and funding portals may intermediate purchases or investments
Investors can make a maximum investment of $2000 or 5% of their income if their net worth and annual income are both less than $100,000
Investors with over $100,000 in net worth or income may invest up to 10% of either
Businesses must offer total disclosure to all investors
When enacted, potential startup investors within the U.S. will increase from 3.5 million to 233.7 million. Look at the visual scale above. That entire blue square accounts for the mass of unaccredited investors.
See that speck of yellow within the blue square? That represents accredited investors, the block that startups can currently solicit.
The potential cash infusion is also intense, with a maximum of anywhere from 5% to 10% of an estimated $50 trillion. The image below offers a good idea of the scale difference, demonstrated by font size.
Some simple math makes such potentialities even more impressive:
A maximum between $2.5-5 trillion to startups within 1 year of implementation
$1 million cap per organization translates to anywhere from 2,500,000 to 5,000,000 successfully funded startups
Talk about strength in the majority. Even the more realistic projection, $300 billion, is 10 times the current VC investment market.
Holdback until 2016 at the Earliest
While startups wait, the SEC deliberates. Slowdown is typically due to bureaucracy and red tape, but the organization's molasses pace is easy to understand, and expected to continue. $50 trillion is an astounding number, as is the 233.7 million newcomers that may participate. A regulatory body familiar to working with a smaller group, the SEC may fear it lacks the ability to keep up.
Remember, the maximum businesses Title III could initially fund hovers between 2.5 and 5 million. Even with the conservative estimate of $300 billion, that means upwards of 300 startups can reach their annual cap. Overseeing and investigating such enterprises requires time, resources, and fresh ideas the SEC seems incapable or unwilling to spend.
Still, the bureaucracy is moving ahead at a snail's pace. In October 2013, a month after enacting Title II, the SEC reviewed around 585 pages of equity crowdfunding laws applicable to Title III. Progress, though dawdling, does have some organization.
States Taking Action: Intrastate Equity Crowdsourcing
Startups are hardly the only ones holding their breath. Numerous states are also impatient, and many are introducing or considering legislation that will implement Title III before the SEC's 2016 projections. Of course, such crowdsourcing would have to be intrastate, limiting the cash innovative startups could potentially find within a more restricted region.
States that have already introduced or are in the process of introducing intrastate equity crowdfunding include Washington, Texas, Maryland, Michigan, Georgia, Oregon, Tennessee, Wisconsin, Main, Kansas, Tennessee, Alabama, Idaho, and Indiana. Many other states are either debating action or otherwise passing such legislature. Only two states so far, Florida and North Carolina, have shot down legislation.
As with everything that is state-specific, methodology and standards vary quite a bit. All are eager to link with Title III, however, leading most states to conform to the legislation's standards. Portals are even taking interstate steps, such as crowdsourcing organization CraftFund.
Most states see the prospective funding as a means to either stay competitive or improve economically. Makes sense too. Equity crowdsourcing groups are setting up shop in Washington D.C and advocating in states where crowdsourcing equity has yet to pass. Similarly, templates for introducing legislature, organizing crowdfund campaigns, and total disclosure documents are circulating, helping to streamline the entire process.
Equity crowdsourcing advocates are quick to mention that small business loans are at 75 percent of their 2008 peak. Unlike large and medium-sized enterprises, which enjoy lighter credit standards, small organizations have little wiggle room and even less recourse. Equity sharing provides a good alternative that streamlines funding and is more inclusive than loans from traditional lenders.
Title III: New Voices, New Practices
The raw potential of Title III is impressive. It offers startups an alternative means to prove their viability and expand without institutional red tape. Far from just fiscal, however, Title III's impact is also social.
Many of the startups that crowdsource are driven by passion or innovation rather than raw profits. The collective worth and size of non-accredited investors is massive, and within it is a cluster of niche interests, social concerns, and hobbies. Typically limited to giving advice or consuming, Title III will give non-accredited investors far more influence over products, services, and planning. The overall effect may radically affect culture, with product trends becoming more bottom-up in manufacturing and distribution.
Adoption by states, though primarily a product of frustration, adds some interesting possibilities. While they are being careful to stay with Title III's standards, states are still experimenting with methods and pragmatics alike. Public planners and crowdsourcers are studying the efficiency and overall growth of different approaches. Systemization and conglomeration will likely follow. That precedence can easily affect the SEC's own implementation of Title III and its fine print.
Nonetheless, investors and startups will be waiting until (at least) October this year to find out. In the meantime, we'll have to satisfy ourselves by keeping updated on Title III's progress and readying ourselves for its enactment.