Surviving in the new frontier of investingThis is a FINRA Investor Alert, republished here with permission. Read more here.
Investors can now buy securities through crowdfunding.
“Crowdfunding” generally refers to the use of the Internet by small businesses to raise capital through limited investments from a large number of investors.
Under new rules effective May 16, 2016, the general public can invest in capital raising by start-up companies. This advisory is designed to help the public understand the crowdfunding rules and processes so they can make informed decisions about the risks and rewards of investing in these early-stage businesses.
What Are the Rules?
Title III of the Jumpstart Our Business Startups Act (JOBS Act) established crowdfunding provisions that allow early-stage businesses to offer and sell securities.
The SEC subsequently adopted Regulation Crowdfunding to implement the crowdfunding provisions of the JOBS Act. The role of the Financial Industry Regulatory Authority (FINRA) is to oversee the registration of crowdfunding portals and to ensure that they comply with the federal securities laws and FINRA rules. Broker-dealers and funding portals that are registered with the SEC and are FINRA members are permitted to offer and sell securities on behalf of issuers to the investing public using crowdfunding.
Investors will be subject to investment limits that we describe below. Investors should be aware that crowdfunding investments carry significant risk: you can lose some or all of your investment.
Who Can Invest?
Like stocks and bonds, anyone can invest in crowdfunding offerings. But because of the risks involved, you are limited in how much you can invest during any 12-month period in these kinds of securities. The limitation on how much you can invest depends on your net worth and annual income:
If either your annual income or your net worth is less than $100,000, then during any 12-month period, you can invest up to the greater of either $2,000 or five percent of the lesser of your annual income or net worth.
If both your annual income and your net worth are equal to or more than $100,000 then, during any 12-month period, you can invest up to 10 percent of your annual income or net worth, whichever is less, but not to exceed $100,000.
Say your annual income is $150,000 and your net worth is $80,000. JOBS Act crowdfunding rules allow you to invest the greater of $2,000 or five percent of $80,000 ($4,000) during a 12-month period. So in this case, you can invest $4,000 over a 12-month period.
Know Your Net Worth
To calculate your net worth, add up all your assets and subtract your liabilities. The resulting sum is your net worth. To learn more, read FINRA’s Know Your Net Worth, which includes a worksheet to help with your net worth computation. For purposes of JOBS Act crowdfunding, the value of your primary residence is not included in your net worth calculation.
When you calculate your annual income or net worth, you may include your spouse’s income or assets even if those assets are not held jointly. However, if you use a joint calculation, you and your spouse’s aggregate investment may not exceed the limit that would apply to an individual investor at that income and net worth level.
How to Invest
In addition to investment limits described above, other requirements and procedures have been put in place to protect and inform those who invest in crowdfunding offerings.
Among the most important, you can invest in an offering pursuant to Regulation Crowdfunding only through an online platform of a broker-dealer or a funding portal, a new type of intermediary that was created by the JOBS Act. Companies may not offer crowdfunding investments to you directly—they must use a broker-dealer or funding portal.
The broker-dealer or funding portal must be registered with the SEC and be a member of FINRA. To check registration status and additional information on broker-dealers, visit FINRA’s BrokerCheck. To check if a funding portal is registered, go to FINRA’s Funding Portals Web page.
To begin the investment process, you will have to use a new or existing account with the broker-dealer or funding portal. While brokers can offer investment advice and recommendations, funding portals cannot. Also, a funding portal cannot solicit purchases, sales or offers to buy the securities being offered or displayed on the platform.
Be aware that you will be limited in your ability to resell your investment for the first year—and you may need to hold your investment for an indefinite period of time. While you are allowed to transfer shares to certain parties such as a family member or the firm that issued the securities, this may not be easy to do.
Read and Understand Key Disclosure and Education Information
Since crowdfunding investments are likely to be early-stage ventures and may be highly risky, the JOBS Act and Regulation Crowdfunding include provisions designed to inform investors about these investments and their potential risks.
Companies that conduct offerings under Regulation Crowdfunding are required to disclose, among other things:
- A description of the business of the company and its anticipated plan of business, including its name, legal status, physical address and website address.
- A discussion of the material factors that make an investment in the company speculative or risky.
- A discussion of the company’s financial condition.
- The names and positions of the directors and officers; the name of each person who is a beneficial owner of 20 percent or more of the company’s outstanding voting equity securities; and additional information such as the business experience of the directors and officers over the past three years.
- The price of the securities or the method for determining the price.
- This information is to be filed in a document called Form C and uploaded to the SEC’s Edgar system for access by investors and crowdfunding intermediaries.
Depending on the amount of money being raised—which includes any amounts raised by the company in the prior 12 months in reliance on JOBS Act crowdfunding—issuers are also required to make certain financial disclosures, including:
Amount Raised Required Minimum Disclosures
$100,000 or less Financial statements and specific line items from income tax returns, both of which are certified by the principal executive officer of the company.
$100,000.01 to $500,000 Financial statements reviewed by an independent public accountant and the accountant’s review report. If audited statements are available, those must be provided.
$500,000.01 to $1 million For an issuer using crowdfunding for the first time, financial statements reviewed by an independent public accountant and the accountant’s review report. If audited statements are available, those must be provided.
For all other issuers, financial statements audited by an independent public accountant and the accountant’s audit report.
Be aware that an audit of financial statements involves a higher level of scrutiny than a review.
Broker-dealers and funding portals that operate Regulation Crowdfunding platforms are required to:
- Provide educational materials to help investors understand this type of investing, as well as make available information about the offering and the company raising the funds (such as Form C).
- Provide communications channels that allow discussions to take place about offerings on the platform.
- Obtain a representation from the investor that he or she understands that they may lose their entire investment, and can bear such a loss.
- Provide prospective investors with questions designed to demonstrate an understanding, among other things, that it may be difficult to resell the securities and that investing in these types of securities involves risk.
While investing in early-stage businesses may bring rewards, it also carries risks. These tips can help you determine if a crowdfunding offering is right for you.
1. Ask yourself if you can handle the risk—and the potential loss of your investment. Both are real possibilities when it comes to companies that issue securities using crowdfunding. The venture may not succeed. Startups and early-stage ventures can and do fail. You should be able to afford, and be prepared to lose, your entire investment. If you are risk-averse, are just starting to invest, have only a little money to invest, or may need the money in the short term, crowdfunding investments likely are not for you.
2. Read and understand the educational and financial information, and all disclosures, provided by the issuer and crowdfunding intermediaries. If you are working with a financial professional, or seeking information over a crowdfunding platform’s communication channel, ask direct questions about the investment, including worst-case scenarios. It’s also a good idea to seek a second, or even third, opinion especially when it comes to highly speculative investments. This might include checking with an accountant who understands financial balance sheets and likely has no vested interest in the investment.
3. Recognize that fraud is a possibility. As with all investment opportunities, the possibility of fraud is real. Protect yourself by understanding the tactics a fraudster might use—and how to avoid them. As noted above, check out investment professionals using BrokerCheck and go to FINRA’s Funding Portals Web page. Under Regulation Crowdfunding, offerings must be conducted through a registered broker or funding portal. A basic Internet search is also valuable. Proceed with caution if you turn up legal or regulatory concerns about company officials, or news reports that raise other red flags.
4. Revisit your financial goals. Setting clear, prioritized goals—each with steps to achieve the goal, a price tag and a time frame—will help guide your investment approach, including whether crowdfunding offerings have a place in your portfolio. Basic strategies such as asset allocation and diversification can help manage risk and make sound investment decisions.
Changing Your Mind
You have up to 48 hours prior to the end of the offer period to change your mind for any reason. Once the offering period is within 48 hours of ending, you will not be able to cancel for any reason even if you make your commitment during this period.
If the company makes a material change to the offering terms or other information disclosed to you, you will be given five business days to reconfirm your investment.