New risks involved in Title III changes to JOBS Act
The 2012 Jumpstart Our Business Startups (JOBS) Act was passed in order to provide startups access to cost-effective investor capital by easing various securities regulations. This was the first step in enabling ordinary investors to participate in equity-based crowdfunding. The second step, Title III, was approved on October 30th by the SEC, but will not take effect until 180 days after they are published in the Federal Registrar.
Current SEC rules permit only accredited investors to participate in crowdfunding. An accredited investor is someone who earns greater than $200,000 per year, or whose net worth is over $1 million without taking into account their place of residence.
However, Title III permits anyone to invest up to $2,000 or 5% of their annual income or net worth, whichever amount is larger, in projects attempting to raise up to $1 million in a 12-month window. While the change in policy should help startups raise capital by allowing more individuals to invest in them, both parties still face with risks.
The crowdfunding market does not face nearly as much due diligence from ordinary investors when compared to venture capital firms, thus making crowdfunding more enticing to entrepreneurs. Entrepreneurs who raise capital in this manner may believe that they could be less forthcoming with information for such ordinary investors who may have less of an understanding than accredited investors of what they are investing in. Companies who choose to not disclose information consequently put their investors in a situation that may not provide them with enough information and elevate them to a higher threshold of risk.
Obviously not every investment will result in a positive yield, but startups should be forthright so that even inexperienced investors know what they are getting into. Should a company fail to do so and their investors feel taken advantage of, the directors and officers will be at risk and held accountable by the SEC. The solution to mitigate the situation is rather simple, and it falls on the shoulders of startups. Despite the fact that small businesses face less scrutiny from ordinary investors, they should still be open, honest, and hold themselves accountable to the individuals providing the means to grow the business.
About the Author
Marcus Janus is an Area Vice President in GallagherWGA’s Management Liability Practice. He specializes in assisting organizations and their executives with protection and advocacy for their exposures to Directors’ & Officers’ Liability, Employment Practices Liability, Fiduciary Liability, Professional Liability, Crime, and Kidnap & Ransom.