In April 2012, the Jumpstart Our Business Startups Act (JOBS Act) was signed into law by President Barack Obama. The idea behind Title III was to open up investments to non-accredited investors by allowing them to invest in private startups and small businesses. Prior to Title III, investing in private companies was limited to accredited investors, those with a net worth over $1 million, excluding their primary residence or income of at least $200,000 for the last two years (or $300,000 combined income if married) and institutions.
The concept of Title III was sound in theory; it should foster entrepreneurship and provide small businesses access to needed capital from a larger pool of investors. But Congress over-regulated the bill, and the requirements to comply with the regulations of Title III make it cost-prohibitive.
The Good, The Bad and The Ugly
The Good:
$1 million – Title III allows small businesses to raise up to $1 million over a 12-month period via a broker/dealer or online portal intermediary.
General Solicitation – It also allows small businesses to engage in general solicitations of the public in order to procure investments.
Investor Protection – Businesses must describe the use of proceeds from the offering and discuss its financial condition. In addition, businesses are required to amend the offering materials during the offering period to reflect material changes and provide updates on their progress toward reaching the targeted offering amount.
Non-Accredited Investors – Investors making less than $100,000 per year can invest $2,000 or 5 percent of their annual income, whichever is greater. Investors making over $100,000 per year can invest up to 10 percent of their annual income. During a 12-month period, the aggregate amount of securities sold to an investor through all crowdfunding offerings may not exceed $100,000.
The Bad:
Over-Disclosure – Businesses must provide detailed disclosures about its officers and directors, and the owners of 20 percent or more of its securities. These disclosures may reveal personal information to the public regarding individuals who might rather maintain their privacy or anonymity.
Financials – A company conducting a Title III offering must provide financial statements to investors, including the company’s tax returns, reviewed by an independent public accountant or audited by an independent auditor. A company that raises between $100,000 and $500,000 is required to have its financial statements reviewed by a public accountant, and companies that raise over $500,000 must undergo a full audit.
Reporting Requirements – A business that has conducted a Title III offering must file an annual report with the SEC and provide it to investors. This ongoing reporting requirement does not terminate unless: 1) the business has filed at least one annual report and has fewer than 300 holders of record; 2) the business has filed at least three annual reports and has total assets that do not exceed $10 million; or 3) the business is acquired.
The Ugly:
A company conducting a Title III offering can expect to shell out between $50,000 and $150,000 in costs, fees and expenses.
As the regulations set forth in Title III are far more burdensome that those in Regulation D offerings for accredited investors, the SEC has estimated it will require 100 hours of work from professionals, including accountants and lawyers, to comply with the regulations.
There are also fees associated with the crowdfunding portal or b/d, and a company can expect to pay a fee of between 7 percent and 10 percent of the total money raised.
Not included in the above compliance costs and fundraising fees are the costs of an accountant’s review of the company’s financials or the audit. Depending upon the money raised, this could cost an additional $25,000 to $75,000.
Indeed, these enormous costs are typically far too great for your average startup or entrepreneur.
Buyer Beware
What may seem an attractive investment in a potentially revolutionary company may result in a complete loss to the investor as a result of the company’s costs to comply with Title III. Companies that are uninformed or unaware of these regulations may find themselves short on capital and unable to fund operating expenses as a result.
Whether you are a company seeking to raise capital under Title III or an investor looking to invest in a Title III offering, caveat emptor.
Ross David Carmel, Esq. is a partner at Carmel, Milazzo & DiChiara, LLP. www.cmdllp.com
