Among the many opportunities available to investors are those involving “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.
Crowdfunding investments carry significant risk, and you can lose some or all of your investment. Here’s some information to help you understand crowdfunding rules and processes so you can make informed decisions about the risks and rewards of investing in these early-stage businesses.
What Are the Rules?
Title III of the 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. FINRA’s role is to oversee and examine crowdfunding portals to ensure that they comply with federal securities laws, Regulation Crowdfunding and FINRA rules.
Anyone can invest in crowdfunding offerings. But, because of the risks involved, the rules limit how much non-accredited investorscan invest in these kinds of securities during any 12-month period. Other requirements and procedures are also 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 type of intermediary that was created by the JOBS Act. Issuers may not offer crowdfunding investments to you directly, for instance by using their own websites as offering platforms—they must conduct their offering exclusively through the platform of a broker-dealer or funding portal.
The broker-dealer or funding portal must be registered with the SEC and must be a FINRA member. To check registration status and additional information on broker-dealers, visit FINRA’s BrokerCheck. To see if a funding portal is registered, go to FINRA'sFunding Portals page.
The Investment Process
To begin the investment process, you’ll have to open an account with the broker-dealer or funding portal. While investment professionals can offer investment advice and recommendations, funding portals cannot. Also, a funding portal can’t solicit purchases, sales or offers to buy the securities being offered or displayed on the platform.
To aid investors in decisions about whether to invest in a crowdfunding offering, Regulation Crowdfunding requires issuers to make certain information about the offering publicly available and requires that the platform of the broker-dealer or funding portal provide communications channels by which individuals can communicate with one another or with representatives of the issuer.
If you make a crowdfunding investment, you’ll have up to 48 hours prior to the end of the offer period to change your mind and cancel your investment commitment for any reason. Once the offering period is within 48 hours of ending, you won’t 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’ll be given five business days to reconfirm your investment.
Key Disclosure and Education Information
Since crowdfunding investments are likely to be early-stage ventures and might 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; and
- 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 amount raised by the company in the prior 12 months in reliance on JOBS Act crowdfunding—issuers are also required to make certain financial disclosures.Learn more about these tiered disclosure requirements.
Broker-dealers and funding portals that operate Regulation Crowdfunding platforms are required to provide certain investor education materials and information about the offering and company, as well as communications channels to discuss the offerings. They must also obtain confirmation that investors understand the risks involved and can bear the loss of their investment.
Four Tips to Keep in Mind
These tips can help you determine if a crowdfunding offering is right for you.
- Ask yourself if you can handle the risks. Startups and early-stage ventures can and do fail, and you could lose your entire investment. In addition, crowdfunding investments carry liquidity risks, as you’ll be limited in your ability to resell your investment for the first year—and you might need to hold your investment indefinitely. You’re allowed to transfer shares to certain parties, such as a family member or the firm that issued the securities, but this might not be easy to do. If you’re risk-averse, are just starting to invest, have only a little money to invest, or might need the money in the short term, crowdfunding investments likely aren’t for you.
- Read and understand the educational and financial information, and all disclosures, provided by the issuer and crowdfunding intermediaries. If you’re working with an investment 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.
- 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. Use BrokerCheck to verify whether an investment professional and broker-dealer are registered and review their disciplinary history, and check the registration status of a funding portal on FINRA’s Funding Portals page. 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.
- 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 you manage risk and make sound investment decisions.
