Understanding Crowdfunding and the JOBS Act
As of May 16, 2016, new rules will permit the general public to invest in capital raising by start-up companies through crowdfunding transactions. The Financial Industry Regulatory Authority (FINRA) released an Investor Alert to help explain the rules of crowdfunding to the public so they can make educated and informed decisions prior to investing in a start-up business.
The Jumpstart Our Business Startups Act (JOBS Act) will allow for businesses in the early stages to offer and sell securities through crowdfunding. Shortly after the JOBS Act was announced, the Securities and Exchange Commission adopted Regulation Crowdfunding. FINRA will oversee the way crowdfunding is registered and ensure they are in compliance with regulations set forth by the agency and federal securities laws. Once Regulation Crowdfunding goes into effect, SEC-registered broker-dealers and funding portals and members of FINRA can offer and sell securities using crowdfunding on behalf of the investing public issuers.
Investors will have limits during any 12-month period due to the associated risks in crowdfunding investments. Limitations are based on annual income and net worth. These guidelines are as follows:
- You may invest up to $2,000 or five percent the lesser of your annual income or net worth if either your net worth or income is less than $100,000.
- You may invest up to 10 percent of your net worth or annual income — but not exceed $100,000 — if both income and net worth is equal to or more than $100,000.
If you want to know how to find your net worth, you would add up all assets and subtract liabilities. What you end up with is your net worth. Under the JOBS Act, your primary residence may not be included when calculating net worth. You may use joint calculations, but the aggregate investment is still limited by the same amount for individual investors.
If you want to invest in crowdfunding for a startup business, you may only do so through a registered broker-dealer’s online platform or a funding portal. A company cannot offer investors crowdfunding investments directly. Furthermore, the broker-dealer or funding portal must be a FINRA member and registered with the SEC.
Be aware of potential risks, including liquidity risks in which, for the first year, you would be limited in reselling your investment. You may need to keep the investment for an indefinite period of time. Shares may be transferred to various, specific parties, but the process to do so may be difficult.
FINRA also offers four tips to help investors make an educated decision regarding crowdfunding offers:
- Know if you can handle the risks and potential losses
- Research rules, disclosures, and information regarding the crowdfunding
- Remember crowdfunding can still result in fraud
- Make sure your financial goals fit this transaction