I was in a mood to do something exciting and risky, and was ready to throw caution to the wind. I’m too old to take up hang-gliding or rock climbing, and dirt-biking and big game hunting aren’t my thing. I think, though, that I have found the perfect vehicle to add some thrills to my life. I purchased shares in a crowdfunded securities offering.
Crowdfunding has been around for many years, as people with ideas have sought to connect with people with money. Until recently, crowdfunding operated on a rewards basis, where supporters would receive everything from t-shirts to small parts in indie movies in exchange for a contribution. That all changed with the Jumpstart Our Business Startups (JOBS) Act, which was signed into law by President Obama in April 2012. The legislation created a new exemption from Securities Act registration for crowdfunded securities offerings. The SEC adopted Regulation CF to implement the statutory provisions in 2015, and the rules became effective in May 2016. These offerings are often referred to colloquially as “equity crowdfunding,” to distinguish securities transactions from rewards-based crowdfunding. Securities crowdfunding may, however, include both equity and debt offerings.
Issuers must offer their securities through an SEC-registered intermediary, either a registered broker-dealer or a new type of entity, a “funding portal.” Congress and the SEC required the use of intermediaries in these transactions because of the relative lack of sophistication and familiarity with securities offerings on the part of both the issuers and the investors. These entities are also generally subject to FINRA registration and regulation. FINRA currently lists 27 firms on its "Funding Portals We Regulate" page. This list served as my jumping-off point for my crowdfunding adventure.
The funding portals are all subject to the same basic regulation, but they all look and function quite differently from each other. Portals can perform fewer functions than can registered broker-dealers, and are subject to a less rigorous regulatory regime than their broker-dealer counterparts. The SEC rules assign to funding portals a vital gatekeeping role to screen issuers and offerings for fraud and abuse. The degree to which portals are capably performing these functions remains an open question as the crowdfunding market develops.
I experienced a mixed bag of results as I made my way through the various portals. One site simply wouldn’t load, while another brought me to a sudden halt at a page displaying “DEMO: Investment Opportunities” and nothing else. Others were little more than links to the portal’s filings on the SEC’s EDGAR site, while some had no current offerings available. On one site, I found myself locked in an endless cycle of signing in followed by a "please sign in" prompt. Another portal required the site to approve my membership application, and as of this writing, I am still on the outside looking in.
The sites that were functional and navigable and that had open offerings generally relied on self-certification. Investment caps apply based on the purchaser’s income and net worth. I input my figures, and am sure that these were not otherwise verified by the sites. One site did, however, require me to upload a copy of my driver’s license to confirm my identity.
Most portals required me to acknowledge a lengthy list of disclosures by clicking a yes or no radio button. I had to agree with statements that in spirit at least indicated that:
One site made me take a pop quiz on the disclosures made on the previous page, and the site where I decided to invest made me click on the company’s offering documents before I could proceed. I didn’t have to read them, of course, but I did have to come into contact with them before moving on. It is fair to say that many crowdfunding disclosure statements are not prepared with the rigor and detail found in public documents or materials in other forms of private offerings. For example, one issuer seeking to expand its business across the country stated that:
For example, if you invested $10,000 in this offering, you would receive 10,000 shares of [Issuer] common stock. If [Issuer] were to conduct an initial public offering at $5.00 per share, you would have 10,000 shares worth $50,000, a return of 5x your original investment. (There can be no assurance, however, that [Issuer] will conduct an IPO and, that if it does, you will be able to sell your shares to realize a return.)
So, you could realize a five-fold return on your investment. You probably won’t, but hey, anything’s possible!
The disclosure documents for the offering which I eventually selected had more than 15 pages of company risk factors. The disclosure reiterated the likelihood that I would never ever ever see my money again, and pointed out that I had no vote or say in the company’s operations. I also learned that the company had no proven business model and that the company established the stock price. And dividends? Don’t ask.
The essential truth of equity crowdfunding is that it is not an investment made, to borrow language from the Supreme Court’s Howey decision, with “a reasonable expectation of profits.” Crowdfunding serves a vital purpose of promoting entrepreneurship, and allows investors to participate in the offerings of companies as diverse as a manufacturer of floating solar cells and the operator of a gourmet grilled cheese truck. Crowdfunding will likely not lead to any large-scale democratization of the capital markets, but it will allow some worthy startups to see the light of day. Investors should view crowdfunding as a chance to promote businesses in which they believe, or companies that just sound fun, rather than as an opportunity to reap a bonanza of rewards.
Investors should be educated and aware of all the risks and pitfalls of investing in crowdfunded offerings. They may want to rely on the services of a third-party firm such as CrowdCheck to access disclosure and due diligence on issuers and the investments they are offering.
I went ahead and invested a couple weeks’ worth of coffee money in a startup media company. Under the rules, I have 48 hours from the company’s stated deadline to cancel my investment and get my money back. The money is in escrow (I hope) until the offering closes later this summer.
If I decide to cancel, I might go hang-gliding.
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