Title III of JOBS Act May Revolutionize Early-Stage

The final regulations for the “crowdfunding” component of the Act are anticipated to be released soon by the SEC, allowing for non-accredited investors to put capital into startups. Although this will not affect traditional fundraising, it will potentially disrupt the venture capital business.

The SEC is expected to soon give more clarity to rules that could change the way startups attract cash, not to mention the rules of the venture capital business.

However the private equity market, with its focus on more mature companies, is unlikely to be affected.

The long-awaited rules in question would govern Title III of the JOBS Act, which pertain to crowdfunding. The new regulations allow for a general solicitation of both accredited and non-accredited investors, and require either a funding portal or broker-dealer to intermediate investments. With the newfound freedom for anyone to invest in startups—rather than a mere 1 percent of the (accredited-only) population—many venture capital participants are wondering to what extent crowdsourced capital will crowd out established venture investment firms.

Title III may become a major force in early-stage fundraising, as it significantly broadens capital-formation opportunities for young companies.

“The idea that you can get more exposure to investors for your company sooner in a life cycle has a certain level of appeal for some types of companies,” says Lee A. Schneider, counsel at the law firm Debevoise & Plimpton. He adds that companies can simultaneously raise capital from both high net worth individuals under regulation D, as is typically done in private equity, while crowdfunding from a broader audience of non-accredited and accredited investors.

The new flexibility for private capital fundraising allows smaller companies to get exposure and benefit from a perceived “wisdom of the crowd,” where experts in certain fields can jointly judge whether they believe the startup has potential, says Schneider.

Schneider makes the point that the new rules will allow new investors to participate in startups who previously were excluded based purely on wealth level, not experience. For example, he says, a non-millionaire Ph.D. in a certain field may nevertheless be very qualified to invest in a startup in the same field, but is currently barred from doing so.

Another benefit of crowdfunding may be the ability to raise capital from an enthusiastic crowd of investors who make for natural early customers of the given product or service. “At the end of the day, it’s really a question of what your target audience is for a particular raise,” says Schneider. “And it makes the company think about who their future audience is and how they are going to make [that audience] grow.”

A larger number of people able to invest may lead to a social buying atmosphere. “When a company is open to the public during a fundraise,” says Schneider, “crowds will discuss it and eventually influence each other. When a crowd gets together to discuss the merits of an investment, good information often turns up that would not have otherwise been discovered.”

Before the SEC approves the official rules of crowdfunding under Title III, Schneider says there will be an open meeting announcing the approval, and usually the effective date is 60 days after publication in the Federal Register. They have not yet indicated when the proposed rules may come out, but it is rumored to be in October 2015.

Once Title III takes effect, the number of investors in the country could increase exponentially, dramatically changing the world of venture capital.

Unless the SEC changes its mind, however, Title III will not have much impact on the raising of limited partnerships, as it only relates to raising capital for operational companies, not funds.

Likewise, private equity, which invests much greater amounts of capital, will not likely become a crowdfunding market any time soon.