The biggest challenge with Title III Crowdfunding isn’t the $1,070,000 maximum or the per-investor limits. The biggest challenge is how a small company complies with the disclosure requirements on a tight budget.
The disclosures required by Title III — I’m talking specifically about the long list of disclosures required by 17 CFR 227.201 — are fundamentally the same as those required by Title IV (aka Regulation A), which is itself only a slightly scaled-down version of a full-blown public offering.
There are easy questions, like naming the directors and officers, but the most important disclosures make sense only to securities lawyers. Ask the owner of a small business to list the “risks of investing” and you get mostly a blank stare, not the careful list the regulations anticipate. And when you get through everything else, you’re told to disclose “Any material information necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading.”
To a securities lawyer that’s just a restatement of SEC Rule 10b-5. To the founder of a small business it means nothing.
The result is what we see in the Title III market today, a mishmash. Some sites and companies manage to do it well, but many don’t. The widespread failure of compliance has led some to question whether Title III should be expanded before the Title III industry gets its house in order.
How does the industry get its house in order?
Before trying to answer that question, let’s think about how small companies raised money before Title III.
Before Title III, the typical small business was only vaguely aware of securities laws, if at all, and raised money however it could from whomever it could. Without knowing it, the microbrewery raising $250,000 from friends and family was eligible for the Federal exemption under Rule 504 and might have been eligible for state exemptions as well. But it probably wasn’t making the kind of disclosures required by Title III.
The same was true for would-be Silicon Valley unicorns. I’m pretty sure SoftBank didn’t ask Adam Neumann for a list captioned “Risks of Investing.”
The fact is that investing in a small business before 2016, big or small, generally was driven by relationships, not by legal disclosures. Because disclosure is the heart of the U.S. securities laws, it’s no surprise that the SEC turned to disclosure to protect widows and orphans in Title III. But the full-disclosure paradigm is new to this world. Ironically, the typical Title III issuer – even the issuer whose Form C falls short – is making far more disclosures than most small companies made before Title III, and far more than would-be unicorns are making to VCs today.
Does the paradigm used for large companies and institutional investors make sense for tiny companies and non-accredited investors? I’ll leave that for another day.
As an industry, we can take a few steps to improve:
- Software and Templates – Better software and better templates can help. At the same time, no template or software can produce “Any material information necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading.” I translate that to “What would you tell your grandparents if they were investing?” But still, it’s hard.
- Standardization – Depending on your point of view, standardization is either the price or the benefit of participating in a mass market. In either case, I’m convinced that Title III can’t function properly without far more standardization:
- Standardized Corporate Structures – It would be great if every Title III issuer were a Delaware corporation or a Delaware limited liability company, using the same standardized Bylaws or Limited Liability Company Agreement.
- Standardized Securities – Common stock, a simple preferred stock, a straight term loan, a simple revenue-sharing note, a SAFE, and their tokenized equivalents.
- Standardized Disclosure Templates – An investor should be able to compare the disclosures between companies and portals apples-to-apples.
- Standardized Legal Documents – Subscription Agreement, contract between portal and issuer, terms of the SAFE – everything should be standardized. Toward that end, within the next month I’m going to make a set of standardized documents available for issuers and portals.
- No More $10,000 Minimums – C’mon, man! The Target Amount should reflect the minimum required for a viable business, or to get a necessary patent, or something. The widespread use of artificially-low Target Amounts has damaged the Title III market, driving away serious investors.
As long as I’m at it, I’ll ask just one thing of the SEC. Ideally, figure out a way to eliminate the per-investor limits for accredited investors under Title III, which serve no purpose and are inconsistent with Regulation D. Or, if that’s not possible under the language of the JOBS Act, get to almost the same place by creating a regulatory safe harbor under the Exchange Act, which would allow funding portals to receive commissions from accredited investors in a side-by-side offering.
Everyone benefits, and the Title III market gets healthier.
Questions? Let me know.