Crowdfunding and EB-5 - What Insights do the New SEC Rules Offer for EB-5 Practice?
On October 24, 2013 the Securities and Exchange Commission (SEC) released the proposed rules governing crowdfunding, which is an evolving method of raising capital through Internet and social media websites. Title III of the "Jumpstart Our Business Startups" (JOBS) Act and SEC's proposed rules created an exemption under the securities laws for the crowdfunding method. It allows startups to raise capital more easily.
The crowdfunding rules are amended in Title III of the JOBS Act. Title III permits securities registration exemptions for raising capital in small amounts from large numbers of individuals via the internet, including social media websites. The key provisions of Title III are:
- An issuer is permitted to sell up to $1 million dollars securities in any rolling 12-month period, provided the issuer has met certain requirements, such as initial and periodic disclosures to the SEC; and
- Each investor may not purchase securities in excess of $2,000 or a percentage of such investor's annual income or net worth, up to a maximum of $100,000 US dollars.
Crowdfunding is similar to EB-5 practice in many ways. First, the companies that seek to raise capital through the crowdfunding method, by targeting a large number of individual investors, instead of a few wealthy angel investors and venture capital firms. Second, intermediaries are likely to be used in the process of capital-raising. Third, the investment decision are often made not based on thorough due diligence but on trust and friendship among members of family, ethnic, religious communities.
One seemingly overlooked fact is that most companies seeking EB-5 funding are startups. According to the recent statistics published on the Wall Street Journal, 75% of startups fail . The majority of the investors targeted by crowdfunding and EB-5 funding seeking companies are not sophisticated investors who have sufficient investing experience and knowledge to weigh the risks and merits of an investment opportunity.
Wealthy angel investors and venture capital firms invest in multiple projects. A 25% successful rate is good enough. Crowdfunding investors and EB-5 investors invest in one project. For the EB-5 investors there are even a higher risk involved - their permanent residence in the US. The insights the crowdfunding rules provide to EB-5 investors is to evaluate whether the projects could access to traditional financing through banks, wealthy angel investors and venture capital firms, etc. because comprehensive due diligence research is conducted by the sophisticated investor and the financial institutes. Many startups are denied funding and eliminated in the due diligence process in the traditional financing route. Other than to evaluate whether the projects are good investment products, more importantly, the EB-5 investors must examine whether the projects are likely to comply with the EB-5 laws and regulations and to create the required jobs for the US economy.
Timothy Spangler from the New Yorker commented that: "It's likely that companies that can't get the attention of venture-capital firms or established angel investors will be the ones reaching out to members of the general public-many of whom may not have any significant experience investing in startup companies-to find potential investors."
SEC is seeking public comments to the crowdfunding rules. The process can take a long time. For example, the SEC took around a year to release the implementation rules on general solicitation and general advertisement, a highly relevant section in JOBS Act to the EB-5 practice.
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1DEBORAH GAGE, The Venture Capital Secret: 3 Out of 4 Start-Ups Fail, Wall Street Journal,
2Timothy Spangler, Is Crowdfunding good for the Investors, the New Yorker, http://www.newyorker.com/online/blogs/currency/2013/10/is-crowdfunding-good-for-investors.html
Yi Song, Esq. is an attorney at Mona Shah & Associates focusing on EB-5 and securities law. She is also admitted to practice law in New York and People’s Republic of China. She has authored many published articles on EB-5 financing and securities law. She practiced tax law in China and has experience in class action securities litigation cases. Yi is a graduate from Georgetown University Law Center in Washington, DC.
The opinions expressed in this article do not necessarily reflect the opinion of ILW.COM.