Based on your preferences for industries, kinds of securities, and minimum investment, pick from a list or directory of funding portals and broker-dealer platforms that list suitable offerings. Review the intermediaries’ selection criteria and track records before registering.
Intermediaries known as funding portals and broker-dealer platforms lie at the heart of the equity crowdfunding experience. This is where entrepreneurs and investors find each other. These intermediaries facilitate compliant offerings, disclosures, communication, collaboration, and transactions between issuers and investors.
Starting May 16, 2016, the Financial Industry Regulatory Authority (FINRA) will maintain a list of registered funding portals that have been approved for Title III offerings.
In this section of the Seven-step Plan we will help you select portals and platforms where you’ll find the most suitable securities offerings for your portfolio.
First you should look for equity crowdfunding portals (and broker-dealer offering platforms, which we will explain below) which feature the kinds of offerings that you identified in Step 3 as suitable for your portfolio.
We suggest that you begin searching for suitable offerings on three kinds of equity crowdfunding sites that feature Title III offerings:
After Title III equity crowdfunding launches in May 2016, we will provide plenty of examples in each of those three categories.
Note that some offering platforms will list not only Title III offerings but also Title II (Regulation D) offerings and Title IV (Regulation A+) offerings. Reg D is open to accredited investors only, while Reg A+ is open to all investors including non-accredited. But Reg A+ is structured for later-stage private companies, rather than seed-stage and startup companies.
Do not underestimate the importance of using reputable intermediaries, since some of them will effectively “prescreen” offerings to the extent legally permitted and you can rely on that prescreening to at least weed out the bottom layer of companies.
Most Title III equity crowdfunding sites will look somewhat like rewards-based crowdfunding platforms and very much like Regulation D platforms. The home page typically shows several of the most popular and/or newest offerings. (You can read all about Regulation D and Reg D platforms, including case studies, in Chapter 2 of our book, Equity Crowdfunding for Investors, published by Wiley & Sons, 2015.) From there you have to “drill down” to find a full listing of offerings. If a site has more than a couple dozen listings total, it should be easy to search through them according to industry or sector, time left in the offering before the deadline, and maybe region as well. Hybrid platforms should, in addition, let you search offerings according to the type of crowdfunding project: rewards, debt, Reg D equity (for accredited investors only), and Title III and Title IV equity (for all investors). Especially if you are not an accredited investor, you should be able to search Title III and Title IV offerings without having to peruse a whole lot of Reg D offerings along the way. Some sites let you search according to minimum investment amount as well and combine the search criteria so that you can, for example, look for Title III investments in the Midwest, focusing on the healthcare industry, with a low minimum investment.
Funding portals and broker-dealer platforms may look quite similar—in fact, you might not immediately be able to distinguish one from the other—but there are important distinctions between them that may affect your success in finding suitable investments. Usually a platform will reveal its broker-dealer status at the bottom of the homepage and/or on the “About” page of the site. If you are unsure about an intermediary’s status, you can contact the intermediary and ask whether it is a registered broker-dealer.
Funding portals, as defined in Title III of the JOBS Act, are websites that are registered with the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) for the purpose of hosting equity crowdfunding activities: offering, disclosure, investor registration, communication, transaction, and so on. Funding portals are a new type of intermediary created by Title III, while broker-dealers have been established market makers for many decades. A broker-dealer can be an individual or a company.
Broker-dealer platforms are authorized to do certain things that funding portals (which are not owned or operated by broker-dealers) are prohibited from doing, including the following:
Broker-dealers are subject to higher standards of due diligence than non-broker-dealer funding portals, with respect to how they select issuers and equity offerings to be listed on their platforms. We describe these standards in our FUNDAMENTALS piece “Portals and Broker-dealers.”
We’re not suggesting that the due diligence conducted by all funding portals is less thorough than due diligence conducted by broker-dealer platforms, or that you can always rely on a broker-dealer’s due diligence efforts. We’re just pointing out that broker-dealers are held to a particularly high standard of due diligence by the government. It is possible that a particular funding portal’s due diligence is superior. In any case, investors should, whether alone or in collaboration with other investors or in consultation with a professional adviser, conduct their own due diligence in certain areas of an offering—which we will cover more deeply in Step 5.
How can you tell funding portals and B-D platforms apart? They may be very similar in appearance, because they use the same kind of website architecture, design, and navigation structure. You may not be able to distinguish between them readily, unless you read the “About Us” page and/or the fine print in the footer on the home page. If you are unable to determine whether a site is operating as a broker-dealer, you can (1) contact the platform’s staff and ask about their broker-dealer status or (2) visit FINRA’s BrokerCheck page (http://www.finra.org/Investors/ToolsCalculators/BrokerCheck/) and conduct a search to see if the platform is registered as a broker-dealer or merely as a portal.
Both funding portals and B-D platforms may use objective and subjective criteria for accepting and rejecting issuers that apply to their portals. Objective criteria might include, for example, industry, geographic location, quantifiable performance metrics (such as revenue or key ratios), product testing results, patents issued, and market data). Subjective criteria would include the founder’s management style, credibility of claims regarding competitive advantages, soundness of business strategies, independence of one or more board members, and so forth.
If the platform you are researching does not readily disclose its selection criteria, or describe the selection process they use before they approve an issuer’s application to list an offering., then ask the platform’s principals to describe them for you.
Some portals use third-party services such as CrowdCheck, a Virginia-based due diligence and compliance service provider, to perform due diligence and/or conduct background checks on the owners and officers of issuers. If the platform claims to conduct its own due diligence in-house, make sure the principals have relevant experience in the securities or investment banking industry so that their due diligence is effective. Keep in mind that you (along with the crowd) may still need to conduct your own due diligence before you invest, even if the platform is a broker-dealer. Do not presume that due diligence performed by the intermediary supports your personal objectives and risk tolerance. We provide guidance on due diligence in Step 5.
Equity crowdfunding portals and B-D platforms may be independent enterprises or funding arms of larger enterprises. The latter includes portals owned by municipalities, chambers of commerce, “main street coalitions,” and civic organizations that want to inject capital into businesses in their areas, and universities that want to fund entrepreneurs who spin out of the academic environment.
Whether they are for-profit or not, equity crowdfunding portals and platforms may earn revenue in the following ways:
On most crowdfunding sites, investors do not pay registration fees. The only charges they might have to pay, aside from their actual investments, are transaction fees to third-party payment services such as PayPal, which can range from 1 to 3 percent.
Title III of the JOBS Act, and the SEC rules implementing the act (issued on October 30, 2015), establish the following additional requirements for equity crowdfunding intermediaries:
Title III mandates that intermediaries provide content to educate investors on the risks of investing in private securities and then survey their registered investors to ascertain that they understand those risks before they can invest on the site. This is the first time in history that such a mandate has been issued, and the SEC has yet to clarify how this educational system will work.
It is important that, before you become a registered investor on an equity crowdfunding site and enter your personal information, you should be sure the site is registered with FINRA as follows:
Before you register as an investor, look in the footer (bottom of the home page), the “About Us” page, and the contact page, and make a note of the full corporate name under which the site does business, along with the names of its principals. If that information is not readily available, that’s probably a red flag. When you do find that information, check out the site by conducting an Internet search, looking for independent reviews or favorable mentions in the media. Another way to tell if a site is reputable is if you see at least two or three offerings that have gained traction—meaning they have reached their funding goals or attracted substantial commitments from investors. If a site is too new to have attracted much in the way of commitments, check out the principals’ backgrounds and make sure at least one of them has experience in the securities or investment banking industry—then perform an Internet search to make sure their reputations are not questionable.
As an investor, you should become familiar with an equity crowdfunding site’s application process for issuers. On most sites, registered members can see the application that issuers must complete if they want to list their offerings. The application will give insight into the intermediary’s screening process. See the sidebar in this chapter for an example of a comprehensive application.
Before an issuer’s application is accepted, an equity crowdfunding site must conduct background checks on the issuer’s team: officers, directors, 20 percent equity holders, and “participants” in the offering. If any one of these team members is a “bad actor,” the offering is disqualified. The issuer may reapply after removing any bad actors from the team.
In the case of EarlyShares, for example, background checks are farmed out to CrowdCheck, the Virginia-based compliance and due diligence service. On behalf of EarlyShares, CrowdCheck also reviews the applicant’s records to confirm that its board of directors authorized the offering of shares, its articles of incorporation (or operating agreement in the case of an LLC) are on file with the state, its capitalization table is accurate, it is not involved in disruptive litigation, its intellectual property is registered as claimed, and other key compliance issues. The issuer pays CrowdCheck’s fee directly for this service.
“Regulatory Oversight of Funding Portals,” published by Financial Industry Regulatory Authority (FINRA)
Funding Portal Rules by FINRA (January 29, 2016)
Investment Crowdfunding Platform Directory, published by CrowdExpert.com
David M. Freedman has worked as a financial and legal journalist since 1978. He has served on the editorial staffs of business, trade and professional journals, most recently as senior editor of The Value Examiner (National Association of Certified Valuators and Analysts). He is coauthor of Equity Crowdfunding for Investors, published in June 2015 by…
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