'If you believe that, I've got some swamp land in Florida I'd love to sell you." That round about way of calling someone gullible actually has a pretty nefarious history. For decades, unscrupulous hucksters sold Florida swamp land, Brooklyn Bridges and timeshares on the moon to unwitting buyers. The government stepped in and created rules to help protect investors from being ripped off. That was tough to accomplish on a deal by deal basis, so the protection was built around the investor - the assumption being that if you were worth a good amount of money, you probably knew what you were doing. Thus the concept of being accredited was born. In the last few years, that protection has started to do more harm than good. The internet has made buyers savvier and startups desire access to the investment dollars held by the masses. The SEC has listened and has developed new regulations that open investing up to all. In this episode, Dave walks us through these revolutionary changes.
Dave, the first time we met, and we were talking a lot. We met a long time ago, actually. But, the time we started talking about SeedFunders, I have to admit, I felt a little bit judged, because you asked me if I was accredited. And, you kind of looked me up and down and said, “Are you accredited Sir?” And I was a little insecure about that. But since then I’ve come to understand that it’s just a governmental thing. It’s a governmental label they have. They use it to try to protect people from making bad investments. And we’ve talked a lot about accredited investors and the Jobs Act. And you mentioned that part of the Jobs Act allows non-accredited investors to invest in startups. I think it’s worth going into a little bit of detail on that today.
That’d be great. It’s a good timing. Actually, as you know, I live in a condo in St. Pete. And recently, a young man on staff there. Let’s call him Kody, because well, that’s his name. Kody approached me with the same question. He had basically actually told my wife, Kathleen, that he was listening to our podcasts, and was interested in startups. I met with him in the clubhouse there to answer his questions. I thought he, like so many young people, was going to say he wanted to start a company. But to my surprise, he said he wanted to invest in startups. He said, he understood that broadening your investment at three to 5% of your investable income into higher risk startups was a good strategy. So, our podcasts are working.
That’s amazing. Congrats, Kody. Let’s talk a little bit about it. And so, let’s hit some definitions. What’s an accredited investor?
Well, I get that question all the time. And most people ask, “How do I become an accredited investor?” Well, it’s not something you become or register for somewhere or anything like that. Basically, the SEC has defined accredited investors. Someone that’s worth a $1 million or more without the value of their current residence, or makes $200,000 per year for the past two years or $300,000 joint spouse. So that’s it, you either are or you’re not. You don’t register as accredited investor, you don’t get approved as an accredited investor.
Got it. And we did a whole podcast on the JOBS Act. And I’m assuming that Kody and all of our listeners have heard it at least three or four times. But just in case, let’s summarize a few of the main points.
Sure. There are three main parts of the JOBS Act called really the Jumpstart Our Business Startups or JOBS Act. There’s title two, title three and title four. Now title two, implemented what’s called reg D 506(c). This allows startups to do what’s called general solicitation, to raise capital. Prior to, this startup could not go to anybody that they didn’t know, they had to have a pay network or people that they knew who were investors, they couldn’t just generally advertise. So, with title two, or reg D 506(c) basically, these companies can now go out and advertise, “We’re looking for investors,” on a billboard, on Facebook, on anywhere. They can advertise, they’re looking for investors. But that comes basically with the accredited investors only. So, before they can invest, before these people that learn about it through the general solicitation can invest, they have to determine if they are accredited investors. So really, this part of the JOBS Act, title two or reg D 506(c) is not applicable to today’s podcast, because it’s for accredited investors only.
So, then I’m assuming three and four are applicable.
Yes, both title three and title four, allow non-accredited investors, or as I call them, investors who are not yet accredited to invest in startups. Title three, which resulted in what’s called reg CF, often called regulation crowdfunding or retail crowdfunding, and title four resulted in reg A+. And I mean reg A, not like reggae music, like the festival we just had here this past weekend. But Regulation A, so it’s Regulation A+ resulted from title four of the JOBS Act. Both reg CF and reg A+ allow those who are not yet accredited to invest in startups. And that Joe is revolutionary. That has not been allowed in the US in almost 100 years.
That’s amazing. So how does someone who is not yet accredited invest in reg CF or reg A+?
Well, the SEC created a new entity for this, called a funding portal. A funding portal is approved and regulated by the SEC, and a member of FINRA. So, anyone who wants to invest through these regs must go through the funding portal or a broker dealer. Note that broker dealers can also offer investments through reg CF or reg A+. But most broker dealers use other regulations to raise capital like reg D, and not really the crowdfunding regs of reg CF or reg A+.
I see. So, there a lot of these funding portals on the internet.
Well, the reg CF was approved in May of 2016. So, by February 2018, there were 21 funding portals licensed by the SEC. Now there are 65. Actually, this has plateaued and there haven’t been many more registered in 2021. So, pretty much right now we’re at 65 funding portals.
Wow, so that means we have our next 65 episodes sorted.
No, not really. We can’t talk about all of them. Most of them are small. They’re very specifically targeted to some, one industry. They’re not really general. So, but we can discuss, I think limit our discussion here to what I consider the top three. And these are the top three ranked by, in most places as the three who have done the most deals or raised the most capital or things like that. And those would be StartEngine, Wefunder and SeedInvest.
Got it. So, what’s the main difference with these three?
First of all, SeedInvest is actually a broker dealer. They are not a funding portal. They are a broker dealer, and they do offer reg CF crowdfunding. And in fact, they claim to be the first to offer reg CF crowdfunding. But it really doesn’t make that much difference to the investor on which one of those three, all three are reputable. They’re all doing deals. They’re all established. They’re all highly regulated by the SEC. There’s no restriction on opening an account at any of the three, other than being 18 years or older and a US citizen. So, any not yet accredited investors should look at all three and decide how to proceed. But my favorite is StartEngine.
Interesting. Why is that?
Well, one of the biggest issues in investing, in these early companies is liquidity. Unlike the stock market, there has not been a mechanism to easily sell your securities to someone else, ever. You typically have to wait for a merger or acquisition or even an IPO. For example, Wefunder states on its site, “It’s the safest to assume you cannot sell your… It’s safest assume you cannot resell your investment to any other investor, because there is not yet a liquid secondary market for private companies.” Similarly, SeedInvest does not have a secondary trading market. Although, in July 2019, FINRA did approve what’s called an alternative trading system – ATS to facilitate secondary trading of startup investments for SeedInvest.
And so, where to start and to stand on a secondary market trading system?
Well, they’ve already launched. They’ve launched StartEngine secondary. Their CEO, Howard Marks says it took them three and a half years to get here to where they are today. It’s one of the first, if not the only marketplace in the US, where the general public can trade shares and startups that have raised capital via reg CF or reg A+. Joe, this is revolutionary. There are some restrictions on trading. For example, although reg A+ allows people to list immediately after closing the offer, the entrepreneur can list a company meeting after closing. Reg CF does require one year before it can list on the market. But the marketplace is live and operating. They have four companies listed. The first two were on August the 11th, one the following week and the other in September. So, this is brand new. I did create a brokerage account with them. So, I could check it out and see what happens there. And I’ll probably make the first investment this week and follow up and see how it does.
That’s great, and do you think that non-StartEngine companies will be on there too?
That’s their plan. Eventually, they want to be a marketplace for all reg CF and reg A+ offerings no matter where the issuer received its initial funding. They also plan to eventually allow prior investors and these are those who invested before the company raised capital through reg CF or reg A+. They will allow them to trade on their shares on StartEngine secondary. This would be friends and family who invested early, early Angel investors, people who invested before the company actually raised capital through crowdfunding. That would really be the true democratization of capital where anyone could buy and sell equity in any company without ever having an IPO or being listed on a public market. As I said, this is truly revolutionary. Startup investors will no longer have to wait years or for a return or investment through an acquisition, a merger or an IPO. It makes startup investing much more liquid than ever before.
That’s incredible. So, with all this opportunity, and all this great information on the SeedFunders podcasts, how’s Kody doing?
Well, I talked to him this morning. And he’s already made a couple of investments. So, as we said, he indicates he understands they’re long term investments. So, there won’t be a quick return. And three to 5% of investable income should be the max that you would invest in these high-risk investments. But just the fact that a young person is investing through platforms like StartEngine shows how far we’ve come in the past few years toward the true democratization of capital.