Following the SEC's approval of rules that address Title III of the Jumpstart Our Business Startups (JOBS) Act, some advisors may find themselves vetting crowdfunding investment opportunities for their more risk-tolerant clients. What exactly should they be looking for?
The Securities and Exchange Commission adopted final rules on Oct. 30 to allow companies to offer and sell securities through crowdfunding.
"There is a great deal of enthusiasm in the marketplace for crowdfunding, and I believe these rules and proposed amendments provide smaller companies with innovative ways to raise capital and give investors the protections they need," SEC Chair Mary Jo White said in a statement announcing the decision to permit crowdfunding.
The rules allow companies to raise a maximum of $1 million through crowdfunding in a 12-month period. Some companies are excluded from using crowdfunding to raise capital, including non-U.S. companies and Exchange Act reporting companies, among others.
Individual investors with an annual income or net worth less than $100,000 may invest a total of $2,000 across all their crowdfunding ventures, or 5% of the lesser of their annual income or net worth. The limit for individual investors with more than $100,000 is 10% of the lesser of their annual income or net worth.
Furthermore, during the 12-month period, the aggregate amount of securities sold to an investor through all crowdfunding offerings can't go over $100,000.
Philip Racusin, CEO of EnergyFunders, a crowdfunding platform that focuses on oil and gas opportunities, says there are three things advisors should keep in mind as they evaluate a potential deal for their clients.
"For investment advisors, this is opening a new asset class," Racusin told ThinkAdvisor. "Where the investment advisor can really add value is filtering deals down to the ones that they feel are legitimately good deals, have good fundamentals, have lots of information that will allow the investment advisor to evaluate the terms of the deal and understand the risk factors involved so they can present it to their clients."
He said advisors and their clients should approach crowdfunding opportunities with an understanding that they have a "higher risk-reward profile, so they should balance their portfolio accordingly." He suggested: "They might put 5% of their portfolio in it, or maybe 10% depending on their risk tolerance. They should probably cap it at 10%."
The most important factor in evaluating a crowdfunding opportunity is transparency: Are the terms of the deal clear and easily understood?
"If they're shrouded in mystery then stay away," Racusin warned. "You have to understand exactly what you're investing in and how you will make your money back, how you will make your return, why this is worth it to the originator to seek investment. There needs to be a clear path to that [information]."
The second factor is the reputation of the issuer, according to Racusin. As the new crowdfunding rules open up new ways for firms to raise capital, many opportunities may be with companies that don't have a long track record to study.
"It may be the first time they have started such a business, or maybe this is a new type of opportunity for them, but they should have translatable experience, and they should have a clean background," Racusin said. He suggested advisors approach researching the investment originator "probably the same way that a city does when they're background checking people and giving them licenses."
