17 Apr Tips for Investing in Title III Crowdfunded Offerings

by Justin Ritter

Since its inception in May 2016, Title III crowdfunding (“Title III”) has offered a new way for investors of both extraordinary and ordinary means to invest in the next great startup.  Despite this new method of investing, finding and investing in high-quality Title III offerings may prove difficult to accomplish.  Consider the tips below before investing in a Title III offering.

Before investing, the investor should first generally understand the mechanics of Title III.  With a view from 20,000 feet, Title III crowdfunding allows issuers to offer investment opportunities to practically anyone in the world, without “accredited investor” or similar limitations.  This type of crowdfunding allows the issuer to raise just north of $1mm per 12 months.  The issuer may offer equity, debt or some combination in-between.  Perhaps most innovative, Title III crowdfunding allows issuers to offer their investment opportunities online via brokers or, more commonly, crowdfunding portals. 

By using the brokers/portals, practically any founder can attempt to raise capital via Title III, with as much or as little vetting as the brokers/portals require.  Due to the relative low barrier to entry, the prudent investor should spend ample time vetting the issuers themselves.  The investor’s vetting should at a minimum examine the following:

• Ask: Why Crowdfunding?  When reading a Title III offering via Form C and the related materials, the investor should ask: why is this issuer using Title III?  It should be much easier for high-quality companies to raise money from “friends and family”, Angels or VCs, than compared to Title III.  Moreover, Angels and VCs tend to provide additional benefits that Title III offerings are unlikely to provide, such as relatively easy opportunities for future capital raises, connections to potential acquirers, and general mentorship/guidance.  That said, again, why would a high-quality issuer use Title III?  Two answers come to mind: (i) the issuer believes having hundreds to thousands of investors creates owners that also act as marketers/promoters, and this result will propel the progress of the company and/or (ii) the issuer believes that raising money via Title III will give the issuer better economic and control terms than compared to raising money via Angels, VCs and perhaps to a lesser extent “friends and family”.  The investor should raise a red flag should they believe the issuer is not gaining a value-add by utilizing Title III.  This red flag may be a sign that the issuer could not raise the desired capital by other means.

• Prospect for Acquisition.  Think about the likelihood of an acquisition of the issuer.  If the investor believes acquisition will be unlikely, then they should check to see dividend/distribution likelihood.  If the board is left with the unfettered discretion to make a dividend/distribution, then don’t expect dividends/distributions in the near term.  When deciding the likelihood of acquisition, think about the companies that may acquire the issuer.  With a little Googling, the investor may find actual evidence of similar acquisitions.  This evidence can help gauge the potential exit value of the investment.

• Background of Management Team and Related Equity.  Is this issuer comprised of mostly first-time founders/entrepreneurs?  If so, then this may be a red flag.  Also, what rights do the founders/entrepreneurs have in the issuer?  For example, do any of the founders/entrepreneurs have unexercised stock warrants in an unreasonably high number of shares set at a low price?  This may also be a red flag.  Also, do the founders/entrepreneurs have an unreasonably large stake in the issuer at the time of the offering?  The answers to these questions may be more based on art than science.  But simply put: do not invest if the offering does not pass the smell test.

Despite the current quality issue of Title III offerings, I do believe that, with a few legislative/regulatory tweaks, more high-quality issuers will enter the Title III space.  Said tweaks need to make Title III crowdfunding more appealing to issuers.  Raising the offering cap per 12 months from just over $1mm to somewhere between $3mm-5mm would help.  Until there are more high-quality issuers to choose from, the investor needs to conduct proper due diligence before making a Title III contribution.  Otherwise, such contribution will be more of a gamble than an investment.

Justin Ritter is an attorney with McCallum & Kudravetz, P.C. in Charlottesville, VA who represents and supports members of the local entrepreneurial ecosystem.