Restrictions on Transferring Securities From Crowdfunding: 5 Crucial Things to Know

Understanding the complex arena of crowdfunding comes with its own challenges, more so when it comes to the transfer of securities purchased through this medium. From restrictions to rules and exceptions, it’s a landscape filled with various aspects that need careful navigation.

In this article, we aim to break down the key points and provide insights into restrictions on transferring securities procured via crowdfunding, unraveling the concept one step at a time.

5 Crucial things to know about transferring crowdfunding securities

1. The one-year holding rule isn’t set in stone

While the one-year holding period for crowdfunding securities is a standard rule of thumb, it’s not without its exceptions. This period is designed to protect investors and the market from the rapid trading of potentially volatile securities. However, knowing when and how you can bypass this rule can be highly beneficial.

For example, did you know that transferring your securities to an accredited investor is one of the exceptions? Accredited investors are deemed to have the experience and the financial stability to handle such transactions without the protections intended for the general public. If you’re considering an early transfer, finding an accredited investor could be a viable strategy.

2. Family transfers are more flexible than you think

Transferring to a family member is not just limited to immediate relatives. The definition of ‘family member’ can extend beyond your spouse and children. It may include in-laws, domestic partners, and even entities like trusts that benefit family members.

What’s seldom mentioned is that you’re also able to transfer to a trust that you control or one that’s been created for the benefit of a family member. This can be a strategic move for estate planning or for consolidating investment holdings within a family. Be sure to consult with a legal advisor to fully understand how you can utilize this exception effectively.

3. Life events can change the rules

Life’s unpredictability sometimes intersects with investment strategies, particularly in the event of death or divorce. In these circumstances, transfers can happen irrespective of the one-year holding period. These provisions are there to make sure securities can be settled as part of estate proceedings or divided accordingly during a divorce.

An often overlooked aspect here is that documentation and timing are critical. To ensure a smooth transfer during such challenging times, you have to keep thorough records and seek advice on how to proceed without additional legal complications.

4. Registered offerings open doors

If your securities become part of an offering registered with the Securities and Exchange Commission (SEC), then the usual restrictions on resale don’t apply. This means you could potentially sell your shares sooner than the one-year mark.

What’s rarely mentioned is that this process can be complex and requires significant preparation and understanding of SEC regulations. It’s not a common situation for individual investors, but if it arises, it’s worth exploring with a qualified financial advisor.

5. The pathway for resale isn’t just for insiders

Section 4(a)(1) of the Securities Act provides a pathway for reselling securities for anyone who isn’t an issuer, underwriter, or dealer. It’s an exemption that’s often utilized but not commonly understood by the investing public.

What’s vital and rarely discussed is that navigating this exemption requires a nuanced understanding of what constitutes being an ‘underwriter’ or ‘dealer.’ Inadvertently falling into these categories can lead to compliance issues. Therefore, taking action based on this exemption should always be done after seeking professional advice to clarify your position and responsibilities.

The landscape of crowdfunding securities

  • Investor eligibility varies: Crowdfunding platforms often have criteria determining who can invest. For instance, some platforms may allow anyone to invest, while others may cater exclusively to accredited investors. Understanding the eligibility requirements is essential because they dictate who can participate in crowdfunding opportunities and the extent of their investment.
  • Platform due diligence: Crowdfunding platforms are not created equal. They differ in their vetting processes for the companies they host. Potential investors have to research each platform’s due diligence procedures. This ensures that the businesses you’re investing in have been thoroughly evaluated for their legitimacy and potential.
  • The role of educational resources: Crowdfunding platforms typically provide educational resources to help investors understand the risks and mechanics of crowdfunding investment. This educational component is important for making informed decisions, especially for novice investors unfamiliar with the nuances of securities.
  • Regulatory caps on investment: There are limits on how much individuals can invest in crowdfunding offerings within a 12-month period, based on their income and net worth. These caps are in place to protect investors from overexposing themselves to risk in what can be a very speculative market.
  • Crowdfunding isn’t just equity: When discussing crowdfunding securities, it’s not only about equity investments; debt securities like bonds or convertible notes can also be part of crowdfunding. Each type of security comes with its own set of risks and benefits that investors should understand before committing funds.
  • Tax implications are a factor: The tax implications of crowdfunding investments can be complex. For example, dividends from equity investments may be taxed differently than interest from debt investments. If an investor sells their securities after the holding period, capital gains tax may apply. It’s wise to consult a tax professional to understand the full tax impact of your investment decisions.
  • Reporting requirements for issuers: Companies that raise funds through crowdfunding are subject to ongoing reporting requirements, which include providing financial statements and updates on the company’s progress. This transparency is crucial for investors to monitor their investments and make future investment decisions.
  • Secondary market limitations: Currently, there’s limited secondary market liquidity for crowdfunding securities, making it difficult to sell or trade them. While this may change as the industry evolves, investors should currently view crowdfunding as more of a long-term investment due to these liquidity constraints.

Unpacking the one-year resale restriction

The one-year resale restriction on crowdfunding securities primarily serves to protect investors and the market from the potential volatility and risk associated with newly issued securities.

It acts as a safeguard, ensuring that investors commit to a minimum holding period, thereby encouraging a focus on long-term growth and stability rather than short-term speculative gains. This period also allows the issuing company time to develop its business without the pressure of market fluctuations caused by the immediate resale of its securities.

While there are several exceptions to this rule that permit certain transfers within that one-year timeframe, the restriction underscores the inherently patient and strategic nature of crowdfunding investments, signaling to potential investors that crowdfunding is not a playground for quick flips but rather a platform for considered and deliberate investment in emerging businesses.

Exceptions to the resale rule

A set of exceptions that give investors options for transferring their securities earlier help to mitigate the one-year resale restriction on crowdfunding securities.

These exceptions include the ability to transfer securities back to the issuer, to accredited investors, to family members—which can encompass not just immediate kin but also trusts for their benefit—and in connection with life-altering events such as death or divorce. If the securities are part of an SEC-registered offering, this too allows for an early transfer.

These exceptions create a more flexible investment landscape within the crowdfunding domain, but they should be navigated with caution and, when necessary, with professional advice to guarantee compliance with securities regulations.

When can you transfer securities back to the issuer?

You can transfer securities back to the issuer at any time, even within the one-year holding period that typically applies to crowdfunding securities. This exception is designed to give investors the flexibility to return their investment to the company from which it originated, should they choose to do so.

This could be for a variety of strategic reasons, such as the company offering to buy back shares or the investor looking to liquidate their position. It’s a pathway that provides an additional layer of liquidity for investors in what is otherwise a relatively illiquid market during the initial holding period. However, the issuer would have to approve any such transaction and it would have to adhere to any terms and conditions that the issuer might set forth.

Defining the ‘accredited investor’ in crowdfunding transfers

An ‘accredited investor’ in the context of crowdfunding transfers is an individual or entity that meets certain qualifications outlined by securities regulators, specifically the SEC.

These qualifications typically include having a net worth exceeding $1 million, excluding the value of one’s primary residence, or having an income exceeding $200,000 annually for an individual (or $300,000 jointly with a spouse) for the last two years with the expectation of the same or higher income in the current year.

Accredited investors are deemed capable of bearing the economic risks of investing due to their financial sophistication and are therefore subject to fewer protections.

Accordingly, they can participate in certain investment opportunities from which non-accredited investors are excluded, such as being able to receive transfers of crowdfunding securities within the one-year restricted period.

Transferring crowdfunding securities to family members is a recognized exception to the one-year resale restriction, providing investors with the flexibility to manage their personal and estate planning needs.

The definition of family members in this context is broader than immediate relatives; it may include parents, in-laws, siblings, and possibly other relatives, depending on the platform or issuer’s policies. Moreover, securities can be transferred to trusts or estates where family members are the beneficiaries. It’s essential for investors to be aware of the specific terms and conditions outlined by the crowdfunded company’s transfer policy, as these can vary and may impose certain limitations or requirements on such transfers.

Understanding these nuances can facilitate smooth transitions of investment assets for purposes like inheritance, gifting, or other family-related financial planning objectives.

Rules and exceptions for death or divorce transfers

  • Immediate transferability: In the event of an investor’s death or divorce, crowdfunding securities can be transferred immediately, without having to observe the typical one-year holding period. This rule is in place to facilitate the orderly settlement of the investor’s estate or the equitable distribution of assets as specified in a divorce settlement.
  • Documentation required: To facilitate such a transfer, legal documentation confirming the death (such as a death certificate) or legal divorce papers must be provided. This is to make sure the transfer is legitimate and is in accordance with the legal proceedings related to the investor’s estate or divorce decree.
  • Potential involvement of executors or legal representatives: During the transfer of securities due to death, an executor or legal representative may become involved to oversee the process as part of managing the deceased’s estate. Similarly, in a divorce, a legal representative may be required to make sure the securities are allocated according to the terms of the divorce settlement.
  • Transfer to beneficiaries or divorcees: Securities can be transferred directly to beneficiaries named by the deceased or to a spouse or former spouse in the case of a divorce. The process may involve transferring the securities to individual beneficiaries or into a trust, depending on the stipulations of the will or divorce settlement.
  • No evasion of other legal obligations: While these exceptions permit transfers as a result of death or divorce, they do not exempt the parties from fulfilling other legal obligations, such as estate taxes or other financial settlements that a court might order in the case of divorce. All parties involved need to understand their rights and obligations under the law when such transfers occur.
  • Potential impact on value: The value of securities at the time of transfer due to death or divorce may have tax implications, including estate taxes or capital gains taxes, which should be considered. In some cases, the basis of the securities may be stepped up to their value at the time of death, potentially affecting capital gains calculations for future sales by beneficiaries.

The role of registered offering in securities transfers

A registered offering plays a significant role in the transfer of crowdfunding securities as it provides a pathway to bypass the standard one-year holding period.

When securities are a part of an offering that has been SEC-registered, they become publicly tradable and are no longer subject to the limitations that typically govern private resale transactions. This registration process involves a comprehensive disclosure of information through filings with the SEC, which then becomes available to the public, thus providing transparency and protecting potential investors.

The registration of an offering is a rigorous process that requires the issuer to meet specific legal and regulatory requirements, including financial reporting and disclosures about the company’s operations, which in turn can instill greater confidence in potential buyers when the securities are transferred.

Understanding the position of accredited investors

Accredited investors hold a privileged position in the realm of crowdfunding security transfers due to their status, which exempts them from certain regulatory constraints that apply to the general public.

They are financially sophisticated and have the capacity to bear investment risk without needing the protection that the one-year resale restriction offers. As such, accredited investors can engage in transactions and receive transfers of securities within this period, enabling greater fluidity and access in the private investment market.

This status not only facilitates a more dynamic investment strategy for the accredited investors themselves but also provides non-accredited investors with additional options for transferring their holdings in a manner that is not generally permissible under SEC regulations for other investor classes.

Author: Alice