The number of options for investors is growing. You are [select one]: (a) excited but confused; (b) just confused
Most Americans, and their financial advisers, either (a) don’t know what crowdfunding is or (b) still think crowdfunding is narrowly confined to Kickstarter and other rewards-based platforms. In polite company, the term “securities crowdfunding” or “investment crowdfunding” typically evokes bewilderment, derision, or fear of fraud, oh my.
When the Jumpstart Our Business Startups (JOBS) Act of 2012 was enacted, we figured that by 2015 everyone would at least know what equity crowdfunding is; and we hoped that tens of millions of average Americans would be investing in startups via equity crowdfunding portals. Wrong.
Title II of the JOBS Act, which became effective in 2013, lifted the ban on general solicitation for private securities offerings under the Rule 506(c) exemption of Regulation D. But 506(c) offerings are open only to accredited investors—perhaps 8 or 9 million Americans. So most people have not been invited to the ultra-exclusive equity crowdfunding country club.
Title III of the JOBS Act will let non-accredited investors participate in private securities offerings, but this exemption (also called Regulation CF) has not yet become effective. Title III was supposed to usher in a glorious democratization of the private capital markets, and propel masses of new angel investors to fund the innovative startups and growing small companies that will revitalize the U.S. economy and create innumerable (lower-case) jobs.
Title IV of the act, which just became effective in June 2015, does allow non-accredited investors to invest in “Regulation A+ offerings,” some of which will be made via crowdfunding platforms. But the Title IV exemption is structured primarily for growth- and later-stage companies that want to file “mini-IPOs,” not necessarily for the more exciting seed-stage startups that offer the possibility of spectacular returns. And the general public has not caught on yet to Reg A+. (Do you know anyone outside of the securities industry who has heard of it?)
Another form of equity crowdfunding is the intrastate securities exemption, where issuers with headquarters in a particular state may sell securities to all investors (non-accredited as well as accredited) who live in that state. At this moment, at least 17 states have such exemptions in place, and at least one more is waiting for the governor’s signature. Some of these exemptions are variations of Title III of the JOBS Act, in terms of the dollar limits on raises and investments by non-accredited investors. Intrastate equity crowdfunding is gearing up s-l-o-w-l-y.
Securities crowdfunding also includes peer-to-peer lending (P2P), more recently known as marketplace lending because true peers (individuals) are being overwhelmed by institutional lenders. Debt-based crowdfunding is a very hot sector of the securities markets in the USA and some other countries.
So now we have three kinds of active equity crowdfunding: Regulation D, Regulation A+, and intrastate. No clue when or if the SEC will issue final rules under Title III (Regulation CF). It is possible that Congress will revise Title III before the SEC touches it.
Billions Invested through Regulation D platforms
Issuers have raised billions of dollars through Reg D offering platforms since they launched in 2011 in the United States. These early equity offerings used the Rule 506 exemption under Reg D. That was before the JOBS Act.
What Title II of the JOBS Act did was prompt the SEC to split Rule 506 into parts:
- Rule 506(b) is the “traditional” part, also known as the “quiet deal,” because it retains the ban on general solicitation. For off-platform offerings it permits up to 35 non-accredited investors to participate in each deal. This is where many high-tech startups tend to congregate.
- Rule 506(c) is the “new” part, because it lifts the ban on general solicitation. But only accredited investors may participate, on- or off-platform. This is where consumer product and retail companies tend to congregate.
You might see 506(b) offerings, 506(c) offerings, and Reg A+ offerings all listed on the same equity crowdfunding platforms. But the tendency among successful platforms these days is to specialize in one kind of exemption or another. So, for example, you will see some tech-oriented crowdfunding platforms, such as MicroVentures, with only 506(b) deals.
You will also find platforms that focus on particular industries, such as real estate—which is the hottest sector of securities crowdfunding after P2P. EarlyShares, for example, lists real estate deals using 506(b) and 506(c), but primarily the latter; and is considering Reg A+ deals.
Accredited Investors Predominate
Because Reg A+ is brand-new and intrastate crowdfunding is slow to emerge, the equity crowdfunding world is still occupied mainly by accredited investors under Reg D. This might be comforting to some regulators and investor protection groups, and maybe to some accredited investors who don’t want the world to change.
The world will change. Title III is not dead, though it seems to be hibernating. More states will enact or promulgate intrastate exemptions that welcome non-accredited investors (with investment limits based on their net worth or income). Some of the exclusive bastions of private securities will be blown wide open, and small, inexperienced angel investors will flood in, wildly funding all manner of startups. The private capital markets will shudder. This is good.
Continue with the next article in this series, “Emerging Secondary Market for Crowdfunded Securities,”
or read the previous article in this series, “Who Should Invest in Seed Stage Companies Under Reg A?”
– David M. Freedman, a financial and legal journalist since 1978, writes a weekly column on crowdfunding for Accredited Investor Markets. He is a coauthor of Equity Crowdfunding for Investors, published by Wiley & Sons.