Part 1 of this two-part series explains the basics of equity crowdfunding. That article distinguishes equity crowdfunding from other kinds of crowdfunding, such as rewards, donation and debt-based crowdfunding.
The table (below) shows the three variations on equity crowdfunding based on Title II, Title III and Title IV of the JOBS Act of 2012.
|Variations on Equity Crowdfunding in the USA|
|Exemption [Nickname]||JOBS Act||Launched||Investors||Raise Limit||Investment Limit||Typical Stage of Issuer|
|Regulation D, Rule 506(c)[Accredited crowdfunding]||Title II||2013||Accredited only||None||None||Startup, growth|
|Regulation CF [True equity crowdfunding]||Title III||2016||All||$1 mil||Based on income/worth||Seed|
|Regulation A+ [Mini-IPO]||Title IV||2015||All||$50 mil||Based on income/worth||Later|
You may hear Title III of the JOBS Act of 2012, officially called the “crowdfunding exemption,” referred to as “true crowdfunding.” This is because it was the first exemption to explicitly open angel investing up to unlimited numbers of non-accredited investors. The Title IV exemption did that (only later) in the final rules, known as Regulation A+, set by the SEC in summer 2015.
The SEC issued the final rules under Title III, known as Regulation Crowdfunding (or “Reg CF”), in late 2015. Title III offerings finally launched in spring 2016. [Title III amended the Securities Act of 1933 by adding a new paragraph to Section 4(a) of the Act, designated as new Section 4(a)(6).]
This created a profound shift. Now all Americans, not just the wealthy few, could invest in startups and small businesses via the internet. Title III opened a floodgate—one closed since the Securities Act of 1933—for tens of millions of non-accredited investors to participate in the private equity markets.
Title III explicitly referred to “funding portals,” rather than to the then-prevalent industry term “offering platforms.” Title III offerings must be listed exclusively on funding portals or broker-dealer platforms that are registered with the SEC.
Under Title III, the amount of money an investor can annually invest into equity crowdfunding deals depends on the investor’s net worth and/or income, as follows:
Individuals with an annual income and net worth, excluding the value of their primary residence, of less than $100,000 may invest the greater of $2,000 or 5% of their income, or 5% of their net worth.*
Individuals with an income or net worth, excluding the value of their primary residence, of $100,000 or more may invest up to 10% of their income or net worth (whichever is greater). Such individuals may not invest more than $100,000 per year.
Investors may self-certify that they do not exceed their investment limits. In other words, they do not have to submit tax returns or other documentation as proof.
*In any case, anyone can invest at least $2,000 in equity crowdfunding each year.
Partly because the relatively small $1 million limit, Reg CF raises come mainly from seed-stage and very small businesses. Reg A+ raises come mainly from growth- and later-stage private companies.
For non-accredited and inexperienced investors looking to break into angel investing, Reg CF is where the action is. For one thing, they often face very low minimum investment amounts – $100 or less for most. Reg D offerings, by contrast, typically require a commitment of $1,000 to $10,000 or more.
In its first full year (as of late April 2017), more than 100 companies used Reg CF to raise greater than $35 million. In these raises, more than 35,000 investors used roughly a dozen portals. The most active portal was Wefunder, and perhaps the best known portal was Indiegogo’s collaboration with MicroVentures. Those do not count the other 100 (or so) companies that offered securities under Reg CF but failed to fully fund their crowdfunding campaigns.
Very shortly after the launch of Reg CF in April 2016, Stratifund launched a website that aggregates and rates current offerings under both Reg CF and Reg A+. That’s a good place to start for investors who do not feel familiar with the dozen-or-so prominent offering portals and platforms. Stratifund uses an algorithm to rate the offerings – you don’t receive any subjective judgment or, theoretically at least, bias in the ratings.
Before investing through an equity crowdfunding platform or portal, there are a number of questions you ought to ask. These include:
Do you understand the risks of angel investing in general and the risks of equity crowdfunding specifically?
Should you invest individually or through a special purpose vehicle (SPV)? Some Reg D offering platforms (but not Reg CF platforms at this time) establish SPVs to pool investors into a single entity. This allows them to simplify the issuers’ capitalization tables – which often helps them raise later venture capital.
What tax consequences will you face based on your choice of investment vehicle?
How does an equity crowdfunding opportunity fit into your broader portfolio? Investing in startups can provide spectacular returns (commensurate with the high risk) and non-correlated diversification. But experts advise that you should limit alternative investments to 5-10% of your portfolio.
Will you conduct your own due diligence? Or should you collaborate with other investors on crowdfunding portals? Learn about the wisdom & madness of the crowd.
Do you understand the terms of the offering? Deal terms can be complex, although some new securities (such as Simple Agreement for Future Equity, or SAFE) are more understandable than traditional preferred-stock or convertible-debt offerings. Beware, however, of SAFEs with puny discounts.
Read Equity Crowdfunding for Investorsto learn more.
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David M. Freedman has worked as a financial and legal journalist since 1978. He has served on the editorial staffs of business, trade and professional journals, most recently as senior editor of The Value Examiner (National Association of Certified Valuators and Analysts). He is coauthor of Equity Crowdfunding for Investors, published in June 2015 by…
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