“Backers” in rewards-based crowdfunding campaigns expect either tangible or intangible rewards in return for their financial contributions. Tangible rewards may include prototypes or discounted first editions of new products, promotional items such as branded T-shirts and coffee mugs, or front-row seats at film premiers and concerts, for example. Intangible rewards may include production credit in liner notes of CDs and DVDs, or visits to rehearsals or production sets.
The success of rewards-based crowdfunding platforms like Indiegogo (launched in 2008) and Kickstarter (launched in 2009) proved that large numbers of people would happily fund artists, startups, and small enterprises that they believed in, even when the promised reward was modest and/or had not yet been produced. It was only natural that intermediaries in the angel capital world would exploit and adapt the rewards-based crowdfunding platform infrastructure, harnessing the power of website technology, social media, and e-commerce to accomplish the following objectives:
Early equity offering platforms, such as MicroVentures and CircleUp, launched in 2011 and 2012, respectively. They were open to accredited investors only—individuals who earned income of at least $200,000 per year or had a net worth of $1 million (not including the value of their residence).
True equity crowdfunding for all investors, regardless of income or net worth, was authorized by Title III of the Jumpstart Our Business Startups (JOBS) Act of 2012.
Crowdfunding investors receive equity in the companies in which they invest—preferred stock, LLC shares, convertible debt, or similar securities. Equity crowdfunding is regulated by the Securities and Exchange Commission (SEC) and the Financial Regulatory Authority (FINRA).
From the issuer’s point of view, equity offering platforms and crowdfunding portals present a streamlined process compared with the old, “off-platform” angel capital funding model. Off-platform, it typically takes 8 to 12 months for an entrepreneur to find angels who are interested in an offering and negotiate a deal. Today on equity offering platforms it typically takes two to eight weeks from the time an issuer lists its offer to closing a deal with investors, and in some cases less than a week or even a day. Further, equity offering platforms attract strategic investors to deals from across the country, whereas in the past it was frequently a matter of promoting a deal through a network of personal and professional relationships that spanned a metropolitan area or narrow region of the country. These platforms aggregate angel investors in a way that had not been possible before.
It’s not just the ability to aggregate a larger number of potential investors from a wider area that makes funding platforms powerful tools for issuers of equity shares. Another advantage is that these platforms make it cost-effective for issuers to engage with investors who can afford to invest only small amounts. Off-platform offerings often involve face-to-face meetings with many potential investors, individually and occasionally in groups, which is time-consuming and expensive. Funding platforms automate much of that process, typically lowering the minimum investment for angel investors by a factor of 10 or 50.
From the investor’s point of view, instead of making a lot of inquiries via phone calls and e-mails, meeting with broker-dealers, and joining angel investor clubs to find suitable private offerings, it is now possible to find deals by browsing one or more offering platforms (or visiting deal aggregators such as CrowdWatch and others). Smart investors might still make phone calls, attend meetings, and join clubs, but they can complement and accelerate the search online, where there are no travel and entertainment expenses.
In the United States, on the national level, equity offering platforms developed along three tracks: Regulation D, Regulation A+, and Title III (Regulation CF).
When Congress passed the JOBS Act in 2012, a new kind of equity offering platform was born. Title III of the JOBS Act allows all investors to participate, including unlimited numbers of non-accredited investors—“the crowd.” This was a profound shift. Suddenly all Americans, not just the wealthiest 7 percent, could invest in startups over the Internet. In fact, a single Title III equity crowdfunding deal might involve hundreds or thousands of non-accredited investors.
The language of Title III explicitly referred to “crowdfunding portals,” rather than the then-prevalent industry term “offering platforms.”
Over the past few years, first the media and then Reg D intermediaries themselves started referring to Reg D platforms as equity crowdfunding platforms.
Note: The intermediaries that conduct Title III equity crowdfunding include (1) portals that are not registered broker-dealers and (2) platforms operated by broker-dealers. We explain this distinction further here.
To complicate matters a bit further, when Title III portals finally launched in May 2016, some Reg D platforms listed Title III offerings as well, creating hybrid D/III platforms. SeedInvest, for example, features offerings under Reg D, Reg A+, and Title III on the same page.
We want to introduce three other kinds of online securities offerings in which non-accredited investors can participate: Title IV (Regulation A+), intrastate securities exemptions, and P2P.
Title IV of the JOBS Act, which became effective in June 2015, allows non-accredited investors to invest in “Regulation A+ offerings,” some of which will be made via crowdfunding platforms. 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. Experienced angel investors may be tuned in to Reg A+, but the general public has not caught on yet.
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 26 states and the District of Columbia have such exemptions in place. 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.
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.
Because Title III portals have not launched yet, 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 will catch on over the next few years. 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.
There is no lack of statistics about how much capital has been raised, and how those dollar amounts have increased year over year, in the new asset class called securities crowdfunding. The statistics about investor returns have been much less forthcoming, partly because securities crowdfunding is only a few years old, but also because investor returns are not as “transparent” as offerings and sales on funding platforms.
According to Crowdnetic’s Q1 2015 Report, in the first quarter of 2015 alone, the 17 most prominent securities offering platforms in the United States recorded capital commitments totaling about $650 million—a 35 percent increase from the previous quarter. These figures represent the performance of offerings under Regulation D, Rule 506(c), to accredited investors only; they do not include Rule 506(b) offerings, some of which are listed on crowdfunding platforms as well. (The numbers of 506(b) offerings, and the amount of capital raised thereby, are much higher than that of 506(c) offerings. Rule 506(c) allows general solicitation, while Rule 506(b) does not.) Digging a little deeper into the Crowdnetic report:
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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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