Regulation crowdfunding

What Is Regulation Crowdfunding?

Regulation Crowdfunding, often referred to as Reg CF, is a financing method that allows private companies to raise capital by offering and selling securities to a large number of investors, including non-accredited investors. This falls under the broader category of Securities Regulation, designed to facilitate capital formation for small businesses while providing investor protections. Adopted by the Securities and Exchange Commission (SEC) in 2015, Regulation Crowdfunding enables companies to engage in equity financing or debt financing through SEC-registered online intermediaries, such as funding portals or broker-dealers.

History and Origin

The origins of Regulation Crowdfunding lie in the Jumpstart Our Business Startups (JOBS Act), signed into law by President Barack Obama on April 5, 2012. The JOBS Act aimed to encourage funding of small businesses by easing various federal securities regulations. Specifically, Title III of the JOBS Act, also known as the CROWDFUND Act, mandated the SEC to create a framework for securities-based crowdfunding, a financing method not previously permitted for general solicitation to the public²¹.

After the JOBS Act was passed, the SEC adopted final rules for Title III equity crowdfunding on October 30, 2015, with these rules becoming effective on May 16, 2016. Initially, companies could raise up to $1 million over a 12-month period. To further enhance capital-raising capabilities for startups, the SEC increased this limit to $5 million in March 2021¹⁹, ²⁰. This regulatory evolution has significantly broadened the pool of potential investors for early-stage companies, moving beyond traditional sources like venture capital firms or angel investors¹⁸.

Key Takeaways

• Regulation Crowdfunding allows companies to raise up to $5 million in a 12-month period from both accredited and non-accredited investors.
• All offerings under Reg CF must be conducted through SEC-registered online intermediaries, such as funding portals or broker-dealers.
• Companies must comply with specific disclosure requirements by filing Form C with the SEC and providing it to investors.
• Non-accredited investors face limits on how much they can invest in Reg CF offerings over a 12-month period, based on their annual income and net worth.
• Investments made through Regulation Crowdfunding are typically illiquid and carry high risks, as they are often in speculative early-stage ventures.

Interpreting Regulation Crowdfunding

Regulation Crowdfunding is interpreted as a tool for financial inclusion, democratizing access to capital for businesses and broadening investment opportunities for the public. For an issuer, it represents an alternative path to traditional fundraising, enabling them to tap into a wider community of supporters, including customers and local advocates. For an investor, it means the ability to support innovative startups and potentially participate in their growth from an early stage, which was historically reserved for wealthy individuals or institutional investors.

The regulations, particularly the investment limits for non-accredited investors, are designed to balance capital formation with investor protection. The requirement for intermediaries and comprehensive disclosures aims to ensure transparency, allowing investors to make informed decisions about the high-risk nature of these investments¹⁷.

Hypothetical Example

Imagine "GreenTech Innovations," a startup developing a new solar panel technology, needs to raise $1 million to scale production. Instead of seeking funding exclusively from venture capital firms, GreenTech decides to use Regulation Crowdfunding.

1. Preparation: GreenTech prepares its financial statements, a business plan, and a detailed description of the offering, including risk factors.
2. Intermediary Selection: They choose "FundRise Online," an SEC-registered funding portal, to host their offering.
3. Filing: GreenTech files Form C with the SEC, making their disclosures public.
4. Campaign Launch: FundRise Online lists GreenTech's offering on its platform, allowing individuals to browse the opportunity.
5. Investor Participation: Everyday individuals, including GreenTech's passionate customers, invest as little as $100 each. A non-accredited investor with an annual income of $60,000 might be limited to investing a few thousand dollars across all crowdfunding offerings in a 12-month period.
6. Capital Raised: Over several weeks, GreenTech successfully raises its $1 million from thousands of small investors, enabling them to move forward with production.

This scenario demonstrates how Regulation Crowdfunding allows a company to access capital directly from a broad base of supporters, circumventing some of the traditional barriers to funding for nascent companies.

Practical Applications

Regulation Crowdfunding is primarily used by startups, early-stage companies, and small businesses seeking capital for growth, product development, or expansion. It provides a viable alternative to traditional bank loans or raising capital from a limited pool of sophisticated investors. Companies in various sectors, from technology to consumer goods, utilize Reg CF to:

• Fund New Ventures: Entrepreneurs can launch their businesses by raising initial capital from the public.
• Develop New Products: Existing small businesses can fund the research, development, and marketing of new offerings.
• Expand Operations: Companies can secure capital for scaling production, opening new locations, or entering new markets.
• Community-Based Projects: Local businesses or social enterprises can raise funds from their direct community members who believe in their mission.

All Regulation Crowdfunding transactions must occur through an SEC-registered crowdfunding intermediary, such as a broker-dealer or a funding portal¹⁶. These intermediaries are regulated by organizations like the Financial Industry Regulatory Authority (FINRA), which lists the funding portals it regulates¹⁵. The official guidance from the U.S. Securities and Exchange Commission further details the requirements and processes for both companies and investors involved in these offerings¹⁴.

Limitations and Criticisms

While Regulation Crowdfunding has democratized access to capital, it comes with several limitations and criticisms:

• Fundraising Cap: The $5 million annual limit, while increased, may still be insufficient for businesses with substantial capital needs, potentially requiring multiple funding rounds or additional financing sources¹³.
• Regulatory Burden: Despite being simpler than a traditional public offering, Reg CF still imposes significant disclosure requirements and ongoing reporting obligations on issuers, which can be resource-intensive, requiring legal and accounting expertise¹².
• Investor Risk: Investments in early-stage companies are inherently speculative and carry high risks, including the potential for total loss of investment. Many startups fail, and there is often no secondary market for the securities, making them illiquid¹¹. Investors must perform their own due diligence before investing.
• Valuation Challenges: Valuing early-stage companies is difficult, and investors may not have access to sufficient information or expertise to accurately assess the fair value of the securities offered.
• Investor Management Complexity: Managing a large number of small investors can increase administrative responsibilities and potential complexities in shareholder relations for the issuing company¹⁰.
• Regulatory Compliance: Navigating the regulatory landscape for crowdfunding can be challenging for startups, requiring strict compliance with federal and state securities laws to ensure investor protection and legal adherence⁹. Penalties for non-compliance can include fines, legal injunctions, and reputational damage⁸.

Regulation Crowdfunding vs. Private Placement

Regulation Crowdfunding and private placement (such as offerings under Regulation D) are both exemptions from the extensive registration requirements of the Securities Act of 1933, but they differ significantly in their target investor base and offering characteristics.

The primary distinction lies in who can invest and the level of regulatory scrutiny involved. Regulation Crowdfunding broadens the investor pool to include individuals who do not meet the definition of an accredited investor, making it a more accessible public fundraising method, albeit with lower offering limits and specific intermediary requirements. Private placements under Regulation D, conversely, often target a more sophisticated investor base, allowing for larger raises with fewer ongoing public disclosure obligations.

FAQs

Can anyone invest in Regulation Crowdfunding offerings?

Yes, both accredited and non-accredited investors can participate in Regulation Crowdfunding offerings. However, non-accredited investors face limits on how much they can invest over a 12-month period, based on their income and net worth⁷.

What is the maximum amount a company can raise through Regulation Crowdfunding?

A company can raise a maximum aggregate amount of $5 million through Regulation Crowdfunding offerings within a 12-month period⁵, ⁶. This limit was increased in March 2021.

Are investments made through Regulation Crowdfunding liquid?

Generally, investments made through Regulation Crowdfunding are highly illiquid. There is typically no public trading market for these securities, and they are usually restricted from resale for a period of one year after purchase⁴.

What kind of information do companies need to disclose for a Reg CF offering?

Companies conducting a Regulation Crowdfunding offering must file a Form C with the SEC. This form includes details about the business, its officers and directors, its financial statements, the terms of the offering, and key risks associated with the investment², ³.

Do I need a broker to invest in Regulation Crowdfunding?

You cannot invest directly with a company using Regulation Crowdfunding. All transactions must occur through an SEC-registered intermediary, which can be either a broker-dealer or a funding portal¹. These platforms are responsible for facilitating the offering and providing educational materials to investors.