Much like Reward Crowdfunding, Equity Crowdfunding or “Crowd Investing” is a capital raising mechanism that enables broad groups of investors to fund startup companies and small businesses, but instead of receiving a “reward”, investors that give money to a business receive ownership of a small piece of that business (shares). The idea is that if the business succeeds, then its value goes up, as well as the value of the shares in that business. Conversely, if the business does not do well, the value of the shares will go down.
There are several Equity Crowdfunding platforms currently being used, all of which allow general solicitation under certain circumstances, but each with its own nuances relative to who, what, how and where. It’s imperative that both investors and issuers fully understand the rules and definitions of each, which are summarized below. Visit the SEC Website for the official rules and entry forms.
With the passing of Title III of the JOBS Act on May 16, 2016, for the first time, non-accredited investors (not rich) are able to buy equity in an early-stage company and potentially reap a significant monetary return on investment. However, issuing companies are limited to raising a maximum amount of $1 million, and investors have restrictions on how much they can invest based on their income and net worth, and then there’s that portal thing. Wince event #2, the SEC Final Rules document for Regulation CF is 685 pages long. Work in progress.
UPDATE: The SEC has announced it has adopted amendments to increase the amount of money companies may raise under Reg CF or retail crowdfunding. Initially, Reg CF capped the amount allowable for issuers to $1 million. The SEC has adjusted the amount for inflation and increased the funding limit to $1.07 million. The threshold for investor limits was correspondingly increased in a similar fashion. The Commission approved the new thresholds March 31, 2017.
Effective January 20, 2017 the amount of securities that are allowed to be sold under 504 was raised from $1 million to $5 million. There are provisions for general solicitation and advertising, shares are restricted, non-accredited investors are allowed as long as you don’t generally solicit/advertise and you don’t have to utilize a portal. State regulations come into play as well. If your business is operating in only one state and your investors are located in that state, check out Rule 147 below.
Title II of the JOBS Act and a crowd favorite. Unlike its predecessor, 506(b), general solicitation and advertising is allowed and there doesn’t have to be a pre-existing relationship between company and investor. However, rather than accepting self-verification from the investor that they are accredited, the burden is firmly on the company to obtain written proof that they are. Locating and contacting potential investors for a 506(c) has become efficient with the accessibility of on-line databases filled with institutional investors, family offices, rich people and venture capital firms. No limit on how much you can raise. Voted “Most Likely to Succeed” until Reg. CF gets its act together.
These funding platforms require some heavy lifting, a healthy checkbook, and are suitable for more mature startups. Through November 2016, that average cost of a Tier 1 offering was $120,000, and for a Tier II, $920,000. There are several differences between Tier I and Tier II, for example, T1 allows investments up to $20 million while T2 has a limit of $50 million. Both require an extensive disclosure document and are subject to SEC review. General advertising and soliciting is allowed, non- accredited investors welcome, shares are unrestricted and freely transferable, and issuers can even “test the waters” to see how much interest is in the offering. These offerings are more suitable to companies having a large pool of end-users or followers.
The SEC updated Rule 147 and produced Rule 147A, which is effective on April 17, 2017. All of the requirements of Rule 147 remain intact, such as the issuer still has to have “principal place of business” in the state of the offering, investors are required to confirm their state residency in writing, shares have a restriction period, among others. However — and this matters — 147A allows issuers to make offers of securities across state lines, including via the internet, so long as actual sales are limited to residents of the state of the issuers principal place of business. Most states allow for a $2 million maximum raise, but issuers will need to check with their specific state.
For more information on these Equity Crowdfunding rules and exemptions, or to discuss how we may assist with your Equity Crowdfunding project, please Contact Us.