New U.S. Crowdfunding Rules Offer High Hopes for Capital Formation

Crowdfunding, or crowdfinancing, is the raising of capital from several people through an online medium (the Internet).  According to the Bankless Times, some $10 billion in funding transactions occurred globally through crowdfunding in 2014, $5.1 billion in 2013, and $2.6 billion in 2012. As each country develops and implements regulations around this new industry and general awareness grows, estimates from a variety of sources indicate that the yearly total market potential of the crowdfunding industry could average around $300 billion by 2025.


Generally, there are four types of crowdfunding: (1) donation-based crowdfunding, where campaigns collect money with no promise of anything in return (i.e. GoFundMe); (2) rewards-based crowdfunding, where the sponsor sets various levels of rewards that correspond with pledge amounts (this is currently the most popular type of crowdfunding—i.e., Kickstarter and Indiegogo); (3) equity crowdfunding, which is the exchange of shares of a private company for capital (i.e., SeedInvest, AngelList, Crowdfunder; and (4) debt crowdfunding or marketplace lending, which is the raising of capital in the form of a loan, whether for a personal, small business, or real estate loan (i.e., Prosper, FundingCircle, Patch of Land).

Title II, or Rule 506(c) of Regulation D, Legalizes Accredited Crowdfunding

Under the JOBS Act, the Securities and Exchange Commission (SEC) has implemented or will soon implement three regulatory statutes that will impact the development of the industry. Title II of the JOBS Act (also known as Rule 506(c)), became effective on September 23, 2013 and legalized accredited crowdfunding. Before Title II, issuers could not generally solicit their securities offerings, and were required to have a “substantial and pre-existing relationship” with accredited investors. Today, this is known as a Rule 506(b) offering.  With the advent of Rule 506(c), issuers can generally solicit investors, but must take “reasonable steps” to verify the accredited status of those investors. Rule 501 of Regulation D regards an accredited investor as an individual who either i) earned income that exceeded $200,000 (or $300,000 together with a spouse) in each of the prior two years, and reasonably expects to achieve the same minimum income for the current year, or ii) has a net worth over $1 million, either alone or together with a spouse (excluding the value of the person’s primary residence). Private placement offerings under Regulation D have no maximum on the funds that it can be used to raise.

According to CrowdWatch, at the two-year anniversary of the effective date of Title II, some 4,712 offerings were filed in Title II’s first year representing capital commitments of $385.8 million, and grew 28.7 percent in filings and 125.5 percent in recorded capital commitments in its second year to 6,063 distinct offerings, with recorded capital commitments of approximately $870 million.

Title IV, or Regulation A+, Allows for Easier Mini-IPOs

The final rules of Title IV of the JOBS Act were adopted on March 25, 2015 and became effective on June 19, 2015. Title IV is also known as Regulation A+ because it revamps the old and rarely used Regulation A, which allows non-accredited investors to participate in a company’s “mini-IPO.” However, individual investments are limited to annual investments totaling 10 percent of the investor’s income or net worth (whichever is more). Regulation A+ contains certain reporting requirements, although at a significantly lower threshold than a normal public company. The issuer is limited to a maximum raise of $50 million each year. For Tier I offerings up to $20 million, issuers must undergo coordinated review from both states and federal regulators; Tier II offerings above $20 million have more reporting requirements, but issuers need only obtain approval with the SEC, and not state securities regulators. It should be noted that the cost and time required to file a Regulation A+ offering is significantly higher than that of a Regulation D offering, but the pool of potential investors is larger. Companies interested in raising capital through a Regulation A+ offer may want to seriously consider “testing the waters” for investor interest before incurring the time and expense of filing.

Since Regulation A+ became effective in mid-2015, at least a few dozen offerings have been filed—some publicly and some confidentially—for companies in various industries, including transportation, energy, pharmaceutical, real estate, entertainment, apparel, and even cannabis. A few companies have managed to get their Regulation A+ filings approved in the first six months of the effective date, but the impact of Regulation A+ remains to be seen.

Title III, or Regulation CF, Legalizes Non-accredited Equity Crowdfunding

The most recently approval JOBS Act regulation is that of Title III, or Regulation CF, which will come into effect on May 16, 2016.  Regulation CF is what most people associate crowdfunding with—it allows issuers to raise up to $1 million each year from non-accredited investors, and is the vehicle that many hope will allow retail investors to have access to opportunities traditionally limited to angel investors and venture capital firms. Additionally, Title III creates a regulatory framework around broker-dealers and funding portals that facilitate crowdfunding transactions. Interestingly, the final proposed rules have met a considerable amount of criticism, and advocates are already knee-deep in discussions on how to fix Title III as implemented.


Intrastate Equity Crowdfunding

As of August 2015, 29 states have either enacted separate intrastate crowdfunding exemptions or amendments to their existing blue skies laws to permit some type of instrastate crowdfunding; eight states have proposed or are considering intrastate crowdfunding exemptions; and four states have voted down proposed intrastate crowdfunding exemptions.

Intrastate equity crowdfunding exemptions generally allow for non-accredited investments for investors in that particular state, have higher offering caps (generally $2 million instead of $1 million), and have lesser reporting requirements than the proposed Title III rules. On October 30, 2015, the SEC voted in favor of proposing amendments to existing Securities Act Rule 147 on intrastate offerings to facilitate capital formation, and to amend Securities Act Rule 504 to increase the aggregate offering amount from $1 million to $5 million and apply bad actor disqualification to Rule 504 offerings for additional investor protection. Many believe that the implementation of Title III will cause interest in intrastate equity crowdfunding to sizzle out.

While still in its infancy in the United States, crowdfunding generally is a much more mature market in other countries, such as the United Kingdom and China. Since World War II, the U.S. has been one of the major economic financial and economic powerhouses of the world, and has an established culture of technological innovation. However, some critics—especially in the fintech sector—worry that falling behind in developing timely regulations around new technologies and industries may seriously impede our ability to maintain such economic and political influence.

About the Author

Amy Wan is general counsel of Patch of Land, a leading real estate crowdfunding platform, and  leads the company’s corporate strategy and tactical legal initiatives.

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