By David Drake
The US crowdfunding industry hit a major milestone on March 25 this year as the SEC passed into law Reg A+ under Title IV of the JOBS Act after years of prolonged deliberation and advocating by stakeholders.
Industry experts, entrepreneurs and investors have eagerly anticipated for the passing into law of this regulation to facilitate the democratization of investment by paving way for a greater participation from the general public, mostly unaccredited investors.
But to what extent will this new law cause a convergence of crowdfunding towards its claim as a democratized means of investing? Furthermore, to what extent will the predictions of industry observers and experts about a boom in the market come to pass? These are critical issues that are capable of shaping and influencing the outcome of the new law on the industry landscape at least in the near future.
Since it gained traction in the alternative finance landscape, crowdfunding has been regarded as a democratized means of investing that allows participation from the general public regardless of income group or social class. However, the full import of this claim has not been realized as regulations by the SEC have prevented participation from the majority of average investors (mostly unaccredited investors).
As a result, the passing into law of Reg A+ is meant to remove this limitation. Reg A+ is a development upon RegA which allowed for participation from unaccredited investors but with a limitation of being subject to state blue sky laws and a cap of $5 million as total amount that can be raised in an offering. Reg A+ allows for companies to raise higher amounts in what has been termed a mini IPO. In essence, not only startup or early stage businesses but even growth stage firms can now raise funds from the crowd as an alternative to Venture Capitalists, Angels and other traditional investor groups.
The new law has two separate tiers under which companies can raise funds from both accredited and unaccredited investors. Tier 1 requires a company to register with the SEC, be subject to state blue sky laws (reviews and fees) but without having to file their audited accounts with the SEC. The maximum amount that can be raised under this tier is placed at $20 million per annum. Under tier 2 on the other hand, a company is exempted from state blue sky laws (preemption) and can raise up to $50 million from investors online.
According to Scott Andersen, Partner at consultDA, “Congress, by allowing general solicitation and advertising in the capital formation process, opens broad possibilities for entrepreneurs and new and seamless investment opportunities for the public.” Scott is also the General Counsel for FundAmerica.
The SEC has also placed a limit on the amount average investors can commit into a company in a bid to protect them from losing their investments to companies know as “bad actors.” As a result, investments by unaccredited investors have been pegged to 10% “of the greater of their annual income or net worth.”
Companies will also have to submit their audited reports and must go through a registered transfer agent. Already, FundAmerica, a crowdfunding platform provides services that could make this process easier for issuers.
This latest development is capable of becoming an industry game changer as unaccredited investors, who up till now have only been able to participate in a handful of Reg A deals offered by platforms like Fundrise (that were state specific), can now become active players in the industry playing field.
Furthermore, crowdfunding platforms looking to extend their offerings to unaccredited investors but which have been unable to do so due to unfavorable state blue sky laws have now been provided a low pressure route, thanks to RegA+.
According to Scott Purcell, founder and CEO of FundAmerica, “Crowdfunding for securities will enable millions of businesses to get the capital they desperately need to grow and create jobs. This will usher in a boom period the likes of which this country, and the world, has never seen.”
The steps for filing for a RegA+ offering involves preparation of the offering documents and audit reports which could then be submitted online through EDGAR to the SEC using the “form 8a short-form.”
In comparison to Reg D Rule 506(c), the industry standard for registering offerings, Reg A+ is a bit more complex as it involves more time and cost (in form of legal and administrative charges) and greater level of account disclosure. Nevertheless, it has the advantage of allowing participation from unaccredited investors and the exemption of offerings from state blue sky laws.
However, the limitations of a greater time, cost and disclosure requirement could negatively affect its adoption by platforms and companies (already used to operating under the Rule 506), which could in turn weaken its impact on the market.
In less than 60 days, Reg A+ will take effect. While many industry experts have predicted a boom in the market as an after effect of its passage, the willingness of platforms and companies to undergo the time and cost consuming requirements it entails will determine to a great extent the level of its adoption in the industry. As a result, the convergence of crowdfunding towards its claim as a democratized means of investing depends to a large extent on whether stakeholders are willing to pay the price of undergoing the somewhat stringent requirements involved in order to bring its benefits to a larger percentage of unaccredited investors.
Despite these considerations, the prospect of growth stage companies having their products or services validated by the crowd (in a mini IPO) before finally going public should drive its adoption. This should in turn add to the boom currently experienced in the crowdfunding market. Here’s the summary for the new rules from Scott Purcell:
|New Regulation A+ Crowdfunding Rules|
|WHEN||Rules become effective in 60 days|
|WHAT||Tier 1: requires SEC and state blue sky reviews & fees, raise up to $20M per year, open to unaccredited investors, no audit required|
|Tier 2: requires SEC review but no state blue-sky review (“preemption”), raise up to $50M per year, also open to unaccredited investors (limited to the greater of 10% of income or net worth), annual audit required, must use a registered transfer agent (firms like FundAmerica can help to simplify this for issuers)|
|Both – are open to unaccredited investors, can be used by startups as well as existing businesses, and are exempt from 12(g) registration thresholds|
|COMPARISON WITH RULE 506(C)||PROS
¹IN FULL DISCLOSURE, SCOTT ANDERSEN AND I RECENTLY FORMED AND ARE PARTNERS IN A SECURITIES COMPLIANCE CONSULTANCY FOR BROKER-DEALERS, INVESTMENT ADVISERS AND OTHER FINANCIAL INSTITUTIONS: CONSULTDA.COM.
David Drake is an early-stage equity expert based in New York City. He is the founder and chairman of Victoria Global Corporate Communications; LDJ Capital, a family office and private equity advisory firm; and, The Soho Loft Media Group, a global financial media company with divisions in Publications and Conferences. He is also a Partner at ConsultDA. You can reach him directly at David@LDJCapital.com.