By Chase Nerison
On October 30, 2015, the Securities and Exchange Commission implemented “Regulation Crowdfunding” under Section 4(a)(6) of the Securities Act. Under the provisions of Title III of the JOBS Act of 2012, the SEC was required to adopt these new rules and regulations (Regulation crowdfunding rules). Before diving into how Regulation Crowdfunding, or Reg CF, is attempting to democratize capital markets, it is important to start with a fundamental understanding. This evolving method of raising funds allows non-publicly traded U.S. companies to offer and sell securities to the general public through crowdfunding, which is raising small amounts of money from a large number of people (Regulation crowdfunding). There are three main groups in a Reg CF transaction: the issuer, investor, and funding portal. The issuer is the company issuing their stock in exchange for capital. The investor is the buyer of said stock. Lastly, the funding portal acts as a necessary intermediary between the issuer and investor, which is typically an online platform.
Any securities trading is highly regulated. FINRA, the Financial Industry Regulatory Authority, is a self-regulatory organization for broker-dealers, and they oversee all funding portals. These funding portals sign the issuer, assist with necessary documents to the SEC, and provide an online offering page to their investor base as well as the issuer’s base. Since funding portals have their own investor bases, the online platforms can be subjective and decide which companies’ offerings to allow on their site (Regulation crowdfunding rules). In return for listing the issuer on their platform, the funding portal typically takes a percentage of the raise and sometimes a small base fee or equity percentage. Upon signing with a funding portal, the SEC requires issuers to provide certain information to investors through a Form C. A Form C is made public before the offering and tells the potential investor basic information about the company, its directors and officers, an anticipated plan of business, the intended use of the offering proceeds, and more (Regulation crowdfunding rules).
On the investor side, there are limits to investing in these companies based upon the investor’s annual income or net worth. Since Reg CF allows unaccredited investors the opportunity to buy stock in a private company, there must be limits and regulations as this is a very risky asset class (Crowdfunding and the JOBS Act: What investors should know. FINRA). According to Archer Investors’ research, approximately only 8.25% of the U.S. population are accredited investors (Accredited investors). This provision of Reg CF allows the other 91.75% of the U.S. population to become investors in private markets.
Transitioning to the regulation pertaining to the issuer, there are limits to the amount and frequency of a raise. Originally, the maximum amount raised in a 12-month window was $1.07 million. In Q4 of 2020, this amount was raised to $5 million (Alois, J. D.). Along with the monetary limits, there are other requirements. A company must have self-certified financials if they are raising less than $250 thousand, CPA reviewed financials if they are raising between $250 thousand and $1.07 million, and CPA audited financials if they plan to raise more than $1.07 million. With the specified financials and a published Form C, the issuer is ready to offer on the funding portal. Depending on the funding portal, the issuer can choose to distribute common stock, SAFE notes, debt, or others, but common stock is most popular.
In 2020, equity crowdfunding and the online capital markets saw rampant growth. Due to COVID-19, many Venture Capital firms paused investing in new companies due to uncertainty and other difficulties surrounding the pandemic. Though traditional Venture Capital investments were down, entrepreneurs still needed funding. These founders turned to an emerging alternative source to raising capital. On top of this momentum, the raise limit increase from $1.07 million to $5 million only added to its popularity (2020 US equity Crowdfunding stats - year in review).
The pandemic showed how the Reg CF industry is making it easier to raise early-stage capital. The graph below displays both the total amount raised in each month across the industry as well as the average amount raised per campaign. Both of these statistics have significantly increased since the beginning of 2020, and I believe they are here to stay.
The industry raised $214.9 million in 2020 from 1035 companies compared to $104.7 million in 2019 from 541 companies. Those are 105% and 91% increases! Additionally, 2020 saw over 350,000 investors in Reg CF, which is a 75% increase from 2019 (2020 US equity Crowdfunding stats - year in review). Below is a graph of the total capital raised by year of the main funding portals in the space. Undeniably, 2020 showed a Reg CF boom. This will be a fun sector to watch as it pushes itself into an established Venture Capital and Private Equity field, fighting to democratize capital markets and bring wealth to more individuals.
Works Cited
2020 US equity Crowdfunding stats - year in review. Crowdwise. (2021, May 27). Retrieved September 14, 2021, from https://crowdwise.org/funding-portals/2020-us-equity-crowdfunding-stats-year-in-review/.
Accredited investors. Archer Investors. (n.d.). Retrieved September 14, 2021, from https://www.archerinvestors.com/accredited-investors/#:~:text=Currently%2C%20accredited%20investors%20make%20up,sophisticated%20offerings%20as%20seasoned%20investors.
Alois, J. D. (2021, March 15). As Reg CF Funding Cap jumps to $5 million First Issuers take advantage of the increased funding amount. Crowdfund Insider. Retrieved September 14, 2021, from https://www.crowdfundinsider.com/2021/03/173206-as-reg-cf-funding-cap-jumps-to-5-million-first-issuers-take-advantage-of-the-increased-funding-amount/.
Crowdfunding and the JOBS Act: What investors should know. FINRA. (2017, May 17). Retrieved September 14, 2021, from https://www.finra.org/investors/alerts/crowdfunding-and-jobs-act.
Regulation crowdfunding rules. SeedInvest. (2016, September 21). Retrieved September 14, 2021, from https://www.seedinvest.com/blog/crowdfunding/regulation-crowdfunding-rules.
Regulation crowdfunding. U.S. Securities and Exchange Commission. (2017, May 4). Retrieved September 14, 2021, from https://www.sec.gov/smallbusiness/exemptofferings/regcrowdfunding.
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