Regulation Crowdfunding, when first authorized by Congress as part of the JOBS Act of 2013, inspired much fanfare and high expectations, for its intended ability to give entrepreneurs new opportunities to source capital. However, the resulting final regulations curtailed these exciting regulatory changes. Now, new regulatory revisions proposed by the SEC, could dramatically change the efficacy and efficiency of crowdfunding nationwide.

The JOBS Act excited many investors and business owners in its promise to simplify the complex and expensive process for legally raising capital in the United States. The idea of early stage companies being allowed to raise money from anyone, not just high-net worth individuals, using the internet, was expected to be revolutionary. There was already strong interest in and traffic on “donation crowdfunding” sites, like Kickstarter, so selling stocks and originating loans on the internet (previously not allowed) was rightfully expected to improve access to capital formation, allowing private companies to reach investors typically only participating in publicly traded stocks.

However, by the time the regulations were finalized by the SEC in 2016, serious doubt had emerged regarding its utility. Between 2013 and 2016, other offering exemptions like Rule 506(c) and Regulation A+ had facilitated equity formation online, albeit, with different investor restrictions. The final Crowdfunding rules contained a series of limitations, rightfully intended to protect investors, but ultimately stifling the market for crowdfunding portals. This included investment and offering limits, significant compliance requirements, and a restriction on using special purpose vehicles for crowdfunding.

These doubts were ultimately correct. Between 2016 and 2019, only 51 Regulation Crowdfunding issuers had raised at least $1 million, with an average successful raise amount of $213,678 and a median successful raise amount of $106,900. In 2019, a meager $62 million was raised, compared to $66 billion in Rule 506(c), and almost $1.5 trillion in Rule 506(b). In 2019, IndiGoGo, one of the top names in “Rewards based” Crowdfunding, shut down its Regulation Crowdfunding Portal.

Recognizing the significant shortcomings in Regulation Crowdfunding, the House of Representatives passed the ‘Fix Crowdfunding Act’ in 2016 by a 194-14 margin, however, it never reached a vote in the Senate.

Now,  the SEC is proposing to use its regulatory authority to overhaul the exempt offering framework, proposing to make many of the changes proposed in the Act. The SEC has released a proposed rule and requested feedback and will likely release a final rule this summer.

The proposed changes respond to many of the issuers holding back the equity crowdfunding markets:

1. Using Special Purpose Vehicles - Regulation Crowdfunding currently requires investors to invest directly into an operating company, which causes a host of issues. For high-growth startups, it crowds the cap table, turning off venture capitalists and angel investors. For real estate projects, this makes it more difficult to separate different attributes of an investment, especially for projects earning tax credits or utilizing other subsidies. The SEC has proposed to allow for the creation of special purpose vehicles, called “Crowdfunding Vehicles” that can hold securities in an underlying company and offer securities to investors in a crowdfunding raise. The proposed rule require that the Company and the Crowdfunding Vehicle to be “co-issuers” in the offering, the vehicle would not be allowed to borrow money, and the vehicle can only hold a one to one ratio of the same number, type and rights of its securities in the issuer to the securities it offers.
2. Test the Waters -  Securities offerings are very challenging for small and medium sized companies where valuation is unclear. They risk giving up too much of their business by selling stock, or try to be aggressive with their valuation and their offering fails. Also, they may not know which exemption is most appropriate. While issuers can choose a “range” for their offering, this general uncertainty and the uncertainty of the success of their offering is problematic. The SEC is proposing to allow issuers to “test the waters” with their offering before going “live.” Based on feedback and interest, the issuer can adjust the offering and choose the most suitable exemption, to defray costs and improve the likelihood of success. Unfortunately,while such actions in public markets are sometimes helpful, industry insights from Regulation A offerings seemingly indicate that such expressions of interest are unreliable to date in crowdfunded exempt offering broadly.
3. Offering Limitations - Regulation Crowdfunding capped the per raise limit at $1,000,000 per year (1,070,000 inflation adjusted). This limits the amount of capital issuers can range, discouraging use of the exemption among high quality businesses. The SEC has proposed increasing this cap to $5,000,000.
4. Non-accredited Investor Limits - Regulation Crowdfunding caps non-accredited investors to investing either (1) $2,200 or (2) the lesser of 5% of their income or net worth, unless each is over $107,000, in which case it is 10% of the greater of either. Notably, this is across all crowdfunded offerings for the year. This eliminates many prospective investors, including the many with significant student loan debt from participating at a meaningful level. The SEC has proposed to change this to 5% of the greater of the net worth or income of the investor (until $107,000, when it still increases to 10%).
5. Accredited Investor Limits - Under Regulation Crowdfunding, the maximum amount that any investor is allowed to invest in a year is $107,000, regardless of their accredited status. Under other exemptions, accredited investors can typically invest unlimited amounts. However, based on SEC analysis, roughly 40% of all investors in Regulation Crowdfunding Offerings are accredited. The SEC has proposed removing this cap, which could push a significant amount of Rule 506(c) traffic to Regulation Crowdfunding.

These changes, in the aggregate, have the potential to transform the Crowdfunding industry by making more projects viable to use Regulation Crowdfunding, presenting more specialized investment opportunities, and improving the likelihood of success for those offerings. This is especially true in the real estate industry or in tax equity markets, where projects are potentially more likely to generate cash flow or a prompt return of capital instead of the “long hold” associated with a high-growth startup. These types of investment opportunities may be more appealing or comfortable to everyday or less experienced investors.

Common Owner is a Buffalo-based company providing an exempt offering listing solution and working to become a registered “Funding Portal” with the SEC and FINRA. Common Owner focuses on neighborhood-oriented retail businesses and sustainable real estate development, especially focusing investment opportunities supporting historic rehabilitation and building walkable communities.