Recognizing that access to capital is critical to the health of smaller companies which generate about 50% of U.S. job growth, the Congress passed the Jumpstart Our Business Startups (JOBS) Act in 2012, which set the stage for the development of equity Crowdfunding in the U.S.
The JOBS Act
The JOBS Act includes several provisions specifically designed to enhance Capital formation:
- Title II – Enables “General Solicitation” for Private Placements sold only to Accredited Investors. Specific regulatory guidance is found in S.E.C. Regulation D (Reg D), Rule 506(c).
- Title III – Authorized smaller Crowdfunding (less than $1 million), public sales of Securities to a broader range of Investors than had been authorized under Reg D previously. Crowdfunding is conducted through the internet via FINRA-regulated Crowdfunding Portals.
- Title IV – Establishes a form of Initial Public Offering (IPO) up to $50 million where any level of Investor can participate and where Issuer disclosures are reduced from S-1 requirements in larger IPOs. Regulation A+ of the S.E.C. provides regulatory guidance for raising capital in this manner.
With these new financing options (and some that preceded the JOBS Act), Crowdfunding has become a somewhat confusing term, some involving the sale of a Security (a highly regulated activity) and some, currently the bulk of Crowdfunding activity, involving a pre-sale of a product or service (which is not regulated).
This is a fund-raising approach wherein Capital is advanced to a very small enterprise based upon the promise to deliver a product or service in the future. The most successful internet sites Offering this service include Kickstarter ($2bn raised since 2010) and Indiegogo ($1bn raised since 2010). Rewards-based Crowdfunding does not involve the selling of a Security and, therefore, is not subject to U.S. Securities regulations.
Equity Crowdfunding pertains to the sale of Securities through “general solicitation” for an Offering (i.e. advertising) via the internet.
Title II, Accredited Equity Crowdfunding
This type of Crowdfunding enables, for the first time, general solicitation to Accredited Investors. This significantly expands the ability of Broker-Dealers to communicate the availability of a Reg D Private Placement. Historically, great care was made to avoid publicity about Reg D Offerings because it could cancel the Offerings exemption from SEC registration. Under Title II, a new Rule 506(c) of Reg D was created by the S.E.C., though it requires third-party verification of Accredited Investor status, versus self-verification, which is authorized under the traditional Rule 506(b) Reg D Offerings.
Title III Crowdfunding
(via Crowdfunding Portals) – This type of Crowdfunding has received the most publicity since passage of the JOBS Act. These Offerings are limited in Offering amount (max. $1,070,000, but more typically much less) and, importantly, they enable sales to Investors whose financial profile (income in this case) is well below the Accredited Investor definition in Rule 501 of Reg D. All Crowdfunding Portals must be registered with FINRA.
Title IV, Regulation A+ (“Mini IPO”)
This type of Crowdfunding allows companies to raise up to $20 million per year (Tier 1) or up to $50 million per year (Tier 2) from the general public in a “mini-IPO” style Offering. Reg A+ can provide an attractive liquidity option for successful, but smaller, companies, since Reg A+ Securities are free to trade publicly, and the reporting requirements are significantly lower than for traditional S-1 IPOs.