Equity crowdfunding looks poised to deliver expanded opportunities for founders trying to raise capital, thanks to new guidance from the U.S. Securities and Exchange Commission (SEC).
Among other areas, the SEC has announced updates to how securities are offered under Regulation Crowdfunding (Reg CF), most notably increasing the rolling 12-month offering cap amount from $1.07 million to $5 million. These changes come into effect in January 2021, and could increase access to capital for early and even growth-stage startups.
The Reg CF guidelines were originally adopted under Title III of the JOBS Act back in 2016, providing an exemption from the SEC’s registration requirements for certain crowdfunding transactions. (It should be noted, the Reg CF exemption excludes non-U.S. issuers and offerings must be conducted on an internet platform through a registered intermediary.)
The moves by the SEC come after several years of lobbying, according to New York-based Republic, a crowdfunding platform for startups that teamed up with other industry players to form the Association of Online Investment Platforms as part of the effort. They also arrive as the COVID-19 pandemic has clearly created a need to improve access to funding for small businesses, especially those led by traditionally underserved founders.
In light of the new developments, Republic recently hosted a webinar exploring the updated guidance and the impact it will have on the startup investment landscape. Here’s a summary of the changes, with insights from Republic:
The key crowdfunding changes
The updated guidance goes deeper than just increasing the offering cap to $5 million. According to the SEC fact sheet, the amendments also remove the current investment limit for accredited investors under Reg CF, while also changing criteria for non-accredited investors. Going forward, investment limits for non-accredited investors will be based on whichever is higher: their annual income or net worth (currently investment limits are calculated by whichever is lower).
Meanwhile, the SEC has changed guidelines around general solicitation. Companies will now be able to “test the waters” before filing Form C with the SEC, while there will be permitted limits on advertising after filing Form C. Simultaneously, certain “demo day” communications will not be deemed general solicitation or general advertising.
The amendments also establish rules permitting the use of certain special purpose vehicles that function as a conduit for investors to facilitate investment in Reg CF issuers.
Additionally, the SEC is extending the “COVID-19″ rules for Reg CF for another 18 months. (In May 2020, the agency announced temporary, conditional relief to allow established small businesses to pursue expedited crowdfunding offerings.)
The impact on founders
In 2019, the average crowdfunding campaign on Republic was $500,000 and around 20 companies have now raised the full $1 million amount on the platform, according to Cheryl Campos, Republic’s head of growth and partnerships. Looking ahead, Republic already has companies in the pipeline hoping to raise $5 million.
“It’s a really good way to either do a round where your customers can be owners of the company, or to supplement a round with institutional investors, where institutional investors take the majority of the round, and you let customers, friends, family supporters take the remainder,” says Max Rich, Republic’s deputy general counsel.
Increasing the Reg CF limit means companies can look to reward their early stakeholders and give them a bigger slice of the pie on their own terms, says Campos. At the same time, growth-stage companies (from Series B to D) will also be incentivized to raise or top off funding rounds using crowdfunding. That’s because legal and accounting costs will be the same, but come with more upside thanks to the higher cap.
The general solicitation changes create new opportunities as well. Previously, a founder couldn’t publicly shout from the rooftops that they were planning a campaign. Now they can drum up interest and get a head start, laying the groundwork for a successful campaign launch. “You can kind of build your list of people that you can go to from the get go,” says Campos. That also means companies can commence marketing prior to the campaign with countdowns and ads.
The ability to test the waters should also help founders who have trouble accessing traditional investment. “This really affects underrepresented founders, because they’re the ones who have to build community, generally,” says Campos. These founders don’t always have a pool of friends and family that can help get a campaign started, but the new rules should make it easier to build momentum.
Making it easier to crowdinvest
The changes to investor requirements should help investors get more involved in crowdfunding, particularly the non-accredited variety. Reg CF’s current investor requirements have prevented people who are in a good position to crowdinvest from getting involved. “We had a bunch of people who were retired and had substantial assets but had minimal income, and they were basically unable to invest their assets,” says Rich. He adds that accredited investors shouldn’t be limited when it comes to crowdinvesting either, because they’re not limited anywhere else.
Overall, Republic sees the updated guidance as an exciting development for everyone, because it liberalizes things for investors, but it also makes these rounds more inclusive for big checks. In the past, Republic has dealt with situations where investors wanted to inject more capital into a campaign, but the law prevented them from actually deploying their money. “It didn’t help the company, it didn’t protect the investor and certainly didn’t help us,” says Rich. Come January 2021, that should be less of a problem.
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