Crowdfunding has become a common way for entrepreneurs to secure financing. In 2015, total global crowdfunding raised an estimated $34 billion in financing, compared to $2.7 billion in 2012. ((CrowdExpert, Crowdfunding Industry Statistics 2015 Report (2016), http://crowdexpert.com/crowdfunding-industry-statistics/.)) With such a large impact on the economy, it was only a matter of time before industry regulation was enacted. On May 16, 2016, Regulation Crowdfunding came into affect under Title III of the JOBS Act of 2012. ((Sec. & Exch. Comm’n, Regulation Crowdfunding: A Small Entity Compliance Guide for Issuers (2016), https://www.sec.gov/info/smallbus/secg/rccomplianceguide-051316.htm.))
Under the Regulation, crowdfunders are exempt from the Securities Act of 1933 as long as the total amount of debt or equity sold to all investors does not exceed $1 million in a 12-month period and the transactions take place through an online intermediary. ((Id.)) Additionally, investors themselves are subjected to investment caps based on the investor’s net worth or annual income. ((Id.)) In many ways, the Regulation is nothing but a step in the right direction, as it provides small companies and cash-hungry entrepreneurs an additional legal option when securing financing. Yet it remains to be seen if these formalized limitations will hinder the formerly unregulated industry in a way that will stifle crowdfunding’s future.
Through one quarter of regulation, eleven companies closed their offerings and only five of those reached their fundraising targets. ((Sherwood Neis, Here’s What the First Quarter of Regulation Crowdfunding Has Taught Us (2016), http://venturebeat.com/2016/09/03/heres-what-the-first-quarter-of-regulation-crowdfunding-has-taught-us/.)) Under the Regulation, a failure to reach the target before the deadline results in the committed capital to go back to investors. ((Sec. & Exch. Comm’n, Final Rule: Crowdfunding (2015), https://www.sec.gov/rules/final/2015/33-9974.pdf (discussing Rule 201(k)).)) In an analysis conducted by Stratifund Inc., the first quarter of the Regulation showed that a company’s ability to explain their concept to investors in easy to understand terms correlated with their crowdfunding success. ((Neis, supra note 5.)) Other factors contributing to successful crowdfunding included whether a product seemed practical to everyday consumers, whether investors viewed the management team as capable, and whether the company presented a transparent business model. ((Id.))
While the future impact of the Regulation cannot be guaranteed, this first quarter arguably showed that the Regulation is serves the wellbeing of both entrepreneurs and investors. From the entrepreneur’s perspective, it legitimizes crowdfunding as an accessible form of financing. No longer will a lack of regulation create a stigma of lower-tiered financing that may have accompanied crowdfunding in the past. Regulation also serves as a barrier for capital commitments that can protect entrepreneurs. For example, if crowdfunding campaign aims to raise $750,000, but only is able to secure $60,000, the Regulation forces entrepreneurs to disregard the temptation to deploy the $60,000. This lesser amount is likely not enough to accomplish all of the goals of the campaign, and accomplishing only a fraction of the initial goals may render the $60,000 capital commitment moot. The Regulation thus protects entrepreneurs from potential liability for wasting away investors’ money, but also protects the entrepreneurs’ industry reputation. The reputational concerns are critical because if an entrepreneur gets a reputation for losing investors’ commitments, that entrepreneur will likely face an uphill battle in securing future financing in other ideas that may be innovative and socially beneficial.
From the investor’s perspective, the Regulation formalizes crowdfunding and disperses important information that may not otherwise be provided. Under the Regulation, one of the first things that a business needs to do is file Form C with the FINRA and the SEC. ((Rob Marvin, Regulation Crowdfunding is Live: What Businesses and Investors Need to Know (2016), http://www.pcmag.com/article/344544/regulation-crowdfunding-is-live-what-businesses-and-investo.)) Form C includes the following information that investors can use to decide whether or not the campaign is a viable investment: information about officers, directors, and owners of 20 percent or more of the issuer, a description of the business and the use of proceeds from the offering, the price of the securities or the method for deriving a price, the target amount and deadline to reach that target, whether the issuer will accept investments in excess of the target offering amount, certain related-party transactions, and a discussion of the issuer’s financial condition and financial statements. ((Regulation Crowdfunding: A Small Entity, supra note 2.)) Having this type of information protects investors from making large capital commitments that would be otherwise ill advised. None of these requirements are earth shattering, if investors are going to give entrepreneurs capital to further their endeavors, investors should at least be given basic information about the nature of the business and how the capital will be used.
A final reason that the Regulation will likely prove to be worthwhile is the “Bad Actor Disqualification.” Under Rule 503 of the Regulation, offerings will be disqualified if the issuer or other “covered persons” have experienced a disqualifying event, such as being convicted of, or subject to court or administrative sanctions for, securities fraud or other violations of specified laws. ((Id.)) According to the SEC, “[m]any disqualifying events include a look-back period” that is “measured from the date of the disqualifying event.” ((Id.)) This disqualification is aimed to rid the crowdfunding market of frivolous and fraudulent campaigns, and will protect both investors’ capital as well as the image of this youthful form of financing. It also serves a punitive purpose. If an investor conducts inappropriate business practices, they know that not only will traditional financing become difficult to secure, but crowdfunding will also be off the table.
Regulation Crowdfunding faced initial pushback, as is expected when any new regulation is imposed. ((See JD Alois, OneVest Co-Founder Criticizes Title III Equity Crowdfunding in Open Letter (2016) http://www.crowdfundinsider.com/2016/05/85165-onevest-co-founder-criticizes-title-iii-equity-crowdfunding-in-open-letter/.)) Despite this criticism, the first quarter of the Regulation showed that it can provide both sides of the table with protection that otherwise would not be provided. This protection was illustrated through the campaigns that were successful, the campaigns that were not, and the information that can be gleaned from the first quarter results. One quarter, and especially the initial quarter, is a small sample size, but some of the lessons learned shows promise that the Regulation will be successful well into the future.
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