There are many legal implications attached to an equity crowdfunding raise.
From Regulation A+ to Regulation CF, it can quickly become extremely confusing and difficult to sort out the legal mumbo jumbo.
If you’re looking for a summary of how all of these laws, rules, and regulations apply to YOU, then you’re in the right place.
I got you! It’s an exciting time to be alive. There are so many excellent equity crowdfunding websites that it’s difficult to choose from!
By the end of this article, I want you to have a better idea of where to get started with equity crowdfunding and what you’ll need to do to comply with the various regulations.
I am not a lawyer or an accountant. This article is not meant to construe legal or tax advice, but rather summarize my knowledge of the subject.
3 Types of Equity Crowdfunding Raises
First of all, there are three types of equity crowdfunding raises. Depending on which type that you use, the compliance requirements, costs, and benefits will be different.
#1. Regulation A+ Offering
The Jobs Act revised how Reg A offerings work. They are now referred to as “Reg A+” to reflect the new features. If someone is saying Reg A or Reg A+, they are probably referring to the same type of raise.
A Reg A+ offering falls under Title IV of the Jobs Act. Under Title IV, there are two types of financial raises, including Tier 1 and Tier 2.
Tier 1 Raise
You can raise upwards of $20 million in a 12 month period, including no more than $6 million on behalf of selling security holders that are affiliates of the issuer. These funds can be raised from both ordinary and accredited investors.
Tier 1 offerings must meet the the Blue Sky investing regulations of each state that an investor resides in. You can find state-by-state filing requirements here.
Basically this means:
- Raise $20 million in 12 months
- Open to ordinary and accredited investors
- Must meet Blue Sky investing regulations in each investor’s state
Tier 2 Raise
You can raise upwards of $50 million in a 12 month period, including no more than $15 million on behalf of selling security holders that are affiliates of the issuer. These funds can come from ordinary or accredited investors.
Tier 2 offerings preempt the Blue Sky Laws, meaning that you don’t have to worry about state-by-state regulations. On the downside, there are costly reporting requirements, including audited financials and post-offering reporting.
Under both the Tier 1 and Tier 2 raise, companies can undergo a “test the waters” period to gauge the demand of investors. Investors can submit non-binding indications of interest in the offering.
This test the water period is part of Rule 225. You can publicize the test the waters offering via your social media channels and other methods.
Basically this means:
- Raise $50 million in 12 months
- Open to ordinary and accredited investors
- Preempt the Blue Sky Laws (woo hoo!)
- Audited financials and post-offering reporting
- Can do a test the waters period to gauge demand
On the SEC website, you can find a full guide of the SEC’s Amendments to Regulation A.
#2. Regulation D Offering
Regulation D offerings are the standard form of crowdfunding that existed before the Jobs Act rules were put into effect. They are also how you traditionally raise money for a startup.
When people in the industry cite Regulation D, they are referring to rule 506(b) and 506(c). They are also more likely to refer to these offerings as “private placements.”
Reg D Rule 506(b)
Rule 506(b) under Regulation D is how offerings were traditionally conducted before the Jobs Act came along. They allow you to raise as much money as you’d like from Accredited Investors and up to 35 other purchasers.
While investors don’t have to verify their accredited status, companies must only offer securities to buyers that are accredited. Companies cannot also advertise the offering publicly.
Reg D Rule 506(c)
Rule 506(c) was created as a result of the Jobs Act. It’s a new rule that you can use to also raise money from Accredited investors. It has many of the same stipulations as 506(b), with one major difference.
You are allowed to advertise that you’re raising capital under Rule 506(c). You don’t need to have a prior relationship with the investors that you’re getting funding from. This is referred to as “general solicitation.”
Unlike Rule 506(b), you must verify that each investor is accredited before allowing them to participate in the offering.
Summarized, Reg D means that you:
- Can raise as much capital as you’d like from Accredited investors and up to 35 non-accredited investors.
- Under 506(c) you’ll be able to advertise the offering
- Under 506(c) you must verify accredited investor status
On the SEC website, you can find a nitty gritty explanation of Regulation D.
#3. Title III or Regulation CF Offering
A Title III offering, also referred to as Regulation Crowdfunding or Reg CF is the long-awaited portion of the Jobs Act that enables non-accredited investors to purchase shares in startups.
Under a Title III offering, you can raise upwards of $1,070,000 in 12 month period from ordinary investors. There are also limits in terms of how much an individual can invest, which I discuss more later in this article.
As with a traditional crowdfunding campaign, each startup must disclose information about the company like offers and directors, how the funding will be used, the fundraising period, and more.
The reporting requirements will vary depending on the amount of funding that you are seeking. Below, I’ll provide a short summary of how these tiers differ.
- $107,000 or less: financial statements and tax returns (unless audited/reviewed financials are given)
- $535,000 or less: financial statements reviewed by an accountant (unless audited/reviewed financials are given).
- $535,000 or more: for first time offerers, financial statements reviewed by an accountant (unless audited/reviewed financials are given). For non-first time offerers, financial statements audited by a public accountant that is independent of the issuer.
Along with these stipulations, companies also have ongoing reporting requirements in the form of annual reports. Not every company is allowed to participate in a Reg CF offering. These are some of the things that could disqualify you:
- non-U.S. companies
- companies that have failed to comply with the annual reporting requirements
- companies that have no specific business plan or plan to engage in a merger or acquisition with an unidentified company or companies.
After you file your Form C with the SEC, then you can broadcast the offer. But, there are a lot of requirements regarding what you can and can’t say. Some of these include:
- You can’t say the terms of the offering
- Can post communications with the tombstone information
- Can say you are doing an offering under Section 4(a)(6), as long as it doesn’t mention the terms.
- Drive investors to the intermediary’s website to find out more.
- Think tombstone advertisements (only factual info)
For more information about Title III, you can view the SEC’s website here.
These are the three main types of equity crowdfunding. In another article, I’ve covered the topic of Instrastate Crowdfunding, which is a whole other discussion.
Filing and Disclosure Requirements
In order to do an equity crowdfunding offering, you’re going to face a bunch of filing and disclosure requirements. These rules are primarily there to protect investors.
These requirements are going to vary based on the the type of crowdfunding that you choose to use. Regulation CF requirements will be different from Regulation A+.
To help clarify this confusing part of the fundraising process, I’m going to break down the various forms and filing procedures by funding type. Of course, you should do your own research, but I hope this helps you with the process.
Regulation A+ Form
It takes time to be approved by the SEC for a Reg A+ raise. You can expect that it will take about 60 days to compile, answer, and submit the necessary forms and information to the SEC. Then, it can take anywhere from 30-60 days to get approval for the offering.
- You must complete Form 1-A, which is the offering form for Reg A+ of the Jobs Act.
- You can submit Form 1-A online through EDGAR. You can print a physical copy here.
- You must complete all questions/fields and provide audited financial statements.
Regulation D 506(c) Form
The good news is that there are no Regulation D 506(c) forms that you need to fill out before raising money. You do not have to register your offering of securities with the SEC.
Once you do successfully sell your securities to Accredited Investors, you must file a Form D on EDGAR (or a print version here) within 15 calendar days after you finish your securities sale.
Regulation Crowdfunding Form
As with the other types of crowdfunding, it does take time to prepare for a Reg CF raise. You must fill out paperwork in order to educate investors and the public about the offering.
When doing a regulation crowdfunding offering, you must:
- File Form C on EDGAR and made public (prior to start of offering). Here’s a print version.
- Financial statements, as detailed earlier
- Ongoing disclosure in the form of annual reporting (but need not be audited or reviewed by an accountant). The entity must continue to file annual reports unless the all into a few different categories, as outlined on the SEC website.
Investor Limitations and Rules
There are limitations on the amount that investors can invest when it comes to an equity crowdfunding campaign. As with the other sections, these limitations and rules vary depending on the type of crowdfunding that you choose.
These rules are there to help protect investors against massive financial losses. They are important to know if you’re a platform, company, or service provider in the crowdfunding industry.
Regulation A+ Investors
For Reg A+, both accredited and non-accredited investors can buy shares during your offering. There is one important difference when it comes to Reg A+!
Under Tier 1 offerings, investors have no limitations regarding the amount of money that they can invest.
However, under Tier 2 offerings, non-accredited investors can only invest 10% of their annual income or net worth per year (whichever is greater).
Regulation D 506(c) Investors
When doing a Reg D 506(b) or 506(c) offering, there aren’t any investors limitations regarding the amount that they can invest.
The only limitation is that this type of offering is only available to Accredited Investors (and a small handful of non-accredited investors).
Regulation Crowdfunding Investors
Regulation CF probably has the most limitations on investors of all of the types of equity crowdfunding that we’ve mentioned thus far.
These limitations come in the form of the amount that you can invest in a 12 month period and they are determined by your annual income or net worth (the greater of the two). Your house is not included in your net worth.
According to the SEC website, “If either your annual income or your net worth is less than $107,000, then during any 12-month period, you can invest up to the greater of either $2,200 or 5% of the lesser of your annual income or net worth.
If both your annual income and your net worth are equal to or more than $107,000, then during any 12-month period, you can invest up to 10% of annual income or net worth, whichever is lesser, but not to exceed $107,000. ”
I will cut and paste an example chart from the SEC website below.
As I mentioned previously, a Reg CF offering is available for both accredited and non-accredited investors.
Platform Regulations
Lastly, when it comes to the equity crowdfunding laws, there are the regulations that the US government places on the actual websites, platforms, or portals that you can use to launch a crowdfunding campaign.
Regulation A+ Platform Requirements
Under Reg A+, a company does not need to go through a broker dealer or an intermediary to sell securities. This means that technically, a company could hose a Reg A+ offering on their own website!
As a platform, you will mainly providing a marketplace of investors that new companies can tap into, along with helping them with the process of doing a Reg A+ offering or test the waters campaign.
Regulation D Platform Requirements
Similar to Reg A+, a startup doesn’t have to go through a broker dealer to do a Reg D offering. Depending on the type of offering (whether it’s 506(b) or 506(c)), the company might already be in touch with the investors or they plan to broadcast the campaign online.
As a platform, you can offer a website where startups can connect with investors under a 506(c) offering. This is the type of offering that many crowdfunding platforms started to feature in the early stages of the Jobs Act.
Regulation CF Platform Requirements
Finally, there are Reg CF offerings, which have a few more requirements than the prior two. In order to function as a platform, you must become a registered funding portal and member of FINRA. You can follow the step-by-step process here. Broker dealers can also do Reg CF offerings.
According to the SEC website, “A registered funding portal is prohibited from:
- Offering investment advice or recommendations;
- Soliciting purchases, sales or offers to buy the securities displayed on its platform;
- Compensating employees, agents, or other persons for such solicitation or based on the sale of securities displayed or referenced on its platform; or
- Holding, managing, possessing, or handling investor funds or securities.”
If you plan to do any of the above, then you’ll need to register as a broker dealer, not a crowdfunding portal.
The process for applying to become a registered crowdfunding portal is as follows:
- Reserve your firm’s name with FINRA
- File with the SEC
- Complete FINRA entitlement form
- Submit finger prints
- Pay application fees
- FINA will assess application (within 14 days)
- Examination of application/requests for changes
- Interview of applicant
- FINRA decision.
Where to Go From Here…
Now that you have a clearer idea of how equity crowdfunding works from a rules and regulation standpoint, I want you to reach out to me with your questions!
Hit me up on my about section, shoot me a tweet, or ask me a question on LinkedIn. This will help me tailor more content for you and get all those questions answered.
I hope you found this article to be helpful!
