EQUITY CROWDFUNDING: A CLASSIC TALE OF 'OVER-REGULATION'
EQUITY CROWDFUNDING: A CLASSIC TALE OF 'OVER-REGULATION'
By Thomas Carter | March 13, 2023
Equity crowdfunding is a relatively new method of raising capital that allows small businesses to raise money from many investors through an online platform. Unlike traditional methods of raising capital, equity crowdfunding will enable individuals to invest in early-stage companies in exchange for equity in the company.
While equity crowdfunding has grown in popularity, some regulators have hesitated to embrace the concept entirely. In this blog post, we will explore why regulators should act in favor of equity crowdfunding.
First and foremost, equity crowdfunding provides access to capital for small businesses that may have yet to be able to secure funding through traditional means. In many cases, small businesses need more resources or a track record to secure loans from banks or investments from venture capitalists. Equity crowdfunding provides an alternative option for these businesses to raise capital and grow their businesses. By investing in small businesses, individuals can help support economic growth and job creation in their communities.
Equity crowdfunding also allows individuals to invest in companies they believe in and support. Traditionally, investing in early-stage companies has been reserved for accredited investors, who must meet specific financial criteria.
1. Investor Eligibility: In the US, investors must be accredited or non-accredited, meeting certain income and net worth requirements. To qualify as an accredited investor, an individual must have a net worth of at least $1 million or an annual income of at least $200,000 ($300,000 for joint filers) for the past two years and a reasonable expectation of the same income in the current year.
2. Investment Limits: Non-accredited investors are subject to investment limits in equity crowdfunding. Investors with an annual income or net worth of less than $107,000 can invest up to the greater of $2,200 or 5% of their annual income or net worth in equity crowdfunding offerings over a 12-month period. Investors with an annual income or net worth of $107,000 or more can invest up to 10% of their annual income or net worth, up to a maximum of $107,000, over a 12-month period.
3. Disclosure Requirements: Companies raising funds through equity crowdfunding must provide certain disclosures to investors, including financial statements, details about the investment opportunity, and information about the company's management team and business plan.
4. Risk Disclosures: Companies must also inform investors about the risks involved in investing, including the risk of losing their entire investment.
5. Crowdfunding Platform Requirements: Equity crowdfunding offerings must be conducted through SEC-registered crowdfunding platforms subject to specific requirements. For example, platforms must provide investors with educational materials about the risks and benefits of investing in startups.
6. Transfer Restrictions: Investments in equity crowdfunding offerings are generally illiquid and cannot be quickly or easily sold or transferred. Investors should be aware of the restrictions on transferring their investment before making an investment decision.
7. Investor Protection: The SEC has established rules to protect equity crowdfunding investors, including requiring companies to provide regular updates to investors and setting requirements for crowdfunding platforms. Investors should be aware of these protections before investing.
To summarize, many individuals are locked out and need help to invest in the companies they love. Regulators can do that but have yet to meet market needs fully.
Equity crowdfunding in the United States is regulated by the Securities and Exchange Commission (SEC) under Title III of the JOBS Act. Title III of the Jumpstart Our Business Startups (JOBS) Act is a US federal law enacted in 2016 to help small businesses raise capital through equity crowdfunding. Before the enactment of Title III, private companies were only allowed to raise funds from accredited investors who met certain wealth and income requirements. Title III created a new type of exemption from registration under the Securities Act of 1933 that allows small businesses to raise funds from a wider pool of investors through equity crowdfunding.
Under Title III, companies can raise $5 million in 12 months through online crowdfunding platforms registered with the Securities and Exchange Commission (SEC). This provides a new avenue for small businesses to access funding while allowing ordinary investors to invest in private companies in exchange for equity.
Title III also includes several investor protections, such as requiring companies to provide certain disclosures to investors, limiting the amount that non-accredited investors can invest, and requiring crowdfunding platforms to register with the SEC and comply with certain rules and regulations.
Title III has been praised for its potential to democratize access to capital and spur economic growth by allowing small businesses to raise funds from a wider pool of investors. However, it hasn’t proven to be enough. The essence of equity crowdfunding is to allow anyone to invest in companies they believe in, regardless of their financial situation. This democratization of investing provides opportunities for individuals to support causes they care about and potentially earn returns on their investments. Still, there’s more to this concept than mere financial gain. Equity crowdfunding can help promote diversity and inclusion in entrepreneurship. Historically, women and minorities have faced challenges securing funding for their businesses, and equity crowdfunding allow these entrepreneurs to raise capital and grow their businesses. Equity crowdfunding is the solution to truly promoting diversity and inclusivity in the startup ecosystem by opening funding to a broader pool of investors.
While there are many benefits to equity crowdfunding, risks are also involved. As with any investment, there is the potential for investors to lose money. Additionally, there is the risk of fraudulent activity on crowdfunding platforms. However, these risks are less prevalent via proper regulation and a proactive and activist approach on behalf of the marketplaces listing these kinds of offerings.
1. Due Diligence: Equity crowdfunding platforms can conduct extensive due diligence on companies before allowing them to list on their platform. This can include reviewing the company's financial statements, business plan, legal structure, and management team.
2. Investor Education: Equity crowdfunding platforms can provide investors with educational materials to help them understand the risks and rewards of investing in startups and small businesses. This can include information on diversification, risk management, and portfolio management.
3. Disclosure Requirements: Equity crowdfunding platforms can require companies to disclose relevant information to investors, such as financial statements, business plans, and risks associated with the investment.
4. Investor Accreditation: Equity crowdfunding platforms can require investors to meet specific accreditation standards to participate in equity crowdfunding campaigns. Accredited investors are typically individuals or entities with a high net worth or significant investing experience, which can help to ensure that they have the financial knowledge and resources to make informed investment decisions.
5. Escrow Services: Equity crowdfunding platforms can use escrow services to hold funds raised from investors until the campaign reaches its funding target. This helps ensure that investors' funds are protected and only released to the company once the funding goal is met.
Regulators are essential in ensuring that equity crowdfunding platforms operate fairly and transparently. By setting clear rules and guidelines, regulators can help protect investors and ensure they have access to accurate and reliable information. Still, these risks can also be mitigated through marketplaces that take the time to vet and package deals. Regulators are essential in ensuring that equity crowdfunding platforms operate fairly and transparently and that investors are adequately informed about the risks involved – but let’s remember their proper role. Regulators exist to foster the growth needed to have a healthy and vibrant economy.
Although the recent amendments to Regulation Crowdfunding, which increased the offering limit and adjusted investor limits, have been seen as a positive step towards promoting growth in the equity crowdfunding industry – we need more. We haven’t come close to striking a close enough balance between investor protection and promoting innovation and growth in the industry. Striking the right balance will require ongoing dialogue between regulators, market participants, and other stakeholders – but also the emergence of equity crowdfunding marketplaces with a steadfast commitment to transparency and compliance.
Citizens can advocate for equity crowdfunding in front of regulators by engaging in advocacy efforts and providing feedback on proposed regulations. Here are some steps that citizens can take to make their voices heard:
1. Stay informed: Citizens can stay up-to-date on the latest regulatory developments by following industry news, attending industry events, and subscribing to regulatory alerts.
2. Join advocacy groups: Citizens can join advocacy groups that support equity crowdfunding, such as the Crowdfunding Professional Association or the National Crowdfunding and Fintech Association. These groups often organize grassroots campaigns and lobbying efforts to influence policymakers and regulators.
3. Provide feedback on proposed regulations: Regulators often solicit public comments on proposed rules, allowing citizens to voice their opinions and concerns. Citizens can submit comments through the SEC's online comment portal or other channels, such as industry associations or advocacy groups.
4. Engage with elected officials: Citizens can engage with their elected officials, such as members of Congress, to advocate for equity crowdfunding. Elected officials can be essential in shaping regulatory policy and giving their constituents a voice.
5. Share success stories: Citizens can share success stories about equity crowdfunding and its positive impact on their communities. These stories help to build support for the industry and illustrate its potential to drive economic growth and innovation.
Citizens can be essential in advocating for equity crowdfunding and shaping regulatory policy. By staying informed, joining advocacy groups, providing feedback on proposed regulations, engaging with elected officials, and sharing success stories, citizens can help to ensure that equity crowdfunding remains a viable and vital financing option for small businesses and startups.
