In the United States, the offer and sale of securities must be registered with the Securities and Exchange Commission (SEC) unless there is an available exemption. Registration is costly and time consuming—consequently, startups and smaller companies usually offer securities in “private placements” that do not require registration. Historically, this has meant that such securities could only be offered only to accredited investors—essentially high wealth persons who do not necessarily require protections of the securities laws.
Beginning with the adoption of the Jumpstart our Business Startups Act in 2012 (JOBS Act), lawmakers and the SEC began implementing measures to increase access to capital by small businesses and to allow a wider range of investors to participate in equity opportunities. One of these measures is Rule 4(a)(6) providing for certain ‘crowdfunding’ activities.
In 2016, Regulation Crowdfunding (Regulation CF) became effective to implement and provide guidance for Rule 4(a)(6) crowdfunding offerings. Crowdfunding allows issuers to use the Internet and social media for securities offerings to raise capital from a large number of people in relatively small individual amounts. This is different than traditional private placements that do not permit any general solicitation and forces issuers to offer only to accredited investors (as defined by SEC regulation). There are various categories of accredited investors, but the term generally refers to (a) an individual with either (i) a net worth (or joint net worth with a spouse/spouse equivalent) of at least $1 million (exclusive of a primary residence) or annual income of $200,000 (or $300,000 together with a spouse/spouse equivalent) in each of the two prior years, with an expectation of this continuing, or (ii) an entity with more than $5 million in assets or in which all equity owners are accredited investors.
Crowdfunding offerings under Regulation CF may be done by United States nonreporting issuers that are not investment companies or blank check companies. Regulation CF allows for general solicitation of both accredited and nonaccredited investors with certain limitations. Crowdfunding offerings must be conducted over the Internet through a single intermediary funding portal platform that is qualified for such offerings. Regulation CF specifies the type of information about an issuer, including financial information, that must be provided to potential investors, which ensures that all potential investors receive the same information. The funding portal must allow for communication between potential investors and the issuer, which provides greater communication and creates interest in the securities.
When first implemented, Regulation CF offerings were limited to $1.07 million in a 12-month period, which limited the value of the exemption. In 2021, the offering amount was increased to allow issuers, together with certain affiliates, to use crowdfunding to raise up to $5 million during a 12-month period. The increased limit greatly expands the value of crowdfunding and makes it a more valuable and viable fundraising tool for issuers, particularly small businesses that need less capital to implement their business plans. The amended regulations also increase the amounts that can be purchased by individual investors and drop such limitations for accredited investors.
The JOBS Act also provides that securities sold in Regulation CF offerings are “covered securities,” preempting state securities regulators from regulating such offerings, other than to potentially require notice and filing with the state.
Given the recent changes to Regulation CF, we expect more issuers to consider selling securities through crowdfunding. When considering options to raise capital, issuers should consider pursuing the flexibility and value offered by Regulation CF.