Crowdfunding is simply a means to legally advertise a securities offering via the Internet or other means.
The JOBS Act has provisions (Titles II, III and IV) that allow direct advertising of securities on the Internet by private issuers, without the issuer having to be registered as a broker-dealer or having to hire one to sell their securities. Capital markets in the U.S. have evolved to take advantage of these rules.
A short history is in order to understand crowdfunding, as the term is used in today’s capital markets:
Historically,the terms “crowdfunding” and “crowdsourcing” have been used to describe a non-profit, rewards-based scenario, where persons seek donations or backers to fund artistic endeavors such as writing a book or producing a film in exchange for a token gift related to the project (for example, being listed in the film credits, tickets to a preview, or getting an advance copy of the book, etc.). Popular websites such as kickstarter.com, rockethub.com, kiva.com and indiegogo.com list these types of crowdsourcing offerings.
Additionally, others are now using the term “crowdfunding” to describe any form of advertising for investors allowed under Rule 506(c), which allows advertising for verified accredited investors; or Regulation A+ offerings, which are public offerings with limited reporting requirements.
Regulation Crowdfunding, also known as “Reg CF,” is another securities exemption that allows advertising for investors on the Internet for raises of up to $1 million in a 12-month period. However, there are additional regulatory requirements that make the costs of Reg CF somewhat onerous. These regulations include certain requirements such as drafting an offering disclosure document, contracting with a funding portal, complying with financial reporting and fulfilling filing requirements. Such requirements may make Reg CF one of the most costly means of fundraising yet. Additionally, a separate Reg CF offering must be used to raise money for one property at a time. For example, the initial rules didn’t contemplate use of Reg CF for an ongoing fix-and-flip fund, hard-money loan fund or blind pool offering.
Crowdfunding offers a means for issuers of Rule 506(c) or Regulation A+ securities offerings to reach a wider audience of potential investors with whom to build new relationships. This is good for investors, who now have access to a much broader base of private investment opportunities, and for issuers, who now have a means to legally advertise securities offerings to a wider audience of potential investors. Issuers of Rule 506(c) and Regulation A+ offerings can offer and sell securities on their own websites, or they can pay a fee to a “crowdfunding platform” that will push their offerings out to the crowdfunding platform’s database of investors.
Crowdfunding platforms and other crowdfunding companies are currently cropping up like dandelions after a spring rain.
Below is a table that describes the different types of crowdfunding companies at the time of this publication:
Further explanation of some different crowdfunding platforms follows:
Equity-based crowdfunding platforms and some debt-based platforms operate like a listing service. You will generally pay an upfront marketing fee to advertise the offering to the platform’s database of pre-qualified investors. There are no guarantees as to the amount of money a crowdfunding platform will raise, but they usually have a rigorous screening process and only projects that meet their narrow criteria and that their investors have an appetite for are considered. One crowdfunding platform representative told me they only accept about 4% of the deals that are presented to them. The crowdfunding platforms that have been around for a while have a track record and can make a pretty good estimate of how much they might raise for a particular offering before they ever post it.
Another type of crowdfunding platform will sub-syndicate your offering, i.e., they will create their own securities offering and advertise, via their website, to their own group of investors, using a “fund of funds” structure. Their syndicate will either loan you money or invest as a single investor in your deal. Because they have developed pre-existing relationships with their own groups of investors, they may even invest in a Rule 506(b) offering.
What You Need to Know
When you find accredited investors through a Rule 506(c) crowdfunding platform, you may be able to develop direct relationships with the referred investors and henceforth use them in future offerings. For crowdfunding companies that create a “fund of funds” to invest in an issuer’s offering, you will develop your own relationship with the principals of the crowdfunding company. However, it is unlikely that the crowdfunding company will be willing to share its investors’ contact information with you.
Most crowdfunding platforms are seeking experienced syndicators. They will typically commit to raising a portion of the funds (e.g., up to 50%), and expect you to raise the rest (although some may raise all of the needed funds). Crowdfunding platforms spend a lot of time generating relationships with private investors so that when they accept a new customer, they can “push” the offering out to their database of investors. At the time of this publication, most crowdfunding platforms would commit to raising $1 million to $3 million, although this amount is increasing over time as the crowdfunding platforms, the syndicators who use them, and the investors who become their “members” get more experienced with this type of investing.
Some crowdfunding platforms use securities broker-dealers as a selling component; some use registered investment advisers; and other issuers strictly sell on their own securities.
Further, several companies offer “white label” platforms where you can pay an upfront fee plus periodic maintenance fees to create your own crowdfunding platform to fund your own offerings to your own group of investors. Only time will tell which platforms, models and companies will survive, both from a practical and legal standpoint. But all in all, this is an exciting time for those brave enough to test the waters.
A summary table showing the different types of crowdfunding companies is provided below: