According to data from Accenture, $12.2 billion in investments made their way into financial technology (fintech) firms during 2014. Of those funds, US firms grabbed the lion’s share of funding, with P2P lending specifically a strong market for investments. However, despite the demand for fintech from investors, one area where the US appears to be lagging is in non-accredited investor equity crowdfunding.
Like many countries around the world, US laws have two classifications of private investors; accredited and non-accredited. The accredited investor designation is limited to high net worth investors with individual income above $200,000 a year ($300,000 for joint income) or have a net worth above $1 million. Once designated as accredited, these investors are deemed ‘sophisticated’ and can invest in a wider range of products including hedge funds, private equity deals, and more recently, crowdfunding deals.
The inclusion of crowdfunding is the result of the passing of the 2012 JOBS Act in the US which included guidelines on allowing entrepreneurs and small businesses to raise funds on crowdfund platforms by selling equity. The main attributes of the Act is an increase the amount of shareholders and assets a firm can have before being required to register its stock with the SEC and become a public company.
However, final implementation of the Act remains stuck with the SEC, which has so far only approved guidelines to allow crowdfunding of accredited investors, thereby limiting those in the US who can invest in private companies to high net worth individuals and not the general public. However, the wait is almost over with the SEC releasing final rules for Title IV of the JOBS Act and potentially making crowdfunding available to non-accredited investors in June.
While the wait for retail based equity crowdfunding has taken place, services for accredited investors have been found demand. Since being approved by the SEC, equity crowdfunding platforms such as AngelList Syndicates and CircleUp have made it easier for accredited investors to fund private companies, using smaller funding amounts. In the case of AngelList, startups raised over $100 million during 2014 from private investors using the crowdfunding platform, with many of them graduating to larger rounds in 2015.
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According to guidelines from the SEC, Title IV of the JOBS Act will allow private companies to raise either up to $20 million (Tier 1) or up to $50 million (Tier 2) from retail crowdfunding investors. On the surface, the rules appear to be a breakthrough that will finally put crowdfunding supply in the hands of retail investors. However, the question remains whether any startups will decide to use Title IV and tap support from retail investors, or prefer to work with smaller groups of accredited investors?
In this regard, executives from CircleUp are skeptical that Title IV will find demand from startups. According to Rory Eakin, co-founder and COO of CircleUp, in a blog post about his opinion on the new rules, Title IV comes with high reporting demands to private firms.
Both Tier 1 and 2 require private firms to submit their funding proposals to the SEC for review
Both Tier 1 and 2 require private firms to submit their funding proposals to the SEC for review. However, the process is expected to be much simpler than filing requirements for going public. With Tier 1, the main differentiator is a requirement to abide by Blue Sky filings, which entails the need to file funding reports in each individual state that firm is raising investments from. As such, to crowdfund from the entire US, a firm would need to submit 50 individual state filings. The alternative is to limit funding to individual states.
While Tier 2 exempts firms with complying with Blue Sky filings, and being able to access up to $50 million, they are required to submit semi-annual and annual reports with the SEC. According to Eakin, the reporting requirements of Tier 2 “is asking a private company to carry much of the same regulatory burden as a public company if they want to raise under Reg A+ Tier II.” In replace of retail crowdfunding, Eakin stated that he believed that companies will gravitate towards sourcing funding that are the most economical for them.
Can’t beat the crowd
Reporting requirements notwithstanding, the reason to be bullish about Title IV is that it offers a wider ownership table. Especially for consumer facing companies, having a large ownership table means scores of vested participants that can become cheerleaders for any startup raising funds. In addition, if done correctly, companies will be able to crowdsource feedback from their investors, of which are exposed to fewer shareholders when limiting themselves to only raising funds from accredited investors.