Regulation Crowdfunding: A Game-Changer for SMEs and Startups

Introduction

In recent years, crowdfunding has emerged as a powerful tool for businesses to raise capital, offering a more flexible alternative to traditional financing methods. However, when it comes to offering and selling securities through crowdfunding, companies must navigate the complex landscape of federal securities laws. This is where regulation crowdfunding, also known as equity crowdfunding, comes into play.

Regulation crowdfunding has revolutionized the way small and medium-sized enterprises (SMEs) and startups can access funding. Before the introduction of President Obama's Jumpstart Our Business Startups Act (JOBS Act), raising seed capital was a daunting task for these businesses. They often had to rely on connections with venture capitalists, wealthy individuals, or secure bank loans with favorable interest rates. For over eight decades, only accredited investors with a net worth of $1 million or those who had made $200,000 over the past two years could invest in SMEs or participate in real estate investments.

In 2016, the Securities and Exchange Commission (SEC) introduced regulation crowdfunding to address these challenges. This new framework allows startups and SMEs to raise up to $1.07 million in a 12-month period, opening up new opportunities for growth and expansion. In this article, we'll explore the ins and outs of regulation crowdfunding, its benefits for SMEs, and how it's reshaping the investment landscape.

Understanding Regulation Crowdfunding

Regulation crowdfunding, also referred to as Title III or equity crowdfunding, is a regulatory structure that provides an exemption from standard securities rules. This exemption enables investors to fund startup companies and small businesses in exchange for equity through internet-based regulation crowdfunding platforms.

Unlike rewards-based or debt crowdfunding, equity crowdfunding involves investors providing capital to a startup in return for a share of ownership in the business. Since its legalization in 2016, regulation crowdfunding has gained significant traction. As of December 31, 2018, 1,396 companies had raised a combined $161.5 million through this method.

Key Rules and Legal Requirements

To ensure the protection of investors and maintain the integrity of the system, the SEC has established several rules governing regulation crowdfunding:

1. Fundraising Limit: Companies can raise up to $1.07 million through equity crowdfunding offerings over a 12-month period.
2. Online Transactions: All transactions must take place online through an intermediary, which can be either a regulation crowdfunding portal or an SEC-registered broker-dealer.
3. Investment Limitations: Individual investors are subject to certain limitations on the amount they can invest across securities offered under this system over a 12-month period, based on their income and net worth.
4. Disclosure Requirements: Companies are required to disclose specific information about their business and securities offering.
5. Bad Actor Check: Companies must undergo a "bad actor" check before launching an offering.
6. Transfer Restrictions: Securities purchased in an equity crowdfunding transaction cannot be transferred or resold for 12 months.

Investor Limitations

To mitigate risks associated with investing in startups, regulation crowdfunding imposes certain limitations on investors. These limitations are based on an investor's net worth or annual income:

• Investors with a net worth or annual income less than $1.07 million may invest $2,200 or 5% of their net worth or annual income over a 12-month period, whichever is greater.
• Investors with a net worth or annual income of $1.07 million or above may invest up to 10% of their annual income or net worth across all securities offered over a 12-month period.
• The total amount of securities sold to a single investor via these offerings may not exceed $1.07 million for any 12-month period.

Company Obligations Under Regulation Crowdfunding

Companies wishing to utilize regulation crowdfunding must fulfill certain obligations. These include:

• Filing specific information with the SEC
• Disclosing this information to investors and intermediaries facilitating the offering
• Providing details such as price per share, audited financial statements, public annual reports, majority shareholders information, target offering amount, and business description
• Adhering to communication restrictions regarding the offering

Benefits for SMEs and Startups

Regulation crowdfunding has democratized the investment process, offering numerous benefits to SMEs and startups:

1. Broader Access to Capital: Companies can leverage the internet to reach a vast pool of potential investors.
2. Increased Investor Base: Any individual over 18 years old can now invest in private companies through equity crowdfunding.
3. Inclusivity: Historically underfunded groups, such as female founders and businesses outside major cities, can more easily raise capital from the masses.
4. Brand Ambassadors: Investors in these campaigns often become advocates for the business, potentially recommending its products or services to others.
5. Improved Liquidity: Shares become tradable after one year, offering investors more flexibility and potentially allowing companies to secure better investment terms.

Recent Amendments to Crowdfunding Regulations

In March 2021, the SEC introduced amendments to make equity crowdfunding more accessible. These new regulations include:

• Allowing issuers to move between different exemptions more easily
• Increasing offering limits for Regulation A, Regulation Crowdfunding, and Rule 504 offerings
• Revising individual investment limits
• Clarifying rules governing communications
• Harmonizing disclosure and eligibility requirements

Comparing Regulation Crowdfunding to Other Fundraising Methods

While regulation crowdfunding offers unique advantages, it's important to understand how it differs from other fundraising methods:

Regulation A Crowdfunding

• Open for general solicitation
• No restriction on resale of securities
• Open to US and Canadian issuers
• Higher fundraising limits (up to $20 million under Tier 1 and $50 million under Tier 2)
• Suitable for more established companies due to higher costs

Regulation D Crowdfunding

• Primarily available to accredited investors
• Limited participation from non-accredited investors
• Ideal for early-stage startups with significant revenue and user growth

The Investment Process and Associated Risks

Investing through regulation crowdfunding comes with both opportunities and risks. While it opens up investment opportunities to a broader range of individuals, it's crucial for potential investors to understand the associated risks, particularly given the high failure rate of startups.

The investment process must take place through a crowdfunding intermediary, and companies are required to provide ongoing reporting after receiving investments. This transparency helps maintain investor confidence but also places additional responsibilities on the companies raising funds.

Costs Associated with Regulation Crowdfunding

While regulation crowdfunding offers many benefits, it's not without costs. Companies should be prepared for expenses related to:

• Legal documentation and financial review process (estimated at $4,000 to $10,000)
• Platform fees for the regulation crowdfunding portal (typically 9-14% of the total capital raised, which may be split between cash and equity)

Regulation Crowdfunding Platforms

Several platforms have emerged to facilitate regulation crowdfunding. These intermediaries must register with the SEC and become members of FINRA (Financial Industry Regulatory Authority). Some popular platforms include:

• Buy the Block
• CrowdSource
• Funded.Com
• Equitydoor
• Fundit
• Indie Crowd Funder
• MainVest
• Raise Green
• Slice Capital
• Stampede Securities
• Trucrowd

Post-Investment Considerations

After a successful regulation crowdfunding campaign, there are several important considerations:

• Resale Restrictions: Securities offered under regulation crowdfunding cannot be transferred or resold within the first 12 months.
• Ongoing Reporting: Companies must file information annually with the SEC and post it on their website, fostering transparency and maintaining investor relations.

Conclusion

Regulation crowdfunding has emerged as a powerful tool for SMEs and startups to access capital, engage with a broader investor base, and fuel their growth. By democratizing the investment process and providing a regulated framework for equity crowdfunding, it has opened up new possibilities for businesses and investors alike.

As a digital supply chain finance platform, FreightAmigo recognizes the importance of innovative financial solutions in today's business landscape. While we specialize in logistics and supply chain management, we understand that access to capital is crucial for businesses of all sizes. Regulation crowdfunding represents just one of the many ways that technology and regulatory innovation are reshaping the financial landscape for SMEs and startups.

For businesses looking to leverage regulation crowdfunding or explore other financial solutions, it's crucial to partner with experienced service providers who understand the complexities of modern business operations. At FreightAmigo, we're committed to supporting businesses with their logistics needs, ensuring that once you've secured funding, you can efficiently manage your supply chain and fulfill your promises to customers and investors alike.

As the business world continues to evolve, staying informed about financing options like regulation crowdfunding can help SMEs and startups make strategic decisions for growth and success. By understanding these opportunities and partnering with the right service providers, businesses can navigate the challenges of fundraising and operational management, positioning themselves for long-term success in an increasingly competitive global market.