In recent years, crowdfunding has become an increasingly popular way for startups and small businesses to raise money from individual investors. Regulation crowdfunding allows companies to raise money by selling securities to individuals over the internet.
In this blog post, we will talk more about equity-based crowdfunding, which allows investors to own a piece of the company or project they are funding. We will compare and contrast Crowdfunding, Reg CF vs. Reg A+ offerings. And talk through a few pros and cons of investing in regulation crowdfunding.
The short version
- Crowdfunding is a process where many people pool their money together to support a project or venture.
- Regulation Crowdfunding gives the everyday investor access to support or invest in a larger project or venture through the purchase of securities
- There are limits on when and how much you can invest in regulation crowdfunding based on your income and net worth.
- Crowdfunding can offer higher returns but come with more restrictions and risks.
Crowdfunding vs. Regulation Crowdfunding
There are two kinds of crowdfunding: crowdfunding in general and Regulation Crowdfunding, which allows companies to sell securities through crowdfunding. Crowdfunding as a whole is not regulated by the SEC, meaning individuals have less protection. There is also no limit on how much an individual can invest in a crowdfunding campaign.
On the other hand, Regulation Crowdfunding is regulated by the SEC. Regulations were established to protect investors from fraud and ensure they get what they expect from their investment. With Regulation Crowdfunding, there are limits on how much money a company can raise and how much an individual can invest in an offering.
The benefits of Regulation Crowdfunding include:
- Greater transparency: Regulation Crowdfunding campaigns must file with the SEC, so investors have access to more information about the campaign than they would if it was a regular crowdfunding campaign.
- Reduced risk of fraud: Regulation crowdfunding is regulated by the SEC, so these campaigns have a lower risk of fraud.
Read more: What is the SEC? How does it affect my investments?
The JOBS Act and the history of Regulation Crowdfunding
Before 2012, equity investments in businesses were only available to accredited investors. This changed with the passing of the JOBS Act. The goal of the JOBS Act legislation was to stimulate job creation and economic growth by allowing companies to raise money from the public through three exemptions.
- Reg D Rule 506c: This was the first exemption to come into effect from the JOBS Ac. Reg D went into effect in 2013 and allowed companies to solicit and advertise investment opportunities broadly. This was the start of what we now call crowdfunding. The one significant restriction for individuals was that they had to be accredited.
- Reg A+: In 2015, Regulation A+ (Reg A+) went into effect. Reg A+ came with two major differences. First, it allowed businesses to raise money from accredited and non-accredited investors. Second, it put yearly limits on how much money could be raised, whereas with Reg D, there were no limits on the amount that could be raised.
- Reg CF: Regulation Crowdfunding (Reg CF) was aimed at helping startups and small businesses to raise money via the internet. It capped the amount a business could raise at $1,000,000 but allowed them to raise money from accredited and non-accredited investors. There were limits on how much investors could contribute. In 2021, an amendment to Reg CF raised the limit from $1,000,000 to $5,000,000. It also expanded individual investment limits.
The difference Between Reg CF vs. Reg A+
The main difference between Regulation Crowdfunding campaigns under Reg CF and Reg A+ is the amount of money businesses can raise and the reporting the regulation requires.
- Accepts both accredited and non-accredited investors
- Limit of $5,000,000 Raised Annually
- The fundraiser must be incorporated or do business in the U.S. or Canada
- Required to use an SEC registered broker deal or funding portal
- Only required to provide “reviewed financial statements” if raising $1,000,000 or less
With Reg A+, it gets a little more complex, as there are two tiers.
Under Reg A+ in Tier 2, businesses do not need to use a registered broker-dealer or funding portal. On the whole, this shouldn't be a red flag. However, it's advantageous to have a broker-dealer look things over for you as an investor.
Who can be an accredited investor?
Before 2020, accredited investors had to meet one of the following requirements:
- Have an earned income of at least $200,000 (or $300,000 joint income with a spouse) in the previous two years and reasonably expect to continue to maintain that income
- Have a net worth of at least $1 million alone or jointly with a spouse (excluding the value of your primary residence)
- Hold a Series 7, 65, or 82 licenses in good standing
However in 2020, the SEC expanded the definition of accredited investors to include a wider pool of potential investors.
The rule expanded the definition of “accredited investor” to include:
- Individuals with specific professional credentials, such as a license as a securities broker or investment adviser
- Family offices are private funds that invest on behalf of a single family.
- “Knowledgeable employees” of private funds
- Investments by “spousal equivalents.” This means that married couples could pool their assets together to meet the accredited investor thresholds
Read more: How to become an accredited investor
Who can invest in Regulation Crowdfunding?
Anyone can invest in Regulation Crowdfunding, regardless of their accreditation status. However, there are some restrictions on how much non-accredited individuals can invest.
The SEC has a formula to determine how much non-accredited individuals can invest.
- If your annual income or net worth is less than $107,000. You can invest up to the greater of either $2,200 or 5% of the greater of your annual income or net worth during any 12 months.
- If your annual income and net worth are equal to or more than $107,000. During any 12 months, you can invest up to 10% of your annual income or net worth, whichever is greater, but not to exceed $107,000.
Here are some examples from the SEC website:
What are the benefits of Regulation Crowdfunding?
There are numerous benefits of crowdfunding, such as:
- Low investment requirements. If you wanted to invest in an apartment complex, you would have to have hundreds of thousands to millions of dollars in capital to buy a building. With crowdfunding, and depending on the platform, you can invest in a large multifamily apartment deal for as little as $10.
- Ability to diversify. Most investors start with basic index fund investing because they don't need much capital to start. In addition, you get broad diversification by investing in a general index fund that tracks the S&P. With crowdfunding, you can expand the diversity of your portfolio even further. You can add investments in early-stage companies to commercial real estate. Crowdfunding can also let you diversify real estate investments across geographic areas.
- Potential for higher returns: The S&P 500 index has had a historical return of around 10.5% since its inception. Steady monthly investments in an S&P index fund can easily make you millions over several decades. While a 10.5% return is nothing to sneeze at, investing in crowdfunding offers the ability for higher returns. It is not uncommon to have potential returns in the high teens or greater.
How many of you would have loved to invest in Uber or Facebook in their infancy? If crowdfunding was in place back then, it could have been possible.
Read more: Best Real Estate Crowdfunding Sites for 2022
What are the risks of Regulation Crowdfunding?
As with any investment, there are always some risks involved. One of the most significant risks associated with regulation crowdfunding is that it is a relatively new phenomenon, so there is still a lot of regulatory uncertainty. Additionally, regulation crowdfunding campaigns are often oversubscribed, which means that there is a risk that investors will not receive the total amount they expect from their investment.
- No say in how a deal goes. One downside of crowdfunding investing is that you have little to no say in the deal's details. You put your faith in the management team and hope they will be able to execute the plan they developed.
- Management fees. Much like mutual funds have investment fees, so do investment opportunities via crowdfunding. You need to read the fine print to understand all the costs.
- Complex investment vehicles. Many blindly invest in crowdfunding because they think it is a good idea or because they are chasing high returns. But they don't understand the underlying investments. Understanding the business model of the company you are investing in is helpful. Or, if you are investing in real estate, make sure to understand the basics of the asset class.
- High capital requirements. You can sometimes have minimum investment requirements with the more attractive crowdfunding investment opportunities. In some real estate investment opportunities, it's not uncommon to see that the minimum investment requirement is $25,000, $50,000, or more.
- Capital is locked up. You don't have easy access to your investment capital in many crowdfunding opportunities. In some cases, like with real estate syndications, you can have your money locked up for 3, 5, 7 years or more. Be sure you only invest capital that you don't need anytime soon.
Not all crowdfunding sites are created equal. Some offer more flexible terms than others. For example, here's a quick table that compares some of the most popular real estate crowdfunding platforms.
|Platform||Best For||Accreditation Requirement||Minimum Investment|
|RealtyMogul||REIT & Private Deals||No||$5,000|
|Roofstock||Rental Investing||No||Variable Down Payment|
|Origin Investments||Large Private Funds||Yes||$50,000|
|Arrived||Diversified Residential Real Estate||No||$100|
As you can see, these sites vary a great deal in regards to their investment minimums. Also, some are open to non-accredited investors while others aren't.
Compare: Best real estate investing sites for non-accredited investors
The bottom line: Is crowdfunding a good investment?
Overall, Regulation Crowdfunding can be a good investment because it offers the opportunity to invest in early-stage companies and real estate with high growth potential. And it gives individual investors access to opportunities they might not otherwise be able to access.
However, Regulation Crowdfunding is a relatively new phenomenon, so there is still some regulatory uncertainty. Even if regulated, investing in a startup through a crowdfunding campaign is a speculative investment. Also, no two crowdfunding campaigns and their underlying assets are the same. Therefore, it's essential to do your research and consult with a financial advisor before making any investment decisions.