Last November, the Securities and Exchange Commission (SEC) unveiled several new changes to regulation crowdfunding (CF) and other associated regulations related to raising private capital. Reg CF was introduced in 2016 as part of the JOBS Act and enabled startups and other early-stage companies to raise money through equity crowdfunding, where a group of people provide capital to startups and small businesses in exchange for equity. The SEC’s changes will have a big impact on the companies raising money and potential investors.
1. Startups can now raise more money through equity crowdfunding
Perhaps the biggest headline grabber (as well as the biggest change the SEC made) is that companies can now raise a lot more money through equity crowdfunding. Prior to these changes, the offering limit in a Reg CF raise was $1.07 million. Now, companies can raise nearly five times that amount with $5 million through a Reg CF raise. And the real kicker? They can do this every 12 months.
Slava Rubin, the founder of Indiegogo who actually worked with the Obama administration to help pass the JOBS Act, said $5 million makes all of the work and money that goes into a Reg CF raise much more economical than it was:
“One of the main complaints we heard from entrepreneurs exploring Reg CF were the actual costs associated with the raise. Between financial, legal and platform fees, companies could be looking at setup costs of $100,000 or more. Combined with time, effort and additional marketing expenses, it adds up to a lot of money just to be capped at $1 million. When compared to finding a few angel investors, the costs often don’t justify the effort. But at a $5 million cap, the cost-of-capital economics drastically improve. Also $5 million is real money, not something a few angels can match.”
2. It’s now easier to invest
The SEC also made changes that will allow higher- and lower-income people to invest in startups with greater flexibility, and in larger amounts. Individual accredited investors -- those that have made $200,000 in each of the last two calendar years -- now face no restrictions on how much they can invest through equity crowdfunding.
Additionally, the SEC also changed requirements for non-accredited investors. Prior to the change, U.S. citizens with a social security number and who are at least 18 years of age could invest, but faced certain restrictions:
- If either your annual income or your net worth is less than $107,000, then during any 12-month period, you can invest up to the greater of either $2,200 or 5% of the lesser of your annual income or net worth. In simpler terms, this means you can invest at least $2,200, and then more if 5% of either your annual income or net worth exceeds $2,200. However, if your annual income and net worth both exceed $2,200, you are limited to 5% of the smaller amount.
- If both your annual income and your net worth are equal to or more than $107,000, then during any 12-month period, you can invest up to 10% of your annual income or net worth, but again the lesser amount and not to exceed $107,000.
The SEC didn’t just change Reg CF, but also made changes to other related regulations and exemptions that early-stage and later-stage companies raise capital under.
When startups raise private capital, they must do so under an SEC exemption from the registration of public offerings. For instance, most companies that raise under reg CF are early-stage startups trying to get their seed or pre-seed rounds off the ground. Private companies that raise larger amounts of capital fall under different exemptions.
Companies seeking to raise more than $5 million can do so under different classifications of regulation D, which often may only involve accredited investors. The SEC made changes to rule 504 of regulation D, raising the maximum amount that can be raised from $5 million to $10 million, once again trying to make rule 504 a more attractive outlet for raising capital. Under rule 504, companies that raise capital do not have to register their securities offering with the SEC other than filing a form D when they first sell the securities.
Later-stage companies with lots of traction can raise under regulation A, which is often viewed as a mini initial public offering. Regulation A has two tiers a company can raise capital under. Tier 1 allows companies to raise $20 million of capital in a 12-month period, while companies eligible for tier 2 could raise up to $50 million of capital in the first year. The SEC’s changes just increased the tier 2 capital amount from $50 million to $75 million.
Another big change the SEC made for all registrants was to the “Test-The-Waters” and “Demo Day” communication policies. Now, companies thinking about raising capital through one of these SEC classifications can essentially send certain investors materials to “test-the-waters” and gauge investor interest before the sale of securities.
Additionally, companies that participate in “demo days,” where groups of startups present to potential investors and talk about their companies, can do so without it being deemed as general solicitation or general advertising.