Capital Markets and Crowdfunding Update
Treasury Issues Recommendations on Capital Markets Regulatory Reform, October 6th, 2017
Page 40:
Crowdfunding
The crowdfunding rules implementing Title III of the JOBS Act became effective in May 2016. In the 12-month period following effectiveness, 335 companies filed crowdfunding offerings with the SEC and there were 26 portals registered with FINRA for unaccredited investors. Of the filed crowdfunding offerings, 43% were funded, 30% of campaigns ended unsuccessfully, and the others are still ongoing. Total capital committed was in excess of $40 million. On average, each funded offering raised $282,000 and included participation from 312 investors.
However, in conversations with Treasury staff, market participants have expressed concerns about the cost and complexity of using crowdfunding compared to private placement offerings. Participants cited regulatory constraints, such as disclosure requirements and issuance costs, as well as structural factors, such as the challenges associated with having a large number of investors, as potentially limiting the use of this capital raising method. Some participants also expressed concern that unless crowdfunding platforms can demonstrate clear advantages relative to the ease and availability of private placements, such as meaningfully increasing the amount of investor capital available from unaccredited investors, crowdfunding may lead to adverse selection where only less-attractive companies pursue funding from less sophisticated investors, who may lack the expertise to properly evaluate such investments.
Recommendations
Treasury recommends allowing single-purpose crowdfunding vehicles advised by a registered investment adviser, which may mitigate issuers’ concerns about vehicles having an unwieldy number of shareholders and tripping SEC registration thresholds (2,000 total shareholders, or over 500 unaccredited shareholders). These vehicles could potentially facilitate the type of syndicate investing model that has developed in accredited investor platforms, whereby a lead investor conducts due diligence, pools the capital of other investors, and receives carried interest compensation.
However, risks exist that such vehicles may weaken investor protections by creating layers between investors and the issuer, and present potential conflicts of interest. Appropriate investor protections are critical in the crowdfunding market given the participation of unaccredited investors. Therefore, Treasury recommends that any rulemaking in this area prioritize alignment of interests between the lead investor and the other investors participating in the vehicle, regular dissemination of information from the issuer, and minority voting protections with respect to significant corporate actions.
Treasury recommends that the limitations on purchases in crowdfunding offerings be waived for accredited investors as defined by Regulation D. Crowdfunding might become more attractive if a company can more easily reach its fund-raising goals. Treasury further recommends that the crowdfunding rules be amended to have investment limits based on the greater of annual income or net worth for the 5% and 10% tests, rather than the lesser. The current rules unnecessarily limit investors who have a high net worth relative to annual income, or vice versa, which is inconsistent with the approach taken for Regulation A Tier 2 offerings.
Treasury also recommends that the conditional exemption from Section 12(g) be modified by raising the maximum revenue requirement from $25 million to $100 million. The higher threshold will allow crowdfunded companies to stay private longer. These companies likely lack the necessary size to be a public company and should not be forced to register as public companies until reaching higher revenues. Finally, Treasury recommends increasing the limit on how much can be raised over a 12-month period from $1 million to $5 million, as it will potentially allow companies to lower the offering costs per dollar raised.
