Regulation Crowdfunding: Differences between Reg A, Reg D and Reg CF
This article highlights crowdfunding regulations and the difference between SEC Reg A, SEC Reg D, and SEC Reg CF.
Raising capital for your dream business venture is probably the most challenging task ever. There are indeed banking institutions and close circles of family and friends to help you start your business, but it certainly goes to your debt account. However, thanks to the opportunities and access to network and fundraising platforms, there is one less thing to worry about. The only way to be free of debts and still receive the required funding for your company is to seek assistance from an equity crowdfunding platform.
But there are specific regulations on equity crowdfunding, and understanding them is crucial to the funding process. This article highlights crowdfunding regulations and the difference between SEC Reg A, SEC Reg D, and SEC Reg CF.
SEC Reg A, SEC Reg D, and SEC Reg CF
The liberty crowdfunding platforms offer through their digital mode of operations help entrepreneurs have a transparent financing process. There are four types of crowdfunding methods: equity crowdfunding, donation crowdfunding, debt crowdfunding, and reward crowdfunding. Among the four methods, equity-based crowdfunding offers safety to investors and beneficiaries. It comes with multiple benefits to companies, especially startups, with its conventional fundraising process. Let’s understand more about equity crowdfunding before diving into its regulations.
What is Equity Crowdfunding?
In equity crowdfunding, investors offer to fund business projects with potential growth in return for an equity share in the company. Startups and companies at their early stage can benefit highly from this crowdfunding type. With founders offering company shares for capital, there is no room for debt. As the company shows value growth, the investors will reap the benefits of their funding later in the company. Just like the investors have greater chances of making profits if the company performs well, there is also greater risk involved when the company’s performance does not go as planned.
An investor in equity crowdfunding receives a stake from the company equivalent to his investment. This type of crowdfunding also offers opportunities for investors to offer smaller contributions, unlike the process in conventional fundraising campaigns.
Importance of Equity Crowdfunding
It is a fact that such crowdfunding options involve higher risks as investments are made in ventures that have yet to produce considerable revenue. But the returns an investor receives from well-performing companies are worth the risk. Here are a few reasons why equity crowdfunding is essential for today’s entrepreneurs.
- Easy Access to Capital – From a business owner’s perspective, equity Crowdfunding offers multiple platforms to demonstrate his company’s potential. Unlike traditional capital-raising processes, pitching is not restricted to a certain number of investors. It was challenging to find accredited investors and proceed with other fundraising opportunities if one failed. With the power of online campaigns and a solid social media presence, securing money to support your dream business is easy. All you have to do is find the investors who will see your service scalable, and you are all set to go!
- Less Management Pressure – As a company begins to show a significant increase in value, many investors may come forward to offer more funds in return for shares. This may cause the business owners to increase the number of shares over time. Specific funding methods, especially venture capital firms, tend to dilute the power of shareholders with such an increase. However, it is not the case with equity crowdfunding. The influence of shareholders over the company’s decisions remains the same. This can help the entrepreneurs to have more people to assist with managerial activities.
- Attractive returns – If a business venture qualifies for the approval process of an equity crowdfunding round, it means the investors can sense promising outcomes in the future. A small contribution towards an initiative today can bring in lucrative returns when the company becomes successful. These are perfect rewards for people who fund early-stage businesses, risking their wealth.
Equity Crowdfunding Regulation
The Jumpstart Our Business (JOBS) Act, introduced in the United States in 2012, allows accredited and non-accredited investors to participate in equity crowdfunding. At the same time, it also sets restrictions on the funds a company can secure from these investors. The prime aim of such regulations is to protect the investors’ assets as they are susceptible to fraud.
Equity Crowdfunding types and rules
Equity crowdfunding has certain rules that investors and beneficiaries need to consider before taking a leap. The Securities and Exchange Commission (SEC) instructs the funding companies or firms to register to proceed with the investment process. Based on the regulations passed by the SEC, there are three types of equity crowdfunding – SEC Reg A, SEC Reg D, and SEC Reg CF. These types and the requirements of SEC Reg A, SEC Reg D, and SEC Reg CF are explained below.
SEC Reg A
SEC Reg A crowdfunding is an exemption from the SEC requirements on registration. According to this regulation, the firms that avail of the exemption can experience benefits during the public sale of securities. In 2015, the SEC updated the regulations so the companies could make revenues under two investing options called tiers. Tier 1 allows sales of securities up to $20 million in 12 months. On the other hand, Tier 2 allows up to $75 million worth of security offerings for a 12-month time. You can have an attorney file forms and present them for SEC approval. It takes an average of 3-5 months to be approved.
How does SEC Reg A work?
The other perks SEC Reg A crowdfunding offers compensate for the strict adherence to documentation requirements. The other advantages include the liberty to process financial statements without delivering Exchange Act reports and sticking to audit regulations. The reports must be presented if a company exceeds the limit of 500 shareholders and assets worth $10 million. Before an investor wishes to purchase a company’s securities, he must understand the tier under which the company sells them because the tiers represent two different methods of investments. It must be revealed in the disclosure circular by the companies.
Requirements of SEC Reg A
The requirements of SEC Reg A work differently for both tiers. According to the tier 1 category of investment, a company can sell up to $20 million worth of securities in a year. The statements must also be registered and filed with the SEC, which needs to be approved by the state bodies before selling the securities. The end status of the sale must be reported, and the intermediary reports need not be submitted. According to the tier 2 category, companies can sell securities worth up to $75 million. Every report of audits and financial statements should be filed with the SEC and submitted. However, it is not mandatory for state bodies to qualify them.
SEC Reg D
SEC Reg D crowdfunding benefits private firms and individual entrepreneurs by offering quicker funds than public offerings. There is also a regulation D from the Federal Reserve Board that should not be confused with this regulation. This regulation allows budding entrepreneurs to raise capital without restrictions from accredited investors. Although it does not insist on registering securities with the SEC, the company must file a few forms to qualify for legal approval. SEC Reg D has fewer requirements in comparison with a public offering.
How does SEC Reg D work?
SEC Reg D has three rules such as 504, 506b, and 506c. The first rule, 504, is for companies offering securities up to $5 million annually. Certain exceptions exist in the growth stage, investment, and reporting companies from issuing securities. Rule 506b is the most prominent type under Reg D. It allows the unlimited sale of securities from accredited investors. Rule 506c allows unlimited security sales and is the only regulation allowing general solicitation and advertising for marketing purposes. Raising capital under this regulation is probably the easiest because there are fewer requirements, but it offers equal legal protection to the buyers and investors.
Requirements of SEC Reg D
The requirements of SEC Reg D include accurate disclosure documentation. Firstly, form D must be filed with the SEC adding essential data concerning the securities offering. The security issuer is responsible for presenting a written record of bad acts in the past, if any. Also, compliance with state legislation is crucial while adopting this regulation. Individuals eligible for compensation concerning security sales must be enlisted according to specific state regulations. It is important to remember the advantages that the SEC Reg D offers apply only to the issuers and not their associates.
SEC Reg CF
According to this regulation, crowdfunding companies are not mandated to register with the SEC. Before the updated version of the regulation in May 2016, SEC Reg CF allowed only accredited investors to participate in the offerings. But since the update, any U.S. resident can invest in private and early-stage startups. It now allows companies to receive up to $5 million in funds.
How does SEC Reg CF work?
Now that non-accredited investors can contribute to the companies needing funds, according to the Reg CF, there are more possibilities to make clients prospective investors. Public interest in investments and market values can be gauged using online campaigns. It saves people time and effort, which would otherwise be spent filing disclosures with the SEC. From an investor’s perspective, the opportunity to invest a minimal amount allows even beginner investors to experiment and expect returns. This makes way for companies with growth potential to attract many investors.
Requirements of SEC Reg CF
The companies raising funds through this regulation can receive up to $1,070,000 for 12 months. Investors can invest up to $2,200 if their net worth or income is less than $1,070,000. The companies that do not qualify for SEC Reg CF crowdfunding norms will not be eligible for Crowdfunding exemptions.
Similarly, businesses outside the US, those not compliant with the state’s legal regulations, and companies with no proper business strategy cannot have regulation crowdfunding exemption. Most importantly, any offering must be handled in a single crowdfunding platform registered with the SEC or belong to an SEC-approved dealer.
Difference between SEC Reg A, SEC Reg D, and SEC Reg CF
To understand how independently the three types of regulations work, you must understand the difference between SEC Reg A, SEC Reg D, and SEC Reg CF. Here is the table of traits that differentiate one from another:
|Traits||SEC Reg A||SEC Reg D||SEC Reg CF|
|Issuer||The issuer firm can be relatively young and small.||The issuer firm is usually a small-scale firm with less than $1 million in revenue.||Early-stage issuers are ideal for this type of regulation.|
|Size||The mean offer size is $26 million.||The mean offer size in this regulation is $58 million.||An average of $208k is required.|
|Industries||The top industries here are usually from the financing and manufacturing sectors.||Private funds, technology-based, healthcare, banking, and real estate industries are more prominent here.||Industries like diversified media, personal services, and restaurants are ideal.|
|Time Limit||The offering timeline is between 2 and 4 months on average.||3-4 months is usually the timeline here.||An average of 2-3 months timeline is required.|
|Cost||12% of the total capital raised is the offering cost.||The offering cost is 10% to 12% of the net capital.||5.3% of the money raised is required.|
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