When the JOBS Act was signed into law in 2012, it brought about many changes in the private capital markets, namely, the dramatic increase in the availability of capital from more expansive pools of investors. Later on, 2016 saw Regulation Crowdfunding, also known as Title III or RegCF, go live. At that point, US-based issuers could raise up to $1.07 million from both accredited and nonaccredited investors. Additionally, companies in the startup stage through to full operating companies across all industries can take advantage of this exemption to raise capital.
However, due to the comparatively low limit of RegCF in the early days when the regulation was introduced RegCF was largely overlooked by many companies seeking to raise capital. Now, it continues to gain momentum due to the limit of RegCF increasing to $5 million in March of 2021. Since then, RegCF has reached a significant milestone. In October 2021, companies surpassed a cumulative total of $1 billion raised under the regulation. Now that the limit has increased nearly five times from where it started, we expect the adoption of Reg CF to continue to grow much faster than the half-decade it took to reach $1B.
Getting Started with RegCF
For issuers looking to use Regulation CF for their offering, it is relatively straightforward for those looking to raise up to $1.07 million. For raises of this size, the issuer is not required to submit audited financial statements to the SEC. They must retain a securities lawyer to complete their Form C and obtain a CrowdCheck Due Diligence report. Next, the issuer must find an SEC-registered transfer agent to manage corporate books and cap tables, a requirement under the regulation. Additionally, the issuer must also select a FINRA-registered broker-dealer to raise capital directly from the issuer’s website.
The process for raising up to $5 million is pretty similar. However, the main difference is that issuers require an audit. With this being the only difference, there is not much in terms of the change to the regulatory and compliance requirements.
What do RegCF Broker-Dealers Need?
For broker-dealers working on RegCF raises, it is something different than anything else they’ve done; they need to be prepared to handle things they may not have needed to consider in other types of capital raising activities. These things include:
- Investment Landing Page: Once the landing page is created and ready to go live (a step sometimes done by investor acquisition firms), the broker-dealer must manage it. This includes taking over or registering the domain name. This ensures the broker-dealer is in total control, with the ability to shut it down or change/amend things as needed.
- Back Office: After an issuer signs up with a broker-dealer, the broker-dealer provides them with the escrow and payment rails. For the escrow account, the broker-dealer is on title as a broker-dealer so that they handle all payment components like credit cards, ACH, wire, cryptocurrency, and IRA. Typically, the bank or trust providing the escrow account will also offer wire and ACH. Since broker-dealers currently cannot hold any crypto, crypto payment options allow issuers to submit crypto that gets exchanged into fiat USD.
- Due Diligence: The broker-dealer will be able to rely on the CrowdCheck report, an industry standard.
- Registration: The broker-dealer must be registered in all 50 states to be able to provide the best help to an issuer.
What Compliance is Needed?
The compliance officer also has responsibilities they need to meet for a successful RegCF raise. This included performing ID, AML, KYC, and suitability on each investor who is investing in the offering. Plus, while accredited investors aren’t restricted to the amount of money they can invest through RegCF, the compliance officer can request an individual to go through verification, but it is not necessary. The compliance officer must also manage the KYC process through the entire offering until the money is released to the issuer. Another new change to RegCF is that companies can have rolling closes, which means that they can start closing each time they hit their minimum. When it comes to closing, the broker-dealer must ensure that the company has filed its Form C amendment.
What Does an Issuer Do to Prepare?
While the broker-dealer fills their component of the RegCF raise, an issuer will typically work closely with an investor acquisition firm to bring the eyeballs to the website. The issuer is responsible for meeting their regulatory requirements, like preparing their audit if raising over $1.07 million. Even if an issuer does not have their audit ready, they can still start their raise up to the $1.07 million amount. Once the audit is done, the offering can be amended to go to $5 million instead. Since securities are being sold directly on the issuer’s website, the traffic they’re driving there is only for them. Previously, when RegCF offerings could only be done on a registered funding portal, traffic would be directed to a site with many other offerings as well.
This is not to say that funding portals don’t serve a purpose; instead, some issuers (especially those who have grown out of the startup phase) prefer more direct traffic. Currently, there are over 70 funding portals (and more on the way). Each option has pros and cons depending on the issuer and the raise that must be considered when launching RegCF. Additionally, some investor acquisition firms prefer an individualized landing page because it directs traffic and attention solely to the issuer.
Investment Process for RegCF
When the investor (or potential investor) goes to the landing page and begins the investment process, the first thing collected is their email address. This allows the investor acquisition firm to remarket to the individual if they left the page before completing an investment. Every day, a report of drop-offs will be provided that details which stage of the investment process the investor left. Plus, data is provided as to where each investor is coming from.
After the initial stage of the process, the investor will proceed to enter their information, like how much they want to invest, their income, how they want to invest, and other data necessary to complete the investment. Once all of the information is entered, the investor will review and sign the subscription agreement before submitting their investment.
Once the subscription agreement has been submitted, the investor receives an email allowing them to register their account with the issuer’s private label page to manage the investment they’ve made. Even though the broker-dealer manages the website, the investors’ experience end-to-end is with the issuer. Once the investment is completed, the investor will be able to find it in their portfolio. Through the portfolio, the SEC-registered transfer agent and the company manage the cap table and provide individual investors access to their investments. For each investment, the investor can view all of its details rather than keeping that information in paper documents. They can see what rights they have for each security, how much they invested, how they paid, etc.
Through the entire investment process, not only is the investor involved but there are many other parties involved. Beyond helping the company set up the investment, the broker-dealer also helps to ensure that the issuer has everything ready in their platform. The broker-dealer is then responsible for ensuring that the offering and investors are vetted into the platform as well. Additionally, the compliance officer will also have to verify the investors through the platform’s compliance management system. Once the investor is approved, their funds are sent to escrow, which the broker-dealer monitors to make sure they’ve all arrived. When the minimum is met, the broker-dealer closes, allowing the company to receive their funds and the cap table to be updated.
For 2022, we anticipate that RegCF will be a game-changer. The amount of capital raised under the regulation makes it a perfect fit for seed and Series A companies that may have otherwise used RegD. Like RegD, issuers can target accredited investors, but they can also target nonaccredited as well. This significantly increases the potential pool of investors and opportunities available to raise capital. While there are an estimated 8.5 million accredited investors, only 110,000 have been verified. When considering nonaccredited as well, this number grows substantially to 233 million individuals.