Crowdfunding is an easy and popular way to raise money. In accordance with MarketWatchThe global crowdfunding market was $ 12.27 billion in 2020 and is expected to more than double to $ 25.8 billion by 2027.
Classical music is not immune to crowdfunding. Go Fund Me was used to raise money for a music student to attend a summer music program, go to an audition, or buy a new instrument, and a musician can use Kickstarter to raise money to release an album.
One of the products of the pandemic is classic concert crowdfunding. Earlier this year, “Through the Noise” premiered in London. crowdfunding of classical music concerts…
In this crowdfunding for concerts, called “noisy nights,” people can sponsor concerts that interest them by pledging to pay a certain amount of money. If the concert has enough sponsors to move forward, each sponsor will receive tickets based on the amount deposited. If the concert doesn’t move forward, sponsors don’t pay anything.
Other popular crowdfunding platforms like Kickstarter and IndieGoGo use backer-based platforms similar to noisenights. In sponsor-based crowdfunding, sponsors who contribute a minimum amount usually receive the product or services they are funding. And if a project doesn’t have enough sponsors to promote in a sponsor-based system, sponsors usually don’t pay anything.
Go Fund Me or MightyCause are crowdfunding platforms for donors. The difference between donor and sponsor payments is that payments in the donor system are donations and there is no minimum. Donor systems are best suited for projects or needs that are charitable in nature.
Another type of crowdfunding is stock crowdfunding. Using platforms such as WeFunder, Seedinvest, and StartEngine, equity crowdfunding allows investors to buy a small stake in startups and small businesses. This article discusses equity crowdfunding with a focus on its use in real estate.
Why stock crowdfunding is a sale of securities (while sponsor and donor crowdfunding is not)
Equity crowdfunding is more heavily regulated than sponsored or sponsored crowdfunding. This is because stock crowdfunding is regulated by the Securities and Exchange Commission (SEC).
The Securities Act of 1933 (the Securities Act), passed after the stock market crash of 1929, defines security generally. All promissory notes, stocks, bonds, certificates of indebtedness, profit sharing agreements, investment contracts and many other listed items are defined in the Securities Law as “securities” and are subject to regulation by the Securities and Exchange Commission.
Equity crowdfunding involves the sale of shares or other equity. Thus, it directly falls under the definition of “security” in the Securities Act.
Even if crowdfunding does not fall into one declared category, it can still be a security if it is an investment contract. An investment contract is (1) an investment of money, (2) in a joint venture or pool of assets, (3) with an expectation of profit, where (4) the profit comes from the efforts of the founder or a third party.
By using crowdfunding, both supported and supported by donors, people “invest” money in a common venture. But they do not expect profit. In donor-supported crowdfunding, donors expect nothing in return for their contributions. Crowdfunding supporters expect to receive a product or service in exchange for their contribution, but do not expect a profit.
Readers wishing to learn more about investment contracts should read my previous article. Orange groves, payphones, visas and violins: why your real estate or business investment may be subject to securities regulations…
What is the CF Regulation?
Unless there is an exception, anyone who sells a security must register that security with the SEC. The two most popular exceptions are Rule 506 (b) and Rule 506 (c), neither of which works with stock crowdfunding.
Rule 506 (b) offers cannot be sold by general invitation or general advertising, which can make it difficult for a startup to find investors other than friends and family. In addition, the Rule 506 (b) proposal can only take place for 35 non-accredited investors, and more detailed disclosures are required if non-accredited investors purchase securities.
Rule 506 (c) proposals may be advertised (within the limits set by the SEC). But only accredited investors can purchase securities under Rule 506 (c), and the accredited status of these investors should usually be determined through a third party certification process.
The CF Regulation (Reg CF), effective in 2016, allows advertising and sales to non-accredited investors (with restrictions), but the securities must be sold online through an SEC registered intermediary.
To use Reg CF, the issuer must be incorporated in the United States and have been in business for at least six months. The issuer also cannot be a reporting company under the Stock Exchange Act 1934, a blank company, or has not previously complied with the reporting requirements of Reg CF.
Reg CF requires an issuer to file a Form C with the SEC and disclose specific information about the issuer, its principals, placement, the issuer’s business, and investment risks to investors. Depending on the size of the proposal, the issuer must provide financial statements that are either certified (for proposals of USD 107,000 or less) or verified (for proposals between USD 107,000 and 535,000 or up to the maximum proposal amount for new issuers), or have been audited (for bids over USD 535,000) by a certified public accountant.
The issuer must also file Form C updates within five business days after reaching 50% and 100% of its fundraising targets and must file annual reports with the SEC on Form C-AR in three years (or less in certain circumstances).
The SEC reported that from From 1 July 2018 to 30 June 2019, issuers raised just $ 54 million using Reg CF, with an average collection of just $ 80,000. Reg CF was the least popular way of raising capital for companies. In contrast, issuers raised $ 1.4 trillion using Rule 506 (b), $ 210 billion using Rule 506 (c), and $ 260 million using Rule A.
Crowd reports that $ 214.9 million was raised with Reg CF in 2020, with an average of $ 275,000 raised in each campaign. This is a huge increase over previous years, but Reg CF proposals are still being overshadowed by proposals under Rules 506 (b) and 506 (c). And in 2020, only 48 companies raised the maximum annual amount of $ 1,070,000.
Earlier this year, the maximum amount allowed under Reg CF was increased to $ 5 million from $ 1.07 million. This increase is likely to make Reg CF’s offerings more attractive, especially for real estate companies that typically require over $ 1 million in capital.
What are the disadvantages of stock crowdfunding?
Because there are limits on how much money non-accredited investors can invest, the average investor amounts will be lower in a Reg CF proposal than in a Rule 506 (b) or Rule 506 (c) proposal. And fewer investors means that there should be more investors in the offer. It can be difficult for a small issuer to manage an investor relationship with potentially hundreds of investors. More investors can also complicate the accounting or tax reporting of the issuer.
In addition, SEC-registered intermediaries charge significant fees for their services. Depending on the intermediary and the offer, these fees can range from 9% to 12% of the capital raised. These fees may be in the range that the issuer would experience if it used a broker-dealer in a Rule 506 (b) or Rule 506 (c) proposal, but they are still not insignificant.
Another drawback is that blank check companies cannot use Reg CF. Due to the fast pace of many real estate transactions, real estate funds can raise money before identifying the specific real estate assets they plan to acquire. These funds can be considered blind pools and are therefore prohibited from using Reg CF.
Reg CF may also not be applicable to real estate funds that aim to acquire real estate. In today’s competitive market, many real estate transactions are closed within 60 days of a contract. However, according to the website of one popular intermediary, Reg CF, it usually takes much more than 60 days for a company to reach its funding goal — three to six months.
Crowdfunding and real estate funds
Crowdfunding is usually not the first option that real estate sponsors should consider due to the restrictions on blind pools and the slow pace of capital growth. A Rule 506 (b) or 506 (c) proposal may take the same amount of time, but these types of proposals can be used to raise funds for a blind real estate fund.
It is best for a real estate sponsor who wants to advertise to raise funds from accredited investors using Rule 506 (c). Not only will the number of investors likely be smaller and easier to manage, but accredited investors can better resist the risk and liquidity of real estate investments.
Some real estate funds that are having difficulty raising funds from accredited investors using Regulation 506 (c) or 506 (b) may want to add an accompanying Reg CF offer and sell units to non-accredited investors in the second offer.
Because Rule 506 (b) offers do not allow general advertising and Reg CF offers are advertised, an issuer cannot open a Rule 506 (b) offer and a Reg CF offer at the same time. However, the issuer may close (cease fundraising) pursuant to the Rule 506 (b) offer and switch to the Reg CF offer. The transition from Reg CF to Rule 506 (b) is more risky and should not be made without a waiting period and confirmation that none of the investors in the Rule 506 (b) offer were attracted by advertising a previous Reg CF offer.
One popular approach is to offer both Regulation 506 (c) and Reg CF at the same time. Some issuers believe they can then direct non-accredited investors who respond to Rule 506 (c) advertisements to a crowdfunding portal with instructions to buy shares there. This usually doesn’t work. While both Rule 506 (c) and Reg CF permit general advertising, the type and content of permitted advertising permitted for Reg CF (other than through an intermediary site) is minimal.
As such, an issuer cannot place an investor attracted by general advertising under Rule 506 (c) into a Reg CF offer, even if the Rule 506 (c) offer is completed prior to the commencement of the Reg CF offer. Issuers may use advertisements for both a Rule 506 (c) offer and a Reg CF offer if the issuer restricts that advertisement to “gravestone” advertisements with content permitted by Reg CF.
However, Reg CF may have a place in real estate capital growth. This can be useful for raising additional capital after an acquisition, such as improving a major overhaul. Or the issuer can use Reg CF to raise capital to pay off a high cost bridging loan and refinance the property with a regular mortgage. Reg CF may be appropriate even for a small-owned issuer looking to raise funds of less than $ 1 million. But for most, Reg CF shouldn’t be the first choice for raising real estate fund capital.
This series draws on Elizabeth Whitman’s experience and passion for classical music to illustrate creative solutions to legal problems faced by businesses and real estate investors.