The Securities and Exchange Commission (SEC) has published a statutory report on Regulation Crowdfunding commonly referenced as Reg CF. The mandated report must be forwarded to Congress three years after Reg CF rules became effective (May 2016).
Reg CF is the smallest of three federal “crowdfunding” exemptions allowing issuers to raise just $1.07 million from both accredited and non-accredited investors.
According to the report authors:
“the number of crowdfunding offerings, as well as the total amount of funding during the considered period, was relatively modest.”
The report tallies activity under Reg CF from May 2016 to December 31, 2018. At the end of the period, there were 45 active Portals and 9 Broker-Dealers which had participated in at least one Reg CF offering.
Three platforms accounted for two-thirds of all initiated offerings and proceeds raised.
According to the SEC:
- Between May 16, 2016, and December 31, 2018, there were 1,351 offerings, excluding withdrawn filings, seeking in the aggregate a target, or minimum, amount of $94.3 million and a maximum amount of $775.9 million.
- Of the completed offerings, approximately $107.9 million has been raised during the period.
- 29 offerings reported raising at least $1.07 million from May 16, 2016, through December 31, 2018
- The typical offering was small and raised less than the 12-month offering limit. The median target amount sought was $25,000 and the median maximum amount sought was $500,000.
- Pointing to an external report, the SEC notes that the total number of investors in successful offerings increased from 77,558 in 2017 to 147,448 in 2018
Regarding the cost of launching a Reg CF campaign, the SEC states:
“According to the survey, the average issuer employed three people who collectively spent 241 hours to launch a crowdfunding campaign. Based on the survey estimates, the total cost of creating a campaign page, issuer disclosures, film, and video, and hiring a marketing firm, a lawyer, and an accountant amounts to approximately 5.3% of the amount raised.”
The report mentions that cost and complexity have impacted this sector of online capital formation. The authors point to previous SEC Small Business Forums where participants have made recommendations to improve Reg CF for the past few years but to date, no action has been taken on these recommendations.
The document includes some anecdotal feedback from crowdfunding platforms. For example, one platform states that “while few offerings reach the current limit, many issuers choose not to rely on the crowdfunding exemption because the limit is too low.”
Another intermediary thought the current cap was ok.
But several respondents stated that the offering limit should be higher, recommending limits from $5 million to $20 million.
Negative Selection Bias?
Importantly, the SEC report states:
“Some of these market participants stated that the existing offering limit may deter some high-quality, high-growth issuers with substantial financing needs from relying on Regulation Crowdfunding, thereby lowering the average quality of issuers in the Regulation Crowdfunding market. One intermediary respondent stated that raising the offering limit could attract more issuers and expand opportunities for non-accredited investors.”
Many platforms have crafted a workaround to bypass constricted Reg CF rules regarding investment caps and investors limitations. It is now commonplace to run two concurrent offerings: a Reg CF and Reg D side-by-side for accredited investors. But some intermediaries told the SEC this was “unnecessarily confusing to investors and more costly to issuers.”
The report says that no enforcement actions have been taken against Reg CF issuers by the SEC but FINRA has taken 4 separate actions against a funding portal and NASAA says a small number of actions have been taken by state regulators.
A fair amount of review is given to the development of (or lack of) a secondary market for Reg CF issued securities. To date, no platform has been able to successfully maintain a marketplace for securities as the size of the market is simply too small and affiliated costs too high.
The important concept of a Special Purpose Vehicle (SPV) for aggregating investors into a single entity is addressed. The report cites the potential investor protections an SPV structure could provide. An SPV could facilitate a vehicle where “small investors [could] invest alongside a sophisticated lead investor who may negotiate better terms, protect against dilution by negotiating during subsequent financings, mentor the company, and represent smaller investors on the board.”
The report contrasts the US market to several other global jurisdictions.
In contrast to the UK, the largest European crowdfunding market, approximately £333 million ($450 million) was raised during 2017, a number that is “significantly larger” than the reported amounts raised by US crowdfunding issuers during the entire period of the SEC study.
Of course, the UK economy and population is also dramatically smaller than the US.
The SEC study notes that:
“crowdfunding investors in the UK are subject to more favorable tax treatment compared to their US peers” and “UK regulations also generally permit issuers to raise larger amounts of capital through crowdfunding offerings compared to the offering thresholds in Regulation Crowdfunding.”
The UK tax treatment mentioned by the SEC references two popular programs designed to boost innovation and entrepreneurship: the Seed Enterprise Investment Scheme (SEIS) and the Enterprise Investment Scheme (EIS). Both programs mitigate investor risk while providing material tax benefits for investors such as immediate tax deductions and no capital gains*.
So the statutory report by the SEC will be forwarded to Congress for review. It is evident that Reg CF is providing some limited success to smaller issuers, creating jobs and opportunity, but this success is rather small. It could be improved.
Now the next question is what will elected officials do with the information provided by the SEC? Will these officials decide to act and improve Reg CF? Or will the report gather dust on a Congressional shelf somewhere?