Regulation CF (also sometimes called Section 4(a)(6), or just ‘Crowdfunding’)

Who Can Invest: Open to all investors, but investment limits apply based on income and net worth.

Investment Limits:¹ Investors earning or with a net worth (not counting home equity) under $124,000 can invest up to the greater of $2,200 or 5% of the greater of their annual income or net worth, in all Reg CF offerings, for a given 12 month period (in other words, that maximum is a cap on all Reg CF deals combined that you might invest in in a given year).

Those exceeding $124,000 in both annual income and net worth can invest up to 10% of the greater of their annual income/net worth, with a maximum of $124,000 annually.

Spouses can calculate those numbers jointly.

One last thing. If you’re an “accredited” investor (generally meaning particularly wealthy, but with some other exceptions.. we’ll explain that in our discussion about Reg D in a future installment), none of those limits apply to you, and you can invest as much as you want.

Investment Process: Must invest through a registered funding portal or broker-dealer. Portals ensure regulatory compliance and host disclosures. Broker-Dealers are more highly regulated than funding portals, so their clients are allowed to conduct their offerings more or less on their own website, as opposed to having them listed with dozens—sometimes hundreds—of other deals, which is what happens on a funding portal.

The information each funding portal or broker collects from an investor is essentially the same. But with a portal, you’re typically going to be very aware of the identity of that portal because you’ll be on their website. And you’ll likely need to create an account with the portal separately before starting the investment process.

Meanwhile, if a broker-dealer is running the offering, there’ll be very little mention of them. If you scroll to the bottom of a standalone crowd issuer’s offering page, you’ll be able to identify them in the fine print. But other than that, they make the offering as much about the issuer as possible, and try to stay in the background. This is typically done because there’s a belief that these “direct listings” can be easier to market.

The main takeaway here is that, if an offering  isn’t on a portal with a lot of other listings, just check the bottom of the web page to make sure there’s a broker-dealer connected to the offering, and you should be good to go.

Regardless of whether a Reg CF offering is being run by a funding portal or a broker-dealer, investors are often asked to provide very sensitive information in this process. This may included photocopies of driver’s licenses, or even social security numbers. But again, so long as there is a licensed intermediary connected to the deal, this is standard. Those intermediaries are required by law to collect that information, and they have to keep it confidential.

Think of it this way. When you created your brokerage account at Fidelity, Schwab or TD Ameritrade, which are ALSO securities brokers, you had to provide that same information. Crowdfunding has the same legal requirements, it is just being managed by these specialized platforms instead of multibillion dollar stock brokerages.

Risks and Returns: All three of these deal types are going to feature higher levels of risk, both due to limited liquidity and the typically earlier stage of the companies doing these types of stock sales.

For Reg CF specifically, transfer of the securities you buy is typically restricted for one year, unless it’s done under one of a few exceptions. These can include sale back to the issuer, sales to accredited investors, and sale to or inheritance by a family member or family trust.

Issuer Characteristics: Primarily startups and early-stage companies raising up to $5 million annually. In addition to a few rules beyond the scope of this overview, the issuers should be “operating companies” with business activities or at least a business plan, and must be based in the US. Also, they can’t already be publicly traded.

Companies must file disclosures, including financial statements, with the SEC. In addition to much of this information being present on the company’s offering website, the specifics are all contained in what is called a Form C. That’s the document that an issuer files with the SEC, and you can always access that through the issuer’s deal page.

Issuers in Reg CF offerings also have lots of flexibility in terms of what types of securities they can issue through Reg CF. You’ll see equity/stock, debt, convertible notes, revenue share deals, and sometimes even tokens.

One fairly common structure is called a Simple Agreement for Future Equity, or SAFE. You should understand that SAFEs are not actual securities, and when you invest through one you don’t yet own a piece of the issuing company. That doesn’t necessarily mean that something shady is going on. SAFEs were created by venture capital accelerator groups as a fast-track way for smaller companies to raise money.

What they are is a contract saying that, if certain events happen, you end up with securities because you signed the contract. Usually those events are a public offering, a buyout of the company, or a later fundraising where the company’s value is calculated (i.e., a “priced round”). But some platforms don’t list all three events, so make sure to check on that.

Either way, if you get in on a SAFE and the triggering event happens, when you do get the securities, they are priced at a discount to whatever the company value is at the time of the event, and that’s how you get your return.

A final wrinkle for CF issuers is that they are allowed to sell their shares through a Special Purpose Vehicle, or SPV.

One thing that ends up happening with crowd investing, almost by definition, is that the company is going to end up with a bunch of shareholders. But sometimes the company, or their other early investors, don’t like that idea. When that happens, they’ll set up an entity whose sole purpose is to hold the shares of the company’s investors. Except the investors actually hold an interest in the second entity, as opposed to the company raising the money. Any upside still passes through, minus some management and filing fees, and it helps the company keep its list of investors less cluttered. That entity is a SPV.

Incidentally, this is also one reason that companies use SAFEs—crowd investors in a SAFE are often listed as a group in one row of the company’s investor records.

Make sure to check in next time, when we turn our sites to Reg A.

And Bob Marley’s got nothing to do with it!

That’s the next set of crowdfunding rules—Regulation A.

Til Next Time!