A report card for the SEC’s new equity crowdfunding rules

This month, the Securities Exchange Commission approved major updates to rules enacted via the 2012 JOBS Act. Their stated goal was to “harmonize” the guidelines that establish exemptions for equity crowdfunding, Reg D and Reg A+ offerings. These changes are a powerful step forward for both startups and investors alike.

This is a space I’ve watched closely since we launched Indiegogo in 2008 and Vincent earlier this year. I spent four years working with the Obama administration, the SEC and FINRA to help pass the JOBS Act in 2012. After that, it took another four years of rule refining with the SEC and FINRA before finally seeing equity crowdfunding go live in May 2016. At Indiegogo, we worked with several great partners, helping fund nearly 150 businesses via equity crowdfunding in just a couple of years.

For those who worked behind the scenes, we knew that the initial 2016 rules for equity crowdfunding were baby steps. We were balancing unknown risks with legacy rules, aiming toward broader democratization for both investors and entrepreneurs. Now, crowdfunding’s day has come, and I commend all involved including the regulators, politicians, startups and investors who all worked together to push the ecosystem forward to the next step.

That said, even today equity crowdfunding isn’t perfect. There are limits to how much you can raise, how you can communicate and how much documentation you need to provide. In reality, it’s not much different than raising from a pre-seed or seed investor, or far removed from a traditional product crowdfund. In short, it works.

The SEC made some important changes to the rules, and it’s valuable to explore them one by one. Rather than look at them on a macro scale, here are some of the bullet points that are important to entrepreneurs.

  • Regulation Crowdfunding (Reg CF) is the basic equity crowdfunding raise for companies. Now, companies can raise up to $5 million from investors, up from the current $1.07 million cap. Any investor can participate.
  • Regulation D, Rule 504 (Reg D) is another type of equity crowdfunding, but exclusively for accredited investors. With the new rules, its maximum funding cap raises to $10 million from $5 million.
  • Regulation A+, Tier II (Reg A+), which is for more established companies, can now raise $75 million via equity crowdfunding, up from the current $50 million. This is a huge move, enabling established companies to gain millions of dry powder. Any investor can participate.
  • Thanks to a “test the waters” provision, companies can build Indiegogo-like crowdfunding pages that allow companies to share information with investors prior to fundraising. This is new for Reg CF, but was previously allowed for Reg A+.
  • Demo day communications, in general, will no longer be considered general solicitation.
  • Reg CF and A+ offerings can use special purpose vehicles (SPVs) to consolidate their investor base into a single line item on a cap table.
  • Reg CF fundraisers can be done every 30 days, down from every 180 days.

Now for a report card. In hopes of clarifying these changes a bit, I looked at each specific point and gave it a letter grade depending on how important it will be to up-and-coming entrepreneurs. While many of the rules got an A or better, some are still lagging and, as we move into a new administration and new year, the difference between crowdfunding success and failure could be spelled out in these simple changes.

1. Regulation Crowdfunding (Reg CF) limit increase

Grade Previous rules (2016) Updated rules (2020)
A Maximum allowed fundraise of $1.07 million Increase in maximum fundraise to $5 million

This change is significant. One of the main complaints we heard from entrepreneurs exploring Reg CF were the actual costs associated with the raise. Between financial, legal and platform fees, companies could be looking at setup costs of $100,000 or more. Combined with time, effort and additional marketing expenses, it adds up to a lot of money just to be capped at $1 million. When compared to finding a few angel investors, the costs often don’t justify the effort. But at a $5 million cap, the cost-of-capital economics drastically improve. Also $5 million is real money, not something a few angels can match.

2. Regulation A+ Tier II limit increase

Grade Previous rules (2016) Updated rules (2020)
C Maximum allowed fundraise of $50 million Increase in maximum fundraise to $75 million

In this case, it’s nice that the cap has gone up, but this isn’t a game-changer. Rarely do Reg A+ offerings even hit the $50 million cap, and those considering Reg+ rarely cite the cap as a key deciding factor. It’s always nice to see the number go up, but this doesn’t change much.

3. Reg D (Rule 504) limit increase

Grade Previous rules (2016) Updated rules (2020)
B Maximum allowed fundraise of $5 million Increase in maximum fundraise to $10 million

While similar to Reg A+ above, this is incrementally better since the limit for Reg D was only $5 million previously. Doubling to $10 million is a nice jump and the difference between five and 10 is legitimate.

4. ‘Test the waters’ for Reg CF

Grade Previous rules (2016) Updated rules (2020)
A+ Companies are not allowed to do any investor marketing until the offering is open. Companies can now “test the waters” and openly discuss the investment opportunity prior to the offering opening.

This is awesome. As mentioned before, running a Reg CF fundraiser can be expensive. Now, being able to test for investor interest without having to commit to the costs or efforts of the full offering is huge for companies. This also lowers the barrier of entry for companies exploring a raise, which in turn should expand the number of offerings launched. I expect 2021 to be full of test-the-water campaigns.

5. Demo day communications for Reg CF

Grade Previous rules (2016) Updated rules (2020)
B Companies cannot disclose an upcoming investment opportunity at demo days. Companies can now announce and court investors at demo days.

This is nice, but primarily impacts incubators and accelerators, which are a small portion of the startup ecosystem. This does formalize a gray area of the previous rules though, which is very helpful from an uncertainty perspective.

6. Special purpose vehicles (SPVs) allowed for Reg CF and Reg A+

Grade Previous rules (2016) Updated rules (2020)
A+ No SPVs allowed, all investors must individually be listed on a cap table. Companies can now pool all investors from a public fundraise into a single SPV, one line on the cap table.

This is huge. One of the biggest challenges with the previous rules was that SPVs were not allowed, forcing every single investor to be on the cap table. This is a nightmare for businesses trying to manage communications, compliance and document sharing for hundreds of individual investors. Now, all Reg CF investors can be consolidated into a single SPV — represented as a single entity on the cap table. So much cleaner, so much easier — this is a game-changing update.

7. Shorter fundraising cycles (Reg CF)

Grade Previous rules (2016) Updated rules (2020)
A Companies can only fundraise once every 180 days. Companies can now fundraise every 30 days.

This seems trivial, but I think this change is important. This allows for the entrepreneurs to create tranches, which is great for price discovery and momentum. One example is a company can raise $2 million at one price and then another $2 million offering at a higher price 30 days later. All of this will still need to comply with the $5 million total raise cap over a 12-month period. A company can also move from one regulatory exemption to another more swiftly. I think more and more people will talk about this change.

Concluding thoughts

These rules should go into effect for use early next year. While there is always room for improvement, I expect it to be an exciting 2021. For those of us who have worked for nearly a decade on these rules, this may feel like another baby step.

But when taking a five-year viewpoint, these changes are massive improvements. I am excited that these actions further speed money velocity and allow more people on both the entrepreneurial and investment side of the ecosystem to participate.