Equity Crowdfunding Success Should Spur Further Deregulation

Equity Crowdfunding (Reg CF), the innovative tool that allows middle class people to invest in early-stage companies, has now topped $1.1 billion in investment. Growth has been exponential with 50 percent of all investment occurring in 2021, according to data analytics company Crowdfund Capital Advisors (CCA). Total investment may double in 2022, equaling all previous years combined.

Created by the bipartisan Jumpstart our Business Startups (JOBS) Act, Regulation Crowdfunding (Reg CF) is the Securities and Exchange Commission’s (SEC) implementation of investing in companies through crowdfunding.

The numbers give hope for capital-starved startups and retail investors alike, as it upends traditional vectors for who receives and invests startup capital. As previously reported, in the past two years Black founders received 1.2 percent of venture capital funding and women just 2.3 percent. But those same cohorts were 40 percent of Reg CF startups that raised over $1 million. 

Similarly, CCA found 92.4 percent of all Reg CF offerings took place outside known venture capital meccas.

The numbers validate last March’s loosening of Reg CF rules by the Securities and Exchange Commission. In a 2019 Concept Release, the SEC accepted comments on ways to streamline and improve the private exemptions including Reg CF. This ultimately resulted in vast improvements. In the past 10 months, issuers have enjoyed a higher offer limit ($1.07 million to $5 million), the ability to consolidate retail investors into one legal bucket through a Special Purpose Vehicle, and greater freedom to gauge interest before hiring legal and accounting professionals with Reg CF’s “Testing the Waters” provision.

Similarly, on the investor side, the SEC removed limits on accredited investors and raised limits for retail investors.

Reg CF’s widespread success starkly contrasts the SEC’s initial hostile approach. This included then-Chair Mary Schapiro and Commissioner Luis Aguilar predicting widespread fraud and scams. As NASDAQ Executive Vice President and General Counsel Edward Knight  testified at a March 2017 congressional hearing:

From the outset the SEC’s view of [equity crowdfunding] was they were not for this they and made it, shall I say, needlessly complicated and did not approach it except as this this was something where the public is going to get harmed and we need to narrow it as much as possible.

While the SEC’s newfound appreciation for Reg CF is welcome, the Commission needs to go further. Further deregulatory moves would crate more opportunities for both entrepreneurs and investors looking for new opportunities.

In a 2021 law review article, I suggested several ways the SEC could make Reg CF more attractive to both entrepreneurs and retail investors, summarized as follows:

• Exempt Secondary Trading.Lack of state preemption for secondary trading stifles Reg CF issuers and investors. Shares in Reg CF companies become fully tradable under federal regulations after one year, but remain largely illiquid because of state rules. These restrictions serve no public policy purpose and depress value. If Congress or the Commission preempted state secondary trading laws, alternative trading systems would instantly emerge to serve this waiting and vibrant market. Secondary trading also has massive future implications. Blockchain-based endeavors and tokenized systems are incompatible with state-by-state secondary trading regulatory regimes. As tokens express multiple uses acting as network keys, as well as having currency and security traits, it is imperative that states do not interfere by imposing stifling and dissonant rules.
• Preempt state filing requirements and notice fees. State filing and notice fees serve as an unnecessary tax on entrepreneurs. Fees and filings take up time and increase capital costs. State regulators have no jurisdiction over Reg CF issuers other than to prosecute fraud. All Reg CF filings are publicly available on the SEC database EDGAR, which makes these requirements superfluous.
• Exempt Reg CF from the 12(g) Rule. The 12(g) Rule states that issuers that meet certain requirements for number of investors and assets must register with the SEC, and in essence, go public. The SEC conditionally exempts Reg CF issuers from the 12(g) Rule, but it should make this exemption permanent. Most Reg CF issuers are not ready to face the rigors of registration and need many more funding rounds, making 12(g) a constant and unnecessary worry.
• Raise the Reg CF Offer Limit to $20 million. Raising the offer limit to $5 million was a good start, but the SEC should raise it to $20 million. That would fill the current gap between Reg CF and Reg A+ Tier II.
• Eliminate investment limits for retail investors. The SEC smartly removed limits for Reg CF accredited investors. It should follow suit for all investors, and allow people to assess opportunities and risk tolerance without limits. Bureaucrats have no special acumen to assess opportunities. While some people may act foolishly, they should be free to do so with their own money. The Commission is precluding wealth opportunities for savvy investors that do not meet Accredited Investor criteria.

Reg CF has succeed beyond what the SEC ever imagined, benefiting entrepreneurs and investors alike, but more needs to be done. The SEC can show true vision by deregulating as per the suggestions above.