The Securities and Exchange Commission (SEC) adjusted for inflation some limits for companies (issuers) raising capital through Regulation Crowdfunding (Reg CF). The adjustment raises the maximum amount that nonaccredited individuals—those not meeting certain financial or sophistication thresholds—can invest in Reg CF offerings, along with the amount issuers can offer without audits. Per the Jumpstart Our Business Startups(JOBS) Act of 2012, which created what became Reg CF, the commission must adjust these limits for inflation “at least once” every five years. For the first time since the federalization of the securities laws in the 1930s, Reg CF has invited nonaccredited investors into the lucrative private markets.
The last time the SEC adjusted the limits was in 2017. That raised the offer limit from the original $1 million to $ 1.07 million. The commission justifies its foot-dragging by referencing its November 2020 vote in the private-market review, titled “Facilitating Capital Formation and Expanding Investment Opportunities by Improving Access to Capital in Private Markets.”
That review greatly benefited Reg CF issuers by, among other improvements, raising the offer limit from 1.07 million to $5 million, removing individual limits for accredited investors, and modifying the formula for nonaccredited investors to increase their limits.
But the new rules did not expand the audit “freebie” to the new offer limit. The original JOBS Act required an audit for any issuer offering over $500,000. That decree was unworkable. The SEC listened to commenters and waived the requirement for an issuer’s offer to the maximum $ 1.07 million, requiring instead only CPA-reviewed financial statements. The difference between these two is around $1,500-$2,500 for the review and $20,000 or more for the audit.
The November 2020 rules kept the audit “freebie” at the old $ 1.07 million offer limit; issuers offering more needed an audit. This creates a dilemma for Reg CF issuers: pay for an audit to offer the full $ 5 million or stay at $ 1.07 million for the financial statement review. Many issuers choose to remain at the lower level. That is unsurprising, since an audit is cost-prohibitive to most Reg CF issuers. A 2019 SEC report found the median Reg CF issuer had incorporated two years prior, had three employees, total assets of $30,000, cash on hand of $4,000, and no revenue (roughly half lacked revenue). With the recent inflation adjustment issuers can now offer $1.235 million without an audit.
The SEC should eliminate this dichotomy and allow all issuers to offer the maximum amount without an audit. Given the stage in their life cycle and the uncertainty in how popular their raise will be, nearly all issuers would fail to reach $5 million anyway. But short of that, it should adjust for inflation again next year. Another adjustment may raise the offer limit without an audit to perhaps $1.5 million, a 50 percent increase from the original 2016 version.
Regulation Crowdfunding is working. It has been a huge success in providing early-stage capital to businesses, which would not have gotten it otherwise. During the pandemic, it set multiple records as investors shifted toward online investing, including crossing the $1 billion mark in total investment.
It has become an essential part of many companies’ capital raising strategies even when they have other options, because of ancillary benefits in aligning customer and company economic interests and incentives. And it has dispersed capital more evenly throughout the United States instead of it being confined to a few elite zip codes. In fact, year-over-year growth in Reg CF reveals the top states as Arizona, Utah, New Jersey, Minnesota, Georgia, and Vermont, well beyond the usual coastal money hubs.
(Source: Crowdfund Capital Advisors)
As fears of a deepened recession grow, entrepreneurs will likely to turn to their most ardent supporters for capital, including existing customers, friends, family, and current investors. The SEC should help these job creators by revisiting the inflation adjustments again next year.