(Spoiler Alert: Accredited investors will be the primary VC source in 2016.)
Startups will soon be able to solicit investments from anyone, thanks to new SEC rules.
The crowdfunding regulations, known as Reg CF (or Title III), open startup equity to all investors, where before companies could only solicit capital from accredited investors.
This is a big change, but it doesn’t mean that hoards of crowdfunding investors will flood the private equity market yet. The shift needs time to take effect, and even so, crowdfunding may not make the best sense for a lot of startups.
Here are five things to expect from the crowdfunding regulations in 2016.
1. Expect to see a flood of online platforms register with FINRA.
The SEC will require all intermediaries in crowdfunding transactions (for example, CircleUp, SeedInvest, and my firm, FlashFunders) to register with “a national securities association” — FINRA is now the only national securities association.
Intermediary platforms will be able to have financial interests in issuers on their own platforms as long as the intermediary receives the financial interest from the issuer as compensation for the services provided through the intermediary’s platform and the financial interest consists of securities of the same class and having the same terms, conditions, and rights as the securities being offered through the intermediary’s platform.
2. Don’t expect companies to be “equity crowdfunding” until mid-2016.
Title III regulations will not be actionable until 180 days after they’re entered into the Federal Register. This means the first Title III offerings will commence in mid-2016 at the earliest.
FINRA will bucket all intermediaries into two categories: “funding portals” and “broker-dealers.”
But between now and mid-2016, there are still a few unknowns. How long will it take for FINRA to approve intermediaries? Will FINRA treat broker-dealers and funding platforms the same? Will FINRA cap the number funding portals and broker-dealers up for approval?
3. Expect Reg D to continue to deliver the majority of capital to startups in 2016.
Accredited investors will still be the primary source of venture capital funding in 2016.
Startups with serious traction (that tend to have more than one option) will use the path of least resistance, which is still Regulation D. Reg D requires no SEC approval prior to taking in funds, just a Form D after the sale of securities.
The fastest growing startups will need more than $1 million, so even if they use Reg CF, they will need to rely on Reg D to fulfill their capital needs.
4. Don’t expect every fundraising platform or intermediary to provide all-in Reg CF services, including Form C, financial reviews, audits, annual filings, etc.
Some existing platforms might not find it economically viable to wrap in all the legal and financial services to conduct Reg CF offering. Additional services will include preparing Form Cs and filing them with the SEC, fulfilling financial reviews and/or audits, and delivering on the annual requirements after rounds are closed.
Platforms with existing in-house legal and finance resources may be able to make this process viable by deferring costs for companies until closing. It would be tough for startups to pay for this up front unless their rounds are for less than $100,000, which require only that the company certifies its own statements.
5. Don’t expect startups to be eager to raise more than $500K via Reg CF.
The SEC published its own estimates on what it might cost to raise between $500,000 and $1 million via Reg CF (page 415-416 of the SEC Final Rules). They considered all of the compliance and intermediary’s costs and estimated a company’s cost to be between $44,000 and $94,000 up front, and $3,000 to $13,000 each year afterwards to fulfill annual SEC reporting requirements.
The bottom line
As equity crowdfunding and Reg CF become more widely recognized vehicles for raising capital, 2016 will be the year the accredited investor puts a serious stake in the venture capital game. The upfront costs and long-term implications of raising funds from both accredited and unaccredited investors together on intermediary platforms is still a murky process that the next year will undoubtedly work to clarify.
Brian Park is cofounder of FlashFunders.