Equity Funding Blog

The Three Types of Equity Crowdfunding

crowd funding word cloud

Because most people tend to associate the term “crowdfunding” with platforms like Kickstarter and GoFundMe, many people assume that equity crowdfunding platforms (ECPs) operate just like they do. There are some similarities between those platforms and ECPs, but at the end of the day, sites like those don’t provide investors with a material return on investment. They’re donation and reward-based platforms that are primarily used to fund social causes, films, and other projects generally associated with the arts or entertainment. Equity crowdfunding gives investors the chance to invest in a startup or existing company and to gain a percentage of ownership in the company.

There are several articles on the web that will tell you equity crowdfunding is not legal yet, and they’re not entirely wrong. Those articles are referring to equity crowdfunding under Title III of the JOBS Act, or Equity III crowdfunding, which is still pending review by the SEC. Title III is not likely to go into effect until mid-May of 2014. However, ECPs like EquityNet currently operate under existing securities laws, so while one type of equity crowdfunding is not currently available, two others are. We call these two types of equity crowdfunding Equity I and II. We’ve provided a brief summary of all three types below.

Equity I Crowdfunding

Equity I crowdfunding is a product of the IPOnet, SEC No-Action Letter issued in 1996. This no-action letter allows for accredited investors to view private investment opportunities on a password-protected site, such as EquityNet. The vast majority of issuers who use Equity I crowdfunding rely on Rule 506 of Regulation D, which allows small businesses to raise an unlimited amount of capital from an unlimited number of accredited investors.

Of the three types of equity crowdfunding, Equity I exposes entrepreneurs to the smallest investor audience due to the fact that their offerings can be viewed only by accredited investors via a password-protected platform. Consequently, entrepreneurs who use Equity I crowdfunding are only able to reach out to a subset of the 6-8 million accredited inves- tors in the US. Despite the relatively small investor audience, issuers using Equity I have the least amount of regulatory compliance when compared to Equity II and Equity III crowdfunding. For more information regarding the requirements to file under Rule 506, click here.

Equity II Crowdfunding

On September 23rd Title II of the U.S. JOBS Act became effective, allowing businesses to publicly advertise their need for funding for the first time in 80 years. The new exemption it created, Rule 506(c), lifted the ban on general solicitation that was adopted in 1933 and ushered in a new type of crowdfunding called Equity II. Companies that engage in Equity II crowdfunding can raise an unlimited amount of capital from an unlimited number of accredited investors. A company that uses Equity II must take reasonable measures to verify the accreditation status of a potential investor.

Equity II crowdfunding exposes entrepreneurs to nearly all of the 6-8 million accredited investors in the US, but because the issuer can publicly advertise his or her need for funding and is responsible for verifying the accreditation status of an investor, filing requirements are more extensive than those under Equity I crowdfunding. For more information regarding the requirements to file under Rule 506(c), click here.

Equity III Crowdfunding

Whenever you read an article that states equity crowdfunding is not legal, it’s referring to Equity III crowdfunding. On October 23, 2013 the SEC voted to propose rules under Title III of the JOBS Act. These rules will create an exemption under current securities laws to allow unaccredited investors to participate in equity crowdfunding and will allow ECPs to offer and sell securities online.

The proposed rules are currently under-going a 90-day public comment period.

After that, the SEC will take 30 days to evaluate the comments and set up another vote 15 days after their review period. When Title III is passed into law, Equity III crowdfunding will expose entrepreneurs to the largest investor audience because they will be able to advertise their capital offerings to over 50 million Americans. However, exposure to a larger investor audience also means that entrepreneurs will have more regulatory compliance to deal with, including financial audits.

If you want to start an ECF campaign, there are several factors to consider. A successful campaign is founded in diligent preparation and forethought. Before starting your ECF campaign, you should:

1) Determine the best type of ECF that suites your needs. Fundraising needs vary depending on what industry sector your company is in. You will need to decide what type of investors you want to reach, how much capital you need, and the amount of regulatory compliance you’re willing to deal with.

2) Familiarize yourself with regulatory requirements. It is essential that you do this or seek assistance from a professional. Governing agencies will not hesitate to take legal action should you not comply with regulations. Do your homework before kicking off your campaign.

3) Create a strong business plan. Not only does this serve as a powerful fundraising tool, it provides you with a framework to effectively manage your business.

4) Find the equity crowdfunding platform that best suits your needs. Look for a platform that stands by its policies to protect its members from fraud, vets its investors, and provides you with an array of fundraising tools including ancillary services and assistance with your fundraising campaign.

This article was originally published in Region’s Business.