April 21, 2020

Investment Crowdfunding Regulations Explained

Most investors are familiar with the word “crowdfunding” and have a general impression of what it means. Stated simply, investment crowdfunding is just a mechanism by which a company (the “issuer”) raises money to fund or finance its operations and growth by selling securities to multiple investors ( the “crowd”).

Crowdfunding is frequently used as a tool to allow people to invest with others in assets such as real estate, including farmland, as a way to diversify their investment portfolio. These offerings are often, but not always, conducted online through a platform or portal.

For example, AcreTrader allows investors to invest in farmland even if they don’t know how to operate a farm and/or cannot afford to purchase a whole farm.

When investing in crowdfunding opportunities, you will often hear the terms “Reg D”, “Rule 506(b) or (c)," “Regulation Crowdfunding or CF”, and “Regulation A+,” with little explanation of what these mean.

Each of those terms refers to a specific exemption in the U.S. Securities Laws that would allow a company to sell securities to multiple investors without being required to register those securities. The purpose of this blog post is to educate potential investors about these exemptions and what an investor might expect to see with each of them.

Before we get into the details, here is a high-level (not all-encompassing) overview of the unique characteristics of the most widely used securities exemptions.

For more specific details on each of these exemptions commonly used for real estate crowdfunding and other forms of crowdinvesting, you can find more detailed explanations later in the article.

High Level Overview Of Crowdfunding Regulations

Regulation D - Rule 506(b)

  • Unable to widely market securities
  • Mandatory investment holding period
  • Must provide financial statements on the offering with no false or misleading statements and disclosure documents for non-accredited investors.
  • Company must verify accredited investor status

Regulation D - Rule 506(c)

(What you will typically see on AcreTrader)

  • Only open to accredited investors
  • Ability to market securities
  • Mandatory investment holding period
  • Company must verify accreditation with financial documentation

Regulation Crowdfunding (Reg CF)

  • Open to accredited and non-accredited investors
  • Mandatory investment holding period
  • Limited marketing capabilities
  • Specific investment limits based on income or net worth
  • A single investor may only invest up to $107,000 in any single year.

Regulation A+ - Tier 1

  • Raise up to $20 million over a 12-month period
  • Open to accredited and non-accredited investors
  • Must be pre-registered through a lengthy application process
  • Ability to market securities
  • Must include reviewed (not audited) financial statements
  • Financial status can be self-certified by investor

Regulation A+ - Tier 2

  • Raise up to $50 million over a 12-month period
  • Open to accredited and non-accredited investors
  • Must be pre-registered through a lengthy application process
  • Ability to market securities
  • Must include audited financial statements
  • Financial status can be self-certified by investor
  • Non-accredited investors cannot invest more than 10% of net worth or income

While this high-level overview covers some of the key differences between these crowdfunding regulations, please continue reading for a more detailed explanation of each.

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An Overview Of Regulation D

Issuers frequently rely on Regulation D (“Reg D”) to raise investment capital. There are two exemptions under Reg D provided in Rule 506(b) and 506(c).

These rules differ with respect to the type of solicitation that may be made, disclosures required and the type of people who may invest. Shares issued under Rule 506(b) or 506(c) will be restricted and may not be sold by the purchaser for at least 6 months to a year.

As summarized by the SEC in its Fast Answers regarding Rule 506 of Regulation D, the following are the characteristics of offerings under Rule 506(b) and Rule 506(c):

From the Securities Exchange Commission:

Under Rule 506(b), a “safe harbor” under Section 4(a)(2) of the Securities Act, a company can be assured it is within the Section 4(a)(2) exemption by satisfying certain requirements, including the following:

  • The company cannot use general solicitation or advertising to market the securities.
  • The company may sell its securities to an unlimited number of "accredited investors" and up to 35 other purchasers. All non-accredited investors, either alone or with a purchaser representative, must be sophisticated—that is, they must have sufficient knowledge and experience in financial and business matters to make them capable of evaluating the merits and risks of the prospective investment.
  • Companies must decide what information to give to accredited investors, so long as it does not violate the antifraud prohibitions of the federal securities laws. This means that any information a company provides to investors must be free from false or misleading statements. Similarly, a company should not exclude any information if the omission makes what is provided to investors false or misleading. Companies must give non-accredited investors disclosure documents that are generally the same as those used in Regulation A or registered offerings, including financial statements, which in some cases may need to be certified or audited by an accountant. If a company provides information to accredited investors, it must make this information available to non-accredited investors as well.
  • The company must be available to answer questions by prospective purchasers.

Under Rule 506(c), a company can broadly solicit and generally advertise the offering and still be deemed to be in compliance with the exemption’s requirements if:

  • The investors in the offering are all accredited investors; and
  • The company takes reasonable steps to verify that the investors are accredited investors, which could include reviewing documentation, such as W-2s, tax returns, bank and brokerage statements, credit reports and the like.

Regulation Crowdfunding Explained

Regulation Crowdfunding (“Reg CF”) was enacted as Title III of the JOBS Act of 2012. It allows eligible issuers to raise up to $1,070,000 in a 12-month period via an intermediary (either a broker-dealer or a funding portal registered with the SEC and FINRA).

Individual investors do not have to be accredited, but are subject to limits on the amounts they may invest in all Regulation CF offerings over a 12-month period as follows:

If either of an investor’s annual income or net worth is less than $107,000, then the investor’s investment limit is the greater of:

  • $2,200 or
  • 5 percent of the lesser of the investor’s annual income or net worth.

If both annual income and net worth are equal to or more than $107,000, then the investor’s limit is 10 percent of the lesser of their annual income or net worth.

During the 12-month funding period, the aggregate amount of securities sold to an investor through all Regulation Crowdfunding offerings may not exceed $107,000, regardless of the investor’s annual income or net worth.

Note that spouses are allowed to calculate their net worth and annual income jointly.

In terms of disclosures an investor should expect to see from an issuer relying on Regulation CF, the issuer must provide the investors with: Information about officers, directors and 20% owners, a description of their business, the use of the proceeds from the offering, the price (or method of determining the price) of the securities, the target offering amount and estimated deadline to reach the target amount, whether the issuer will accept investments in excess of the target offering amount and certain related party transactions.

The issuer must also provide financial information and a discussion of its financial condition. Depending on the amount raised, the financial statements provided will either be “reviewed” by an independent accounting firm or audited.

The issuer must also provide ongoing amendments noting any material changes to the offering or their business for any offering that is still open. Investors will also receive annual reports (available via EDGAR and posted on the issuer’s website) from the issuer not later than 120 days of the end of its fiscal year.

The issuer may advertise the terms of the offering only by a brief notice that directs investors to the intermediary’s platform and must only reference the terms of the offering, a link to the intermediary’s platform and factual information about the issuer’s business. The intermediary may not offer investment advice to the investors.

An investor who purchases securities in a Reg CF offering should expect to hold them for at least one year unless they are transferred back to the issuer, to an accredited investor, as part of a registered offering or to a family member or trust controlled by the investor.

One limitation often discussed is that Reg CF platforms often do not have the ability to “curate” or limit the offerings brought to market. This means that even if the platform views a particular offering as a “bad” one, they may have to allow it on the investment platform anyway.

Regulation A+ Overview

Regulation A+ (“Reg A”) implemented under Title IV of the JOBS Act provides an opportunity for smaller and earlier stage companies to access public funding with more limited disclosure requirements and less expense than undergoing an initial public offering (IPO) through means such as equity crowdfunding investment platforms.

There are two "Tiers" within Regulation A+ with key differences to note. As an investor, it’s important to know which Tier the offering you are considering investing in is offered under because the disclosure requirements are different for each Tier.

Tier 1 of Reg A allows a company to raise up to $20mm in one 12-month period and Tier 2 would allow an issuer to raise up to $50mm in one 12-month period.

Importantly, an issuer in a Reg A offering is allowed to advertise the offering freely and an investor does not have to be accredited to invest in a Reg A offering.

However, if one is investing in a Tier 2 offering, is not an accredited investor, and the securities being offered will not be listed on a national exchange, an individual investor may invest no more than 10% of the greater of the person’s (alone or with a spouse) annual income or net worth (excluding the value of the person’s primary residence and any loans secured by the residence (up to the value of the residence).

Also, unlike in Reg D, a person may self-certify income or net worth for purposes of the investment limits.

The first document a potential investor sees in a Tier 1 or Tier 2 offering is the Offering Circular (Form 1-A) prepared by the issuer. This document must be submitted to the SEC and is subject to review and qualification.

If the issuer decides to “test the waters” by soliciting indications of interest prior to qualification of the offering circular, copies of materials provided to investors must be given to the SEC.

The offering circular contains information required about the issuer’s operations, including information about officers, directors, the business plan, risks of investing and financial information.

Note that Tier 1 offerings may use reviewed financial statements, but Tier 2 offerings must include audited financial statements.

After a Tier 1 or Tier 2 investment, the shares purchased are not restricted and may be re-sold without a holding period such as required with Reg D or Regulation CF offerings.

A Tier 1 offering does not have ongoing reporting obligations for the issuer, but a Tier 2 offering requires the issuer to file Form 1-K annually within 120 days of the end of the fiscal year that includes audited financial statements for the year, a discussion of financial results for the year, information about the issuer’s business and management and related-party transactions and share ownership.

Tier 2 issuers must also file semiannual reports on Form 1-SA within 90 days after the semiannual period with interim unaudited financial statements and discussion of financial results for that period.

Finally, a Tier 2 Issuer must file a current report on Form 1-U within 4 days of certain events including a fundamental change, bankruptcy, change in accountant, change in control, departure of officers or non-reliance on prior financial statements or audit report.

The Tier 2 reporting requirements very much mirror those of a public company.

In Conclusion

It’s easy to see how an investor could get lost in the details of the different types of exempt offerings available to issuers.

Being more knowledgeable about each type of crowdfunding exemption should help investors make better decisions about how to invest and what they can expect from the issuer after the offering.

AcreTrader’s offerings are open to accredited investors pursuant to Rule 506(c) presently and we hope to have offerings available to non- accredited investors in the near future.

If you have questions about AcreTrader or investing in farmland, please contact us here anytime.

Disclaimer: This blog post is intended for educational and informational purposes only . It is not intended and should not be construed as legal advice and does not create an attorney-client relationship. Readers should contact their own lawyer regarding the applicability of the information discussed in this blog to their particular situation and facts.