Crowd-funding is a creative way to sell new products and services. Users can simply post their sales pitch on Kickstarter or a similar site, accumulate pledges and when a threshold volume of pledges is crossed, collect their cash and go to work. For small business owners, crowd-funding is especially effective because it helps them reduce risk by ensuring a sufficiently sized market exists before committing to production. For consumers, crowd-funding offers a way to stimulate the development of desired products or services while receiving special “rewards” or bonus items as incentives for their participation.
The idea behind crowdfunding has been around for decades, with non-profit organizations like the Salvation Army and March of Dimes’ appealing to the public for donations. But it was the Internet that made its commercial application take off in the first years of the 21st century. Today, crowdfunding is responsible for bankrolling everything from the production of handmade cable-knit sweaters to high-tech drones. In 2014, crowdfunding generated funds in excess of $5.1 billion worldwide.
Now, thanks to a recent move by the SEC, many small businesses can raise capital by selling crowd-funded securities.
With this new development, small businesses looking to raise up to $50 million can do so without going through the usual SEC filings. How is that possible? Regulation A+. A sequel of sorts to the SEC’s original Regulation A of 1936 that allowed companies to raise funds from private investors without going through an IPO, Regulation A+ permits companies to “test the waters” by publically soliciting interest in a stock before any shares are actually issued or paperwork has even been filed.
Regulation A+ splits offerings into two levels:
- Tier 1 “for offerings of securities of up to $20 million in a 12-month period, with not more than $6 million in offers by selling security-holders that are affiliates of the issuer”
- Tier 2 “for offerings of securities of up to $50 million in a 12-month period, with not more than $15 million in offers by selling security-holders that are affiliates of the issuer”
Certain baseline regulations apply to both tiers, but the larger Tier 2 offering requires more disclosure.
Other requirements for using Regulation A+ include:
- The company must have its principle place of business in the U.S. or Canada
- Issuers cannot be SEC reporting companies or certain types of investment companies
- Issuers cannot seek to offer or sell asset-backed mineral rights
- There must be a business plan in place, and that plan cannot include mergers or acquisitions with unidentified companies
- Companies cannot have been subject to SEC orders under Exchange Act §12(j) within the past five years or “bad actor” provisions of Rule 506 for the past two years
For small companies, Regulation A+ presents a way to stimulate growth quickly without having to pump millions of dollars into a traditional IPO. Also, a business can safely and inexpensively back out of an offering if sufficient interest fails to appear. For the public, it provides investment opportunities allowing them to get in on the ground floor of a potentially lucrative startup.
Due diligence still required
Even if Regulation A+ proves to be the boon to small business growth as many experts expect, it doesn’t eliminate the need for investors to perform their due diligence before pledging to an offering that may or may not come to pass. Checking the performance of the companies and principals behind any Regulation A+ offering is a must, as the information provides valuable insight into the business’ pattern of meeting their financial obligations.
Experian offers a number of tools investors can use to vet Regulation A+ offerings, including our business credit reports. For a nominal fee of $49 you can purchase a comprehensive report that includes: Key business facts, corporate registration information, payment history and public record information. For an additional $25, an investor may also receive an Industry Benchmark Report comparing business financials (Income Statements, Balance Sheets, etc.) with similar companies in the State.