What Is Regulated Crowdfunding and Why Is There So Much Confusion?

Business.com / Funding / Last Modified: February 22, 2017

Crowdfunding offers businesses with a new opportunity for funding. But what is regulated crowdfunding? And what does it all mean?

What is Regulated Crowdfunding

There is a lot of confusion and misinformation out there about crowdfunding and equity crowdfunding. I wanted to take a moment to try to clear up some of it with some simple information.

To understand regulated crowdfunding, you must know what crowdfunding is and what the different types are. What is crowdfunding and what is all the hype about?

Definition of Equity Crowdfunding

Equity crowdfunding is simply the process where a company raises money from a group of investors (the crowd), via the internet, in exchange for shares in the company.

Many people confuse the types of crowdfunding. There are four main types of crowdfunding (taken from my free ebook “Equity Crowdfunding 101”):

Unregulated

Donation-Based Crowdfunding

Contributions go towards a charitable cause. For example, you pay for a charity in a poverty stricken area to receive much-needed medication.

In donation-based crowdfunding, funds are collected from a community for publically disclosed initiate but there is no direct financial return for the people putting the money in. The return for contributors is usually the satisfaction that comes with helping others in need. In some cases, tax credits are available to donors.

Reward-Based Crowdfunding

Contributors receive a pre-defined product or service in return for the funds they provided to the company or individual.

A contributor advances funds with the promise of receiving a prescribed reward at a later date (ie. paying now for the development of a new smartphone and receiving the phone after it is developed, manufactured, tested and shipped).

Related Article: Inside Equity Crowdfunding: The Quire Difference

Regulated

Equity-Based Crowdfunding

Investors receive a stake (usually common or preferred shares or units) in the company (issuer). The idea being that the investor is either looking to make a return from dividends or capital gains on the growth in value of their stake in the company (or both).

Lending-Based Crowdfunding

Investors are repaid for their investment in a business over a period of time and receives a stipulated return (interest) for the use of their money.

I separated the four types because there is a big distinction between donations and rewards based versus equity and debt-based crowdfunding. The equity and debt-based crowdfunding are regulated by securities exchanges around the world and hence carry strict regulations.  

The size of the average contribution under donations and rewards is much lower than that of equity or debt crowdfunding portals. While both of these forms of crowdfunding, equity and debt, are different they often get lumped together for simplicity as either equity crowdfunding or regulated crowdfunding.

The Fallacy: Equity Crowdfunding is Illegal or Not Yet Available

Many lawyers, investors, companies, consultants and accountants are erroneously telling clients that equity crowdfunding is not legal yet. While they are not wrong per se, they are not being entirely clear.

Many people associate equity crowdfunding with new proposed regulations that allow the everyday investor (or ordinary citizen as some call them) to invest in private placements of companies seeking financing.

Since the regulators have been struggling with coming up with appropriate rules that sufficiently protect the ordinary investor from a significant loss, these crowdfunding rules are slower at being released in most jurisdictions.

Related Article: Gone Too Soon? Why Crowdfunding Could Die Within the Next Decade

The Truth: Equity/Regulated Crowdfunding Is Here

So, what is available? Regulated crowdfunding is available in many countries globally.

Regulators are struggling to integrate new crowdfunding rules into existing regulatory frameworks while dealing with investor protection and lobby groups. That being said, many countries have followed the US regulatory framework for Title II which is restricted to accredited investor crowdfunding.

Like the USA, there are rules in place that are in place in many countries across the globe that do allow for equity crowdfunding to accredited investors. Accredited (or sophisticated) investors are those that meet certain income or asset holdings and hence the securities regulators deem them to either have the financial expertise to analyze investments, or they have enough money that any investments they make will not cause them to be significantly affected financially.

Therefore, any portal that operates selling investments to accredited investors, who still represent a crowd, are considered to be equity crowdfunding.  

Some countries even have rules that allow the ordinary citizen to invest, whether with certain restrictions or in certain cases. In the USA, Title IV allows ordinary investors to invest within certain parameters.

In Canada, the Offering Memorandum allows a company to raise an unlimited amount of money from ordinary and what they call eligible investors (think accredited investor–light version), with certain investment limits.

Other countries also have rules or are implementing rules that will allow the ordinary citizens to invest, but let’s not forget that any portal selling investments to a crowd using existing securities regulations is, in fact, utilizing equity crowdfunding by definition.

 

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