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Regulation Crowdfunding - What is Regulation Crowdfunding?
Crowdfunding is when a business raises a capital from a large number of investors. This mechanism of funding helps to connect entrepreneurs and investors through social media and different crowdfunding websites. This sort of financing arrangement helps expand the base of the investors beyond relatives and a small group of investors like venture capitalists.
In the United States, there has been an increasing trend of Crowdfunding, especially for supporting arts and human skills like music recordings and filmmaking. This arrangement of Reg CF permits a company to raise aggregate financing amounting to USD 5 million in 12 months. In addition to this, specific rules for the offering include:
All transactions under Reg CF need to take place via online portal. It may be by funding portal or through SEC-registered intermediary.
There is a limit on the non-accredited investor to invest across all of the Crowdfunding.
There is a need to file certain information within the security commission.
Certain financial and operational information needs to be disclosed to investors, intermediaries, and other connected parties with the offering.
Generally, the subscriber of the security under crowdfunding cannot sell it before holding for one year.
How does crowdfunding work?
Crowdfunding is a simple arrangement to raise the finance for supporting startups and businesses in their initial years. Further, it has been observed that most of the companies fail due to inadequacy of cash management rather than problems in profitability. So, these funding schemes help the businesses to remain stable and grow. However, there is a greater risk in adopting for offerings as businesses are not mature. Hence, to protect the investor, the Government has introduced certain limitations on investing capacity.
Who is eligible to invest in the crowdfunding?
Anyone can invest in crowdfunding. However, there is a limit on the amount of investment if you are a non-accredited investor. The investment amount is limited to greater than USD 2,200 or 5% of the lesser of net worth or annual income. On the other hand, if you are an accredited investor, then there is no limit on the amount that can be invested. An accredited investor is one who has income exceeding USD 200,000 each of the two most recent years and USD 300,000 in case of joint income with the spouse. Further, there should be some reasonable expectation of the same level of earnings in the current year. Another way to qualify as an accredited investor is holding joint net worth exceeding USD 1 million but excluding the value of a primary residence.
Challenges of Crowdfunding
Following are some of the challenges faced in the Crowdfunding campaign. It may be challenging to find a cost-effective marketing strategy during and after the Crowdfunding campaign. Drafting a compelling message that attracts the interest of potential investors. Developing an excellent and informative video that converts the potential investor& interest to subscriber of the security. It may be challenging to create and plan a reward system and maximization of the return on such offerings.
Advantages of Crowdfunding
Following are some of the advantages related to Crowdfunding. it's a win-win situation where an investor gets an opportunity to generate a return, and a business/start-up gets financing. It makes use of Crowdfunding platforms that's an excellent and incredible way of reaching potential investors. Compliance requirements and other procedural requirements are limited in comparison with the listed company. The companies opting for Crowdfunding do not lose their control as in the case of venture capitalists. So, decision-making and other aspects remain concentrated. Reg Crowdfunding provides the ability to get public opinion on some of the company products. It helps the company to identify strength and weaknesses of their services/products.
Disadvantages of Crowdfunding
There is a cost associated with the process of raising finance. There are requirements related to the filing, documentation, and other issues related to compliance. Sometimes, investors may not be interested in the business idea. So, opting for Crowdfunding can be a waste of time. If a financing campaign under Reg Crowdfunding does not achieve your funding goal, any finance already obtained has to be returned. This might result in damage to the reputations of startup. Under Crowdfunding, adequate funding can be made from the accredited investor and it may be challenging to find for accredited investor for the business.
What are the benefits of Crowdfunding for the investor?
It’s an easy option to invest and earn. Investors can easily access the online platforms through direct online processes. An investor can invest in different Crowdfunding programs. It helps them to diversify their investment portfolio as if there is excellent flexibility. You can simply opt to invest in different funding programs with few clicks on an online portal. For investing in Crowdfunding programs, the investors do not have to consider multiple economic and other factors that significantly impact the stock exchange.
What to do for successful Crowdfunding?
1- Design engaging marketing material
It's said that content is the king. Yes, that's true. An excellent marketing material helps you to stand out from others. It gives you a fair chance to emotionally connect your product with your potential customers.
2- Make an excellent social media strategy
The investors and businesses connect via an online platform, and social media can be an excellent tool to reach out to a more significant base of potential investors. So, setting a sound social media strategy can help to change the fate of Crowdfunding activity.
3- Prepare for the campaign
There is a need to plan a professional campaign program before the execution of the campaign. You need to remain active on the company and personal social media accounts to remain in connection with the potential investor. So, it’s your efforts that decide if your Crowdfunding activity is to achieve the desired goal.
What factor should be considered before investing in crowdfunding-based securities?
There is innate risk in securities issued under Reg crowdfunding. That's the same as greater the risk, greater the return, and vice versa. However, you need to assess if the risk of investing in crowdfunding is in line with your risk appetite. So, the following factors need to be considered in making a decision to opt for securities offered under crowdfunding.
It's important to note that businesses usually carry out crowdfunding at the launching phase and do not have some established products, markets, customers, supply chains, etc. So, there seems to be some massive risk, but the return is high as well, which is not generally offered by the matured companies illiquidity. Once you’ve opted for the security subscription under Reg CF, your amount gets stuck in the security for at least a year. On the other hand, security exchanges offer trading facilities without any restriction of the holding period. So, you need to consider this fact in decision making.
Bad actor disqualification
Bad actor disqualification refers to a fact that crowdfunding offering is disqualified if an issuer or other persons covered in the offering encounter some disqualifying event. The disqualifying events may include security fraud, conviction, sanctions, or violation of some specific laws.
Covered persons include a company offering securities, general partners, officers, directors, promoters, persons compensated for solicitors, etc
Criminal conviction of the covered persons
Disciplinary orders by SEC
Order from federal regulators
Suspension of the covered person from a self-regulatory organization such as FINRA
What factor should be considered before investing in crowdfunding-based securities?
There is innate risk in securities issued under Reg crowdfunding. That is the same as greater the risk, greater the return, and vice versa. However, you need to assess if the risk of investing in crowdfunding is in line with your risk appetite. So, the following factors need to be considered in making a decision to opt for securities offered under crowdfunding.
It's important to note that businesses usually carry out crowdfunding at the launching phase and do not have some established products, markets, customers, supply chains, etc. So, there seems to be some massive risk, but the return is high as well, which is not generally offered by the matured companies.
Once you’ve opted for the security subscription under Reg CF, your amount gets stuck in the security for at least a year. On the other hand, security exchanges offer trading facilities without any restriction of the holding period. So, you need to consider this fact in decision making.
The companies offering to crowdfunding do need to disclose certain information in filing and final prospectus. However, this information is very much limited and not subject to massive regulations. On the other hand, if you opt for investing in some listed security, there is extended information available in the form of quarterly reporting, half-yearly reporting, annual reporting, and some other reporting to fill the compliance requirements. However, you don't need to worry about fraud and other operational problems when you invest in crowd-based security with ScoutMine. That’s because we carry out extensive background checks and other procedural formalities of the offerings.
Frequently asked questions
What is Crowdfunding?
Crowdfunding is when startups/small businesses raise funds from a large base of investors. It's done through online portals and websites. Crowdfunding results in a win-win situation as an investor gets an opportunity to earn a return, and startups get financing.
What’s the limit for raising finance under Crowdfunding?
The business can raise the finance under Crowdfunding up to USD 5 million. Further, there is a restriction on raising finance from the non-accredited investor.
What is the effectiveness of Crowdfunding?
The success of the Crowdfunding is 1/3. It means one out of three Crowdfunding campaigns gets the achievement of their financial goal.
Why do Crowdfunding campaigns fail?
The Crowdfunding campaigns fail because of a lack of momentum within the first 48 hours of the campaign launch. Observation has proved that there is a need for enhanced efforts at the start of the Crowdfunding campaign.
What are the advantages of Crowdfunding?
Crowdfunding helps to access a large pool of funds and has proved to be effective for small businesses and start-ups. In addition to this, the compliance and other regulatory hustles are limited compared to the listing requirements.
What are the disadvantages of Crowdfunding?
Although Crowdfunding (Do's and don't of crowdfunding) has limited procedural requirements, there is a need to comply with specific filing and other requirements related to disclosures which may be costly.