In March 2021, the maximum amount that may be raised using Reg. CF during any 12-month period increased to $5 million, which should open up even more opportunities to nonaccredited investors, and make crowdfunding a much more viable option for real estate sponsors.
The Jumpstart Our Business Startups (JOBS) Act, passed in 2012, was the first legislation to permit crowdfunding, allowing companies access to investors that previously could not participate in private fundraising rounds. Until earlier this year, Title III of the JOBS Act, also referred to as Regulation Crowdfunding (Reg. CF), allowed a company to raise a maximum of $1.07 million during any 12-month period from an unlimited number of investors, including nonaccredited investors. In March 2021, the maximum amount that may be raised using Reg. CF during any 12-month period increased to $5 million, which should open up even more opportunities to nonaccredited investors, and make crowdfunding a much more viable option for real estate sponsors.
Historic Limitations Stymied Use of Regulation CF by Real Estate Sponsors
Due to the previous $1.07 million maximum and the cost of most real estate projects, crowdfunding has not been a viable option for real estate sponsors. As such, sponsors historically have relied upon other private offering exemptions, which limit the offering to “accredited investors” and a limited number of non-accredited investors. The U.S. Securities and Exchange Commission (the SEC) defines an accredited investor as an individual that:
- has at least $1 million in net worth, together with their spouse or spousal equivalent;
- had income of at least $200,000 per year ($300,000 if combined with spouse or spousal equivalent) for the past two years, with a reasonable expectation to earn the same or a higher income in the current year; or
- holds a Series 7, Series 65 or Series 82 license.
The third bullet is a relatively recent addition meant to modernize the definition to prevent unnecessarily tying perceived sophistication level with net worth or income. However, this revised definition still excludes a substantial portion of the U.S. population. It is estimated that people in only approximately 10.5% of U.S. households qualify as an accredited investor. Accordingly, increasing the amount that can be raised under Reg. CF during any 12-month period from non-accredited investor from $1.07 million to $5 million is potentially economy altering and should be considered by all real estate sponsors, as it opens the doors to approximately 89.5% of U.S. households.
Practical Implications of Rule Change
The funds raised under Reg. CF has increased substantially since the beginning of the COVID-19 pandemic and shows little sign of slowing down. In November 2020, Crowdfund Capital Advisers (CCA) reported that the amount invested in Reg. CF deals in 2020 more than doubled, on a month-to-month basis, each month through November. They also noted that the number of offerings increased by 50% and that the average amount invested per investor also increased in the same period.
This all bodes well for certain player in the real estate industry. As investors remain somewhat locked down and looking for investments online and the limitations restricting the value of the projects in which real estate sponsors can invest using crowdfunding have been increased, the savvy and forward-thinking real estate sponsors will seize the opportunity.
Simply put, the amount of capital that real estate sponsors can raise from nonaccredited investors is increasing by 500%. This should make crowdfunding far more attractive to real estate sponsors because they can raise more money during each 12-month period and purchase more expensive real estate. For example, before the rule change, the most expensive project a sponsor could previously purchase, solely relying on Reg. CF and a bank loan, was about $3.5 million (with approximately $1 million from crowdfunding and approximately $2.5 million from the bank loan). Now, the same sponsor can purchase a project for up to about $16.5 million.
The rule changes are important for a few reasons:
- sponsors that have not used Reg. CF before have more incentive to see if it is a viable fundraising strategy—there is more to be gained from the investment, as instead of an upside of $1.07 million, sponsors can raise up to $5 million;
- non-accredited investors will likely have access to better deals; and
- smaller transactions (up to $5 million) may be exclusively financed under Reg. CF, and deals up to approximately $16.5 million can be financed solely through a mix of crowdfunding ($5 million) and traditional bank financing ($11.5 million).
Legal Implications of Using Regulation Crowdfunding
Reg. CF sets forth the legal framework for companies to offer and sell securities through crowdfunding. The rules:
- require all transactions under Reg. CF to take place online through an SEC-registered intermediary, either a broker-dealer or a funding portal;
- permit a company to raise a maximum aggregate amount of $5 million through crowdfunding offerings in a 12-month period;
- limit the amount individual non-accredited investors can invest across all crowdfunding offerings in a 12-month period; and
- require disclosure of information in filings with the SEC, to investors and the intermediary facilitating the offering.
Any company conducting a Reg. CF offering must electronically file an offering statement on Form C through the SEC’s Electronic Data Gathering, Analysis and Retrieval (EDGAR) system and with the intermediary facilitating the offering. Form C contains fillable text boxes that solicit certain information, while other required disclosure that is not requested in the text boxes must be filed as attachments to Form C. There is not a specific presentation format required for the attachments to Form C; however, the form does include an optional “Question and Answer” format that companies may use to provide the disclosures that are required but not included in the text boxes. The information required to be disclosed includes:
- information about officers, directors and owners of 20% or more of the company;
- a description of the company’s business and the use of proceeds from the offering;
- the public offering price of the securities or the method for determining the price;
- the target offering amount and the deadline to reach that amount;
- whether the company will accept investments in excess of the target offering amount;
- certain related-party transactions; and
- a discussion of the company’s financial condition and financial statements.
The financial statements requirements are based on the amount offered and sold in reliance on Reg. CF within the preceding 12-month period, but range from unaudited financial statements to audited financial statements.
For any offering that has not yet been completed or terminated, a company can file on Form C/A an amendment to its offering statement to disclose changes, additions or updates to information. An amendment is required for material changes, additions or updates, and following an amendment companies must reconfirm outstanding investment commitments within five business days, or the investor’s commitment will be considered cancelled.
A company must provide an update on its progress toward meeting the target offering amount within five business days after reaching 50% and 100% of the target offering amount. These updates will be filed on Form C-U. If the company will accept proceeds over the target offering amount, it also must file a final Form C-U reflecting the total amount of securities sold in the offering. However, if the intermediary provides updates on its platform regarding the progress of raise, then the company will need to file only a final Form C-U to disclose the total amount sold in the offering.
A company that sells securities under Reg. CF is required to file on EDGAR and post on the company’s website an annual report on Form C-AR within 120 days after the end of its fiscal year. The annual report discloses information similar to what is required in the offering statement, but neither audited nor reviewed financial statements is required. Companies must comply with the annual reporting requirement until one of the following occurs:
- the company is required to file reports under Sections 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended;
- the company has filed at least one annual report and has fewer than 300 record holders;
- the company has filed at least three annual reports and has total assets that do not exceed $10 million;
- the company or another party purchases or repurchases all of the securities issued pursuant to Reg. CF, including any payment in full of debt securities or complete redemption of redeemable securities; or
- the company liquidates or dissolves in accordance with state law.
Any company terminating its annual reporting obligations is required to file notice on Form C-TR reporting that it will no longer provide annual reports pursuant to the requirements of Reg. CF.
Driscoll R. Ugarte serves as a team lead of Duane Morris’ Life Sciences and Medical Technologies industry group. He practices in the area of corporate law, including private equity financings, emerging companies, mergers and acquisitions and securities.
Reprinted with permission from Daily Business Review, © ALM Media Properties LLC. All rights reserved.