Social Enterprises Benefit From Adjustments to Regulation Crowdfund Limits
Last month, the Securities and Exchange Commission (SEC) made inflation adjustments to Regulation Crowdfund (Reg CF) investment limits and raise limits. A summary of these changes can be found here. These changes affect enterprises raising capital and investors.
Changes for Issuers
For businesses, the limitations on how much capital can be raised in Reg CF offerings are dependent on what kind of financial statements the business has prepared. Businesses with financial statements that have been certified by its chief executive officer can now raise up to $124,000 (up from $107,000). Companies that have financial statements that are reviewed by an independent accountant may raise up to $618,000 (up from $535,000) or up to $1,235,000 (up from $1,070,000) if it is the company’s first Reg CF raise. If a company has audited financials, it may raise up to $5,000,000 (this limit is unchanged).
Changes for Nonaccredited Investors
Investors are either considered accredited (high net worth or high income) or nonaccredited depending income or net worth standards. Reg CF limits how much nonaccredited investors can invest based on the investors’ income or net worth. These limits were also adjusted by the SEC. Currently, a nonaccredited investor may invest $2500 or 5% of their annual income or net worth if their annual income or net worth is less than $124,000 (up from $107,000). A nonaccredited investor, whose annual income and net worth are at least $124,000 (up from $107,000), may invest the greater of 10% of their annual income or net worth up to $124,000 (up from $107,000).
Impact of These Changes on Social Enterprises
Our clients are all social enterprises of one type or another. For these types of businesses, the changes described above allow more money to be raised without spending more money on preparing financial statements. Additionally, many social enterprises rely significantly on investments made by their community, which often includes many nonaccredited investors. These community investors can now invest more into enterprises that match their values.
Reg CF Client Offerings
See how some of our current clients are utilizing Reg CF:
Cubo Beverages is offering up an alternative and sustainable pod-based juice machine that can deliver restaurant-quality smoothies, coffee, tea, juices and wellness drinks with all natural ingredients in under two minutes.
Freakin Fitness is raising capital to fill the gap between large-chain traditional gyms and small community-based functional fitness centers.
Dishquo has developed a meal planning nutrition app that offers customized meal plans, automated grocery lists, 3000+ healthy recipes, health and wellness tools and more.
The Karisha Community Center for Wellness in Austin, Texas is a whole person healthcare community center designed to address healthcare inequities and disparities reinforced by the current model of medical care by shifting from sick care to whole person collaborative care.
Momentors is a software platform developed to provide the right expert information at the right moment. In three simple steps, individuals can get solutions to real-world problems from verified experts.
Considering a capital raise that you can publicly promote? This overview chart is designed to compare key features of direct offering strategies that permit an issuer to solicit investment from its network. None of these strategies require the use of a broker but all have options to allow you to list your offering on a listing portal like SVX.us.com or a Reg CF listing portal. Some strategies are better suited to issuers trying to raise capital primarily from a large group of community (nonaccredited) investors, others are designed to reach a mix of high net worth (accredited) and community investors and one is limited only to accredited investors. Some are limited to one or a few states while others can be nationwide.
There are many factors beyond those noted in the chart that go into deciding what capital raise strategy is right for your enterprise given the location and makeup of your network and the amount to be raised. Some of these strategies allow for testing the waters before moving forward with a direct offering. Note too that there are a lot of details and nuances to consider for setting up a raise that are not captured on this chart. If you are considering a public raise, we are available to help you choose a strategy and design the direct offering that best fits your goals. Contact us for a free consult call to learn more.
Compare and Contrast: Direct Public Offering Strategies
Historic preservation projects are designed to protect a community’s heritage often through the expansion and enhancement of historic properties for public use. Community capital is designed to empower a community’s investment in itself through public offerings that are structured to engage a variety of investors. Preservation projects could meet their goals faster and gain additional political and monetary support through the use of community capital raising strategies.
Community investment strategies differ from typical private strategies as they allow investment broadly from community members rather than restricting investment only to the highest net worth individuals or institutions. Community capital does not have to be the only source of capital for a project, but it can have an impact beyond the funds raised.
Community members can be great allies (or in some cases, strong adversaries) to real estate development projects. Restoring or repurposing a historic building is made easier if a developer has both capital and community support. Why not combine the two?
Including community members as investors in projects not only affects the project’s bottom line, but also impacts the level of community acceptance of the proposed purpose and use of the property. With a community capital approach, community members share in the potential return on investment and can become great ambassadors for the project as it wends its way through any approval process, and later as the property opens for its new or improved purpose.
At Cutting Edge, we work to identify, design and build capital raise strategies that meet client goals and strive to involve community stakeholders. Depending on the purpose and scope of the project, community capital raise strategies might include single, or multi-state, direct public offerings, Title III Regulation Crowdfund offerings or larger Regulation A campaigns. Or, a developer or manager can put together a community investment fund that can support various enterprises or projects. These approaches work not only for real estate projects but across a wide range of industries.
Often at conferences I talk about the different ways to utilize community to raise capital. But this time I wanted to focus on how community capital strategies are part of social and environmental justice solutions and to discuss why who is allowed to invest matters. In other words, I wanted to discuss why the impact of community capital is about much more than just the money. Here are my notes from my remarks at the conference:
We at Cutting Edge Capital like to call our solutions “community capital” strategies. What are community capital strategies? Investment offerings that are open to both high net worth individuals and institutions, and to community (non-accredited or retail) investors.
The current model for capital raising, even in many social and environmental justice enterprises, is to reach out to the wealthiest accredited investors in our networks when capital is needed. That model is not wrong, but choosing only that approach means that enterprises are missing the opportunity to engage all supporters (regardless of their wealth) and missing out on the impacts that flow from doing so.
Community capital strategies democratize our economy in a variety of ways. Here are some of the impacts community capital offerings can have on investors, enterprises, and the broader community:
Community Investors. Community capital offerings allow everyone to invest in alignment with their values. Currently, non-accredited or community investors are not permitted to invest in most private enterprises, including social and environmental impact companies. Most people are limited to putting investment dollars into Wall Street offerings: publicly traded stocks, mutual funds, and money market accounts. Offerings that are open to community allow those members to invest in businesses, cooperatives, nonprofits or other enterprises that offer innovative solutions, are committed to good environmental practices, and/or are supporting social justice missions. It is the practice of so many impact organizations to reach out to community to help shape their missions and the foci of their work. We need to ask ourselves: why do we leave those community members out of the investment opportunity when it is time to implement the ideas the community helps define?
Entrepreneurs/Enterprises. How do we increase equity and access to capital for women and people of color? This is a question we in the impact capital space have been trying address from the start. To date, much of the focus has been on getting more women and people of color in front of existing traditional, institutional, and accredited sources of capital. However, community capital is an alternative to traditional capital that can organically level the playing field. When a broader segment of community is invited to invest, those investors will be more diverse than most existing high net worth investors and funding institutions. Entrepreneurs that receive funding will likely reflect the community that is investing in them. Community members will choose entrepreneurs that speak their language (literally and figuratively), echo their values, and are committed to impacts that solve problems in their community. In other words, if more women and people of color are investing, more women and people of color are likely to receive funding.
Community. When community members invest in local businesses those enterprises can use that capital to thrive and grow — creating jobs and a more vibrant local economy. Any returns generated by those businesses go back to local investors. This creates a cycle of community investment, impact, wealth creation and (hopefully) community reinvestment. The process is one of reinvestment and does not extract resources out of the local economy.
So, how do we do we achieve this? Investors (both accredited and community) need to search out and ask that investment offerings be open to community investors. Enterprises and entrepreneurs (and supporting organizations) need to explore how to make investment opportunities open to community investors.
While Cutting Edge is best known for community capital raising strategies such as direct public offerings, we help many of our clients utilize private placement strategies instead of or in addition to other types of capital raises. The term “private placement” refers to the process of raising capital in an offering that is not registered with securities regulators and is not offered broadly to the public.
Private placements include offering types ranging from friends and family investments in a new retail establishment, to angel investments in a social enterprise, to institutional and venture capital investment in a growth company. Any kind of security can be offered in a private placement, including notes, stock (common or preferred), revenue share securities, convertible notes, SAFEs (security agreement for future equity) or others; and the attributes of each one of these can vary quite a bit (differing rates of return, exit options, valuation, etc.). As clients look at options and assess their potential investor network, we often get questions about whether private placements can include non-accredited investors, whether a private placement can be advertised and what the regulatory or disclosure requirements are.
Below is an overview of options and a brief discussion of key factors.
Accredited Investor Definition. To understand the options, we need to start with understanding what is an accredited investor. An accredited investor is an individual whose net worth either individually or jointly with their spouse equals or exceeds $1 million (excluding primary residence). Or, an accredited investor has “income” in excess of $200,000 in each of the two most recent years and who reasonably expect an income in excess of $200,000 in current year (or $300,000, jointly with their spouse). Businesses can be accredited investors too if they have $5 million in assets. There are a few other types of accredited investors. A full description can be found here.
Statutory exemption, Section 4(a)(2): Non-public Offering. This is the broad private placement exemption of the of the Securities Act of 1933 and it exempts from registration “transactions by an issuer not involving any public offering.” There is no limit on the number of investors but state law may provide limits such as on the number of nonaccredited investors and may require a notice filing to offer or sell securities to residents of the state. Investors must either have enough knowledge and experience in finance and business matters to be “sophisticated investors” (able to evaluate the risks and merits of the investment) or be able to bear the investment’s economic risk as well as have open access to necessary information. There is no bright line test for sophistication or financial ability to bear the risks. Therefore, there are significantly higher risks to use this exemption rather than one of the other exemptions or the safe harbour of Rule 506. The securities issued under this exemption are restricted securities and may not be transferred or sold without registration or use of another exemption.
Regulation D, Rule 504: Small offering ($10 million limit) exemption. Rule 504 provides an exemption for the sale of up to $10,000,000 of securities in a 12-month period and may include sales to accredited or non-accredited investors. There is no requirement to provide specific information to potential investors as in Rule 506 offerings. In general, you may not use general solicitation or advertising to market the securities using this rule unless you have registered the sale at the state level. As with previous exemption, an issuer must comply with state law requirements for any potential state level private placement exemption. Purchasers generally receive “restricted securities” and may not sell them without SEC registration or using another exemption.
Regulation D, Rule 506(b): Unlimited raise allowing 35 non-accredited Investors. Rule 506(b) is a “safe harbor” for the non-public offering exemption in Section 4(a)(2) of the Securities Act, which means it provides specific requirements that, if followed, establish that the offering falls within the Section 4(a)(2) exemption. Rule 506 does not limit the amount of money your company can raise or the number of accredited investors, but to qualify for the safe harbor, your company must: (1) not use general solicitation or advertising to market the securities; (2) not sell securities to more than 35 non-accredited investors (but all non-accredited investors, either alone or with a purchaser representative, must meet the legal standard of having sufficient knowledge and experience in financial and business matters to be capable of evaluating the merits and risks of the prospective investment); (3) give non-accredited investors specified disclosure documents that generally contain the same information as provided in registered offerings; (4) be available to answer questions from prospective purchasers who are non-accredited investors; and provide the same financial statement information as required under Rule 505. Rule 506 offerings, pursuant to Section 18 of the Securities Act, are exempt from state registration and review. The states still have authority to require a notice filing (and related fees) and may also investigate and bring enforcement actions for fraud.
Regulation D, Rule 506(c): Accredited investors only, advertising permitted. Rule 506(c) is also a safe harbour to the exemption under Section 4(a)(2). There is no raise limit under this Rule. This exemption permits advertising and general solicitation of investors but then limits investors to only those who are accredited. The issuer must take reasonable steps to verify that the purchasers are accredited investors before the purchase. Purchasers receive “restricted securities.” As explained above under Rule 506(b), offerings under Rule 506 preempt states from imposing registration and review requirements but states may still impose notice filings and fees.
How to choose? The preceding is merely an overview to help map out possible strategies. We are happy to discuss any of these options with you and go over the risks, pros and cons of each. Each raise can be as unique as the business and its potential network of investors. And, we haven’t touched how the security can be structured. We can help you map out a strategy that works for your business. Contact us for a free strategy call.