We’ve been talking about crowdfunding for a while now, and we’ve started discussing alternatives to the crowdfunding exemption in Title III of the JOBS Act because that exemption is technically not final yet. Last time we talked about rewards-based crowdfunding, which is analogous to the pre-sale of goods and services and does not require any exemption from the registration requirements of the Securities Act because it does not involve the offer or sale of securities.
Another alternative is an accredited crowdfunding platform, which, unlike rewards-based crowdfunding, is a crowdfunding platform that actually does facilitate offers and sales of securities and therefore does require more regulatory compliance.
Accredited crowdfunding platforms, (or “Regulation D crowdfunding platforms”) are only open to investors who qualify as “accredited investors” under Rule 501 of Regulation D of the Securities Act. There are 2 main types of accredited crowdfunding platforms: (1) the investment fund model and (2) the broker-dealer model, but we’ll only talk about one of them today:
Accredited Crowdfunding Platform #1: The Investment Fund Model
The investment fund model is an accredited crowdfunding platform that typically targets high-growth startup companies who would otherwise try to go the traditional venture capital (“VC”) route. Companies that adopt the investment fund model usually form and advise other investment funds which make investments in different startup companies. These other investment funds will then make offerings of their own equity interests to accredited investors in unregistered offerings that fall under the Regulation D safe harbor (Rule 506).
Thus, the companies who adopt the investment fund model of crowdfunding intend to act as investment advisors, meaning that they will have to register as such under applicable law (e.g. Investment Advisors Act of 1940) or otherwise qualify for an exemption (e.g. Dodd-Frank Act exemption for VC fund advisors).
Being an investment advisor means that these companies have the right to receive a profit share upon the termination of the investment funds that they advise; however they are not permitted to accept “transaction-based compensation,” which would require them to register as a broker-dealer and comply with those applicable regulations.
There are a couple of companies employing this investment model that are worth noting: FundersClub and AngelList are online platforms that raise funds and advise startup companies in this manner.
If this sounds confusing, maybe it is. Next time we’ll talk about the broker-dealer model, but in the meantime, please talk to an attorney if you have any questions or are interested in raising funds for your company.