Startups Can Now Raise up to $5M with Regulation Crowdfunding

(SEC amends Regulation Crowdfunding rules- effective as of March 15, 2021)

If you want to simply read about the amendment to the SEC Regulation Crowdfunding rules, see the SEC Compliance Guide here.

In 1929 there was a huge stock market crash in the United States.

In the years leading up to the crash, the stock market was booming and many people were investing huge sums of money into businesses of all kinds- including startups. At the time, there were no regulations around who could invest, how much they could invest, or what companies had to do to prove they were legitimate to invest in.

Millions of people invested their life's savings into businesses with unscrupulous business practices and this all came to a head on October 24, 1929. This day is known as Black Thursday.

Essentially, the stock market collapsed with thunderous rage as millions of panicked investors pulled their money out which spiraled into chaos sparking the worst period of economic ruin and job loss in U.S history.

You may know it as the Great Depression.

It’s safe to say that the Great Depression was the result of many factors- but poor due diligence on the investment front was a major one. The U.S government knew it needed to do something to prevent this type of catastrophe from occurring in the future and thus The Securities And Exchange Commission (SEC) was born. The SEC was established to help restore investor confidence and regulate the industry moving forward.

The Securities Act of 1933

The SEC’s first major move was The Securities Act of 1933 which was designed to help protect investors from fraudulent companies. Under the Securities Act, companies who wanted to offer and sell securities became required to register with the SEC and provide full financial disclosure.

Because registering securities with the SEC is such a long, arduous, and expensive process- the SEC designed a few loopholes (Rule 506(b) and Rule 506(c) under Regulation D) whereby private companies can raise funds without registering with the SEC. However, both loopholes required investors to be accredited in order to take part in the offering.

Essentially, The Securities Act of 1933 denied “regular” people the opportunity to invest in startups.

The SEC defined an “accredited investor” as someone with a net worth of over $1M (not including one's primary residence) or someone making $200k+ per year. This basically meant that, regardless of one’s financial sophistication, a person could not invest in a private company unless they were a millionaire.

The Jobs Act of 2016

From the time of the Great Depression all the way through to 2016, startups couldn’t raise money from “regular people”- they could only take funds from accredited investors. Obviously, this posed a challenge as there are many people who are not millionaires but have the financial savvy and liquid capital to invest in startups. Recognizing this issue, former President Barack Obama signed the JOBS Act into legislation and it took effect in 2016.

The JOBS Act was meant to help democratize investing so all Americans- not just the millionaires- are able to invest funds in exchange for equity in private companies.

The JOBS Act allowed startups to take funding from non-accredited investors- which was a huge breakthrough- but as with anything coming from the government, the fine print outlined some restricting conditions.

In plain English, these restrictions were:

  1. There is a limit to how much one person can invest and this limit depends on that person’s net worth or yearly income.
  2. Startups can only take funds from up to 500 non-accredited investors.
  3. The total amount non-accredited can contribute is $1M.

The last point is an important one. The $1M cap posed a big problem for startups and had some consequences.

According to Ken Nguyen, CEO of Republic.io (one of the worlds leading equity crowdfunding platforms),

“It had this weird unintended effect of discouraging any company with substantial traction- with a lot of revenue- to go through this somewhat onerous process of disclosing financials and filing forms just to raise a million dollars.”

So, while the option to raise funding from “regular people” was now available, most great, high potential, startup ventures opted out and continued to raise funds from accredited investors even though they might have preferred to use crowdfunding platforms. For most superstar, startups it just wasn’t worth it.

Regulation Crowdfunding (Reg CF) rules change

Because of the unintended consequences of the $1M cap on funds from non-accredited investors, the SEC reexamined and revised the rule.

Maximum Offering Amount of $5 Million. A company issuing securities in reliance on Regulation Crowdfunding is permitted under Rule 100(a)(1) to raise a maximum aggregate amount of $5 million in a 12-month period (before the amendments, the limit was $1.07 million). -SEC Compliance Guide

On March 15, 2021, the rule change went into effect.

Under the new legislation, the fundraising limit from non-accredited investors has been raised from $1.07 million to $5 million.

This is a big win for startups as the “juice” is finally “worth the squeeze” as far as fundraising from non-accredited investors goes. When the max was $1M it was hard to justify all of the extra work that goes into crowdfunding. But, startups are built by forward-thinking innovators who very often want to bring “regular people” in as investors.

I believe startups want to see the industry democratized on a basis of morals and ethics, but this strategy also serves them in more business-focused contexts as bringing “regular people” into the fundraising process turns passive customers into active brand evangelists.

Crowdfunding platforms are the vehicles used most often for raising funds from non-accredited investors and as such, this amendment to the rule is a big win for these entities as well.

I hope this change brings true democratization to the fundraising process and helps even the playing field when it comes to economic mobility for “regular people”. I also think it’s about time that Venture Capital firms had some true competition in the early-stage investing game as competition breeds innovation and hopefully washes away the discrimination that plagues the dark corners of the industry.

Endlessly curious about the human condition. Founder of Studio Upstart. Chief of Staff @ Untapped Ventures.

Get the Medium app

A button that says 'Download on the App Store', and if clicked it will lead you to the iOS App store
A button that says 'Get it on, Google Play', and if clicked it will lead you to the Google Play store