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If you are considering investing in a company and have heard the terms private placement or crowdfunding, you can be excuse for feeling a little lost. With new equity crowdfunding rules about to take effect, we take a look below at the differences in the concepts.
CROWDFUNDING VS PRIVATE PLACEMENT
Every year, companies raise billions of dollars by selling investments in private (non-public) offerings that do not require registration according to federal securities laws. These offerings, also called private placements, can function as a significant source of capital for these businesses, especially startup companies.
Investing in these companies is risky, though – you’re not guaranteed any return, and your money could be tied up for a long while. Many private placements specify the amount of money that can actually be raised and the kinds of investors who can be solicited.
These offerings are not made to the general public at large. You usually must be an accredited investor, which means your net worth must be more than $1 million or your annual income must be more than $200,000.
Private placements may also be offered to non-accredited investors in some cases if you want to take the risk of absorbing a loss or not having access to your money for a while – there are restrictions on how and when you can sell these securities.
Thanks to new regulations enacted by the U.S. Securities and Exchange Commission (SEC), a new model of investing is also now available – equity crowdfunding. The new rules lift a ban on widely advertising a private stock placement (which companies use to avoid registering their offering with the SEC). This means they don’t have to make the disclosures they would if they offered the stock to the general public.
In the past, these private placements were mostly funded by angel investors or venture capital firms. Under the new guidelines, though companies can advertise their private stock sales much more widely – in newspapers, through social media and through email blasts, for example.
e-mail blasts, but they can still only sell large amounts of the stock to accredited investors, in most cases.
The new crowdfunding rules in the JOBS Act also build a mechanism for regular people (non-accredited investors) to make small investments. Companies are limited to raising $1 million a year from these non-accredited investors, and depending on how much they want to raise, they may have to provide potential investors with financial disclosures such as audited financial statements.
In a traditional private placement, no disclosures are necessary, companies can raise as much capital as they are able to, and investors can put in as much money as they want. On the other side, the potential pool of investors is much smaller, as the number of people whose net worth is more than $1 million is limited.
Crowdfunding boosters have grown tired of waiting for the SEC to enact the new rules that better fit the modern marketplace. Because they had to wait for the new rules to take effect (which should happen around May of 2016), many companies originally formed to crowdfund stock are trying to turn themselves into platforms that can facilitate private placements instead.
Until the rules take effect, many new technologies will not be able to be used. Once the rules kick in though, it will be interesting to watch how the marketplace sorts out the new model. It may take off or it may be a non-issue, depending on how companies try to take advantage of the new regulations.
The one thing for sure is that it will be interesting to watch. If you are considering one of these options, don’t rush into a decision. Do your research and then make the best decision you can!