Equity crowdfunding has become an successful tool for investors either having to fund their real estate deals or preferring to gain passive real estate profits. There are several ways to get involved in either capacity with crowdfunding, but as with all real estate things, there are several things to consider. Examine what crowdfunding is exactly and how every form of equity crowdfunding functions.
How does crowdfunding include equity?
Equity crowdfunding is a method used by private firms for capital raising. A business is putting out an offer to sell shares to investors through a crowdfunding site. Equity crowdfunding is common in investment and production of real estate and many other forms of private enterprises.
Equity crowdfunding enables everyone to become an investor in a real estate project or company. This also helps entrepreneurs to collect money without spending years jumping through hoops to meet the criteria of the Securities and Exchange Commission (SEC).
Say an accomplished real estate investor, for example, would secure a healthy and profitable contract. They don’t have the money available to buy the property though. The investor can take the deal to an equity crowdfunding platform to provide the opportunity for other investors to get involved in the project.
However it is important to note that crowdfunding platforms do not accept all submitted deals. Crowdfunding sites are very diligent about screening all investment opportunities. They intend to reduce the amount of risk that investors take on their website.
Why does crowdfunding work for equities?
Historically, developers of real estate and private companies have been very constrained in terms of how they could collect money from investors. As crowdfunding has evolved, it has enabled more people to fund public-investment deals and startups.
Once an investment property is purchased by a real estate investor under contract and has fulfilled all legal criteria, they will apply their offer for review to an equity crowdfunding site. When the deal makes go through the due diligence phase of the company, they must start a crowdfunding campaign.
Once the investor has a crowdfunding campaign going for their deal, the investment opportunity for investors to review and invest in is listed on the crowdfunding platform ‘s website. Specific projects would have different minimum investments at different channels.
The campaign is set to have a target amount. The deal is funded if enough investors like the deal and fund the campaign, and the real estate is purchased. Investors now have their equity in the contract, and start earning dividends depending on the structure of the transaction.
Many aspects of a crowdfunding offer would depend on the use of the site. Different sites have their own criteria for the deals they can publish and how they manage the investments. Some crowdfunding platforms simply act as a matchmaker, while others, along with an escrow account, will provide a fund portal.
How do you structure an equity crowdfunding deal?
If somebody invests in a crowdfunding deal, they buy equity in the deal. They are in fact part owners. They do not play any kind of active part in the investment, though.
The person who is putting the deal together is the issuer, sometimes called the sponsor. They find the deal, negotiate the price and terms, and then manage the asset once it’s bought. Also, the issuer is the one guaranteeing any loans.
The sponsor typically either forms a limited liability company ( LLC) with most crowdfunding strategies or a limited partnership with them. This LLC will buy the asset, or a limited partnership.
The angel investors are purchasing interest in Class A membership at an LLC. The members of Class A are the ones who provide the capital contributions and make up some percentage of ownership. The sponsor has an interest in Class B membership. Class B members possess the remaining interest in the LLC and act as the entity ‘s management.
If the deal is a limited partnership, the investors are limited partners, and the general partner is the issuer. Limited partners provide the capital but do not participate in the partnership ‘s management. The general partner does not contribute money but the relationship is handled.
The sponsor can also have Class A membership in some cases, and may also be counted as a limited partner if they also have capital contributions. They would normally have a separate entity that has an interest in Class B membership or is a general partner in that case.
The amount an investor pays for his piece of the deal normally doesn’t correlate with the purchase price. The lender obtains a share of the equity to bring together the contract. This percentage may vary, but is generally between 20% and 35% everywhere.
Some of these transactions are designed so buyers get their target rate of return before any payments are made to the sponsor. This is termed a preferred equity agreement.
For example , assume the issuer provides a preferred return of 6 per cent to the contract. That means the sponsor does not get a share of the profits if the investment does not reach a return of 6 per cent. Once returns are higher than 6 per cent, the sponsor starts earning their profit.
There are different ways of calculating the amount of money the sponsor gets from the profit. The sponsor will usually start receiving their equity share of the profits on anything above the preferred rate of return.
Assume , for example, that the equity is divided 75/25 between sponsor and investor. The preferred yield is 6%, and the actual yield for the year was 8%. The investors would get the full 6 percent and share 25 percent of any above net income.
In some cases, when the return hits a certain threshold the split changes. The split can rise to 50/50 once the returns reach 10 per cent. In this scenario, the sponsor earns 25 percent of all returns from 6 to 10 percent as well as 50 percent on everything beyond that.
Most of the time, an exit date is set for the target. That is when they intend to either sell or refinance the land, so that the investors can get back their money. Normally, the period is between five and ten years.
There are a few forms the sponsor can get paid. The distributions are over the preferred rate on anything. The sponsor also typically charges a fee for the management of assets. Depending on the size of the deal, the asset management fee is usually between 1 percent and 2 percent.
Once the entity purchases the property, they may also charge an acquisition fee. Once they sell the property there could also be a disposition fee.
Finally, when the property is sold the sponsor profits at the end. This is when they get paid out on their share of equity. For example, when they sell the property, assume the partnership nets are $1 million. If the sponsor has an equity of 25 per cent, they will get $250,000 and the rest will be distributed accordingly to the investors.
It is just one clear example of how you can arrange an equity crowdfunding contract. Deals may be arranged in different ways, and are frequently.
Why do stocks vary from equity crowdfunding?
Although there are many laws and regulations that differentiate equity crowdfunding from stocks, the main distinctions are liquidity and investment limits.
Stocks are exchanged in public, meaning investors can purchase a stock in the morning and sell it in the afternoon. You can also sell any portion of your inventories you choose.
For equity crowdfunding, you buy your equity directly from the sponsor of the deal and you commit to the full project word. Although certain forms of equity crowdfunding allow you to sell your shares, relative to publicly traded stocks, the options are restricted.
For equity crowdfunding, the level of risk is usually higher. Publicly owned companies are largely well known and stable. You are investing in a brand new deal with crowdfunding and you trust the sponsor to make it successful and to generate a return for you.
Crowdfunding also has restrictions on how much money a business can raise, and from whom it can raise investment capital.
Gesetzes on crowdfunding
Crowdfunding rules over the years have grown quite a bit. The regulations vary among the various forms of crowdfunding to protect investors while also providing real estate investors and entrepreneurs the ability to collect venture capital.
One area where the rules on crowdfunding differ is on who can invest in a contract. Many deals are open only to accredited investors, while others also require non-accredited investors.
- Accredited investor: An entity with a net worth of at least $ 1 million or a $200,000 or more annual income over the past two years. Requirement for income for the joint income is $300,000. Accredited investors may also be banks, companies, foundations and trusts with $5 million or more in assets.
- Non-accredited investor: An investor who does not meet accredited investor requirements. Specific regulations on crowdfunding however impose other conditions on non-accredited investment.
Congress passed the Securities Act of 1933 following the stock-market crash of 1929. The act was implemented to protect investors and hopefully avoid another crash. The Securities Act set down several stringent guidelines on disclosure standards and anti-fraud clauses.
The SEC controlled the entire process of stock sales with the Securities Act. To any company that wished to attract donations from the general public, this made the process even more costly. Anyone who wants to sell their shares to the public will now make an initial public offering ( IPO).
This method has made attracting investors hard for real estate developers. The real estate deals never appreciated the time , energy and expense of going through the IPO process to grow a real estate.
Rule 506 of Securities Act Regulation D also allowed real estate developers to sell private securities to investors with whom they had a pre-existing relationship. Developers using this rule could sell securities in their production without having to go through the process of registration and other conditions companies that sold securities to the public had to.
Rule 506 requires developers to attract up to 35 non-approved investors and an unlimited number of approved investors to make investments. Nonetheless, it is strict about the developer having a pre-existing connection to the investors. The non-accredited investors need to be professional, meaning they have ample investment and business expertise and experience.
For decades, real estate developers have used the Rule 506 exception to fund real estate developments by tapping into their own personal investor network.
In 1936 Regulation A was introduced into the Securities Act. This presented developers and private companies with the option of soliciting public investments without registering with the SEC and undertaking an IPO. Nevertheless, unlike Rule 506, any organization that sells securities pursuant to Regulation A is expected to apply its bid for review to SEC. Unless the offering meets the criteria, the offering will be “licensed” by the SEC, at which point the company will begin selling securities.
Regulation A has been created with several limitations as to who is eligible for securities offering and how much they can raise. It also did not provide a state law exemption in whichever state the securities were being sold.
The additional requirements with Regulation A entail a lot of extra costs for the issuer. Regulation A was rarely used for several decades because of the additional costs and the limits on the amount that can be raised.
In 2012 the Jumpstart Our Business Startups Act (JOBS) was signed into law. This act was created to aid in stimulating the economy from the recession of 2008. The JOBS Act provided a new rule that lifted the requirement that investors have a pre-existing relationship. That new rule was added as Rule 506(c) to the Securities Act of 1933.
Developers may advertise their securities to the general public under Rule 506(c), but may accept investments only from accredited investors. They also have to verify that somebody’s an accredited investor.
The JOBS Act created opportunities for individuals to raise capital to fund their real estate investments or start-up businesses. It has also given investors alternative investment options over the investments publicly traded on which they were previously limited.
Investment equity under rule 506(c) is not tradable, therefore investors can not resell their shares. They may be bought back by the issuer but they are not required to. Investors are committed to saving long term.
A + Regulation
In 2015, the SEC amended regulations to Regulation A under Title IV of the Employment Act. That produced what is now referred to as Regulation A+.
These changes have increased the amount of capital that can be raised and have the offer exempted from state registration and SEC registration. Many people call this a “mini IPO.” The true beginning of equity crowdfunding was Regulation A+. It was the first to encourage unaccredited investors through a range of crowdfunding platforms to invest in private real estate deals and private companies.
The new provisions of Regulation A+ also require that the bid be submitted with the SEC in order to qualify for approval.
Regulation A+ consists of two strata, each with its own limits and requirements:
- Tier I lets companies raise up to $ 20 million from accredited and non-accredited investors. Someone raising capital under offers under Tier I shall have a coordinated check with the SEC and any state where the securities are sold.
- Tier II has a $50-million higher cap that a firm can reach. Nevertheless, Tier II does have some additional rules and limitations.
Investors can only invest up to 5 percent of their taxable profit, or net worth, if it is less than $100,000. If their income or net worth is over $100,000, they will spend up to 10 per cent. There’s a maximum $100,000 investment, too.
Tier II does not require state review but more robust is the SEC approval process. Companies must also have their financials audited and meet the criteria for continuing reporting.
Investors may sell their own shares of a company using Regulation A+. When the issuing company registers on an exchange, the buyer can sell their stock easily via that exchange. If not, the investor would be able to use other aftermarket markets or sell their shares through a licensed broker dealer.
The cost of the Regulation A+ phase makes this way to collect capital very complicated for many real estate investors and early stage startups. The prices, time and energy needed to use Regulation A+ make it more suitable for well-established companies and real estate investors who need to raise several million dollars.
Crowdfunding Control (CF)
The SEC established Regulation Crowdfunding shortly after the revisions to Regulation A, with new regulations under Title III of the JOBS Act. Such new guidelines made the raising of capital by crowdfunding much simpler for smaller companies and investors. There are fewer conditions for this new regulation and the cost is much more affordable.
Under Regulation CF, investors in real estate may take out investments from both accredited and non-accredited investors. However, the investments must be made through a registered funding portal or a registered broker-dealer online Financial Industry Regulatory Authority (FINRA)
With Regulation CF, the amount that anyone can raise in a 12-month period is limited to $1,070,000. This lower limit may not work for bigger firms, but it probably fits the needs of anyone who can not afford to use Regulation A+.
Shares of investors in a Regulation CF contract can be sold but have less options than with Regulation A+. An investor must wait at least one year for their shares to be sold, unless they are sold to a family member or approved investor. It’s also allowed the issuing company to buy them back. Companies issuing shares with Regulation CF will not be registered on an exchange so selling their shares is more difficult for an investor.
In addition to the rules and regulations discussed here, there are several more that every investor should be familiar with before raising capital through crowdfunding or investing in an opportunity for crowdfunding. SEC regulations are so complex that the process of raising capital with equity crowdfunding should always involve an attorney.
Many crowdfunding sites have been available after the JOBS Act for use by real estate investors and startups. Some of these platforms are specific to investment in real estate while others have a variety of companies available to invest in.
The particular platform that a real estate investor or startup uses depends mostly on the type of offer they want to use and the potential investors they want to target. Most popular crowdfunding sites are restricted to raising accredited investments through Rule 506(c). A limited number of platforms allow for projects under Regulation A+ or Regulation CF.
Top Crowdfunding Platforms for Acredited Investors
- Multiple Equities.
Top real estate crowdfunding platforms for investors who are not accredited
- Small Move.
- Mogul Realty.
- Bottom tier.
There are also other crowdfunding sites providing investments in non-immovable businesses. Some of them are skilled in certain fields, or triggers.
Equity crowdfunding has opened doors for real estate investors, developers and other entrepreneurs to raise money that they would not otherwise be able to raise. This has prompted some exciting new developments in real estate.
Crowdfunding has also funded some very innovative companies that have helped boost the economy and provide technology and resources that have in many ways helped society.
Equity crowdfunding also helps investors to engage in investments in real estate and in businesses they believe in. Most people know the advantages of real estate investment but just want to gain passive income while the asset management is done by an accomplished real estate professional.
Whether you want to raise money through equity crowdfunding for your real estate project or are searching for an alternative investment, you should be educating yourself about the laws and the risks involved. You can begin by checking out our reviews of 2020 ‘s top real estate crowdfunding sites here.
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