Crowdfunding is commonly defined as raising small amounts of money from a large number of people over the internet. Often, the returns on this method of financing – popularized by websites like Kickstarter – are limited to only rewards (like a free t-shirt) rather than stock in a company. In April 2012, a major title of the JOBS Act sought to change this status quo by directing the Securities and Exchange Commission to legalize securities-based crowdfunding through the Kickstarter model in order to aid the capital-raising efforts of fledging startups and small businesses. But this detailed exemption, open to all investors, was not the only crowdfunding exemption in the bill. A last minute compromise, which has been largely overlooked, added a second crowdfunding exemption limited to accredited investors only. This form of crowdfunding – accredited crowdfunding – is merely a Rule 506 private placement sold through an internet-based crowdfunding site, like AngelList, CircleUp, or FundersClub.
This article is the first to examine the impact that accredited crowdfunding will have on retail crowdfunding. It claims that accredited crowdfunding is likely to dominate and, depending on SEC action, could render retail crowdfunding superfluous. This would undermine the latter’s lofty goal of democratizing angel investing. The thesis is that issuers will only use retail crowdfunding if it is the best option under the relevant circumstances. But a careful comparison shows that issuers, as of now, will generally prefer accredited crowdfunding in most cases. Moreover, the SEC has limited ability to alter the calculus through its rulemaking power. After assessing the SEC’s options, the article claims that the SEC should act to encourage retail crowdfunding in only two specialized circumstances: as a follow-on to a Rule 506 offering and when issuers need or want to raise capital from over 2,000 individual investors, each investing, on average, less than $500. Applying a fundamental theory of the securities laws, the article makes specific recommendations for rules to achieve this goal.