Change the Rules, Change the Game: SEC Guidelines Create New Opportunities

Raising capital from private investors is now less restrictive and more accessible than ever before. This is compounded by the fact private investors are now easier to reach than ever before. This is not an exaggerative discussion for the benefit of the few. It affects everyone who has money, invests, or even knows what investing is.

The Pandemic is the Catalyst for Change

The Securities and Exchange Commission (SEC) has been aware of trends in the marketplace created by advances in technology and in accordance has shifted their restrictions of securities law pertaining to operators raising capital from the public. It’s said that the Pandemic has spurred 10 years of innovation in 10 months and it’s apparent for the regulatory giant as well.

The folks in the high castle within the SEC have voted to loosen numerous restrictions and have produced more favorable guidelines for raising capital from the public to ease the noose of the restricting economy created by the pandemic. In covid times, ruled by uncertainty, the economy was hit, and people were hurt financially. To help keep the economy going the government has taken very important and unprecedented actions such as 1) lowering interest rates to all-time lows 2) dropping money from the sky by way of stimulus checks to the American public and 3) loosening restrictions on how, how much, and from who people and companies can raise money.

The first two actions were taken by the Federal Reserve (or simply, the Fed) which is the central bank of the United States and whose job it is to maintain a stable monetary and financial system. The SEC on the other hand is the entity acting on the third point and is the topic of exploration today. Besides the Fed propping up the economy, much like the air under Loony Toons character Wiley Coyote before he falls off the cliff chasing after the Roadrunner, it is the SEC who is making the most profound moves to impact our future financial system.

New SEC Guidelines

It’s clear the government, and the SEC specifically, wants private investors (you and me) to inject more of their capital into investment opportunities to fend off the shrinking economy. So, they are making it easier for us to do so. And I think we should take advantage of it! It opens up opportunities for investors and businesses to make their money grow and fuel their businesses, respectively. A true win-win.

It’s important to note that the premier pillar of the SEC is to protect investors. They were formed in the Great Depression, after the infamous collapse of the stock market in 1929. Congress erected the SEC to prevent that from happening again and to protect the investors from (potentially) predatory raising that led to the crisis. So, everything they have done has been an honorable attempt to foster efficient markets and make sure the common investor doesn’t get drug into bad opportunities that cause the economy to collapse.

Eighty+ years later, however, as we have entered (and have been in for some time) the information age, the common investor can readily access information for a seemingly unlimited number of investment opportunities. Couple that with the fact that the economy is in dire need of people spending, lending, borrowing and otherwise engaging in financial transactions and you have a ripe environment for regulatory change.

That change, which should go into effect within the next month or so, is in regard to Regulation Crowdfunding or Reg CF. Or as normal people call it - crowdfunding.

What is Crowdfunding and How Does it Work?

Crowdfunding is a relatively new way to invest in real estate. It is where companies or individuals can raise money for their startup ventures in small amounts from a large pool of people, typically over the internet. Crowdfunding exemptions were first established in the 2012 JOBS Act and then in 2015, the SEC adopted Regulation Crowdfunding to open the door to make the regulation available to raise money. For the first time, startups could raise capital from everyone online (up to $1,070,000) and be exempt from the SEC’s IPO requirements.

Crowdfunding works by pairing sponsors and investors through online portals (websites where the offerings live). Companies or individuals can file for regulation CF and then offer their investment opportunities on sites registered with the SEC where investors can search, view, and invest in said opportunities. In the past, this wasn’t a big deal for real estate investors because the raise limit was capped at $1,070,000 in a 12-month period. There’s not a ton of real estate that can be bought for that amount. Sponsors would likely be better off raising in a fund or filing a Regulation D 506(b) or 506(c) offering. However, the SEC is now raising the limit to $5M in a 12-month period. When using leverage (probably the most powerful tool in real estate), that means you can purchase a property up to $20-25M depending on the loan amount. That opens a lot more doors for investing!

Let’s discuss all the changes.

New Reg CF Guidelines

Formerly under Reg CF, as we mentioned, sponsors could only raise up to $1,070,000. The new limit is $5M in a 12-month period. That’s a big difference and adds a lot of potential deals the sponsor and investors could take down together.

Investing Limits:

Previously, non-accredited investors were limited to invest only the lesser of 5% of their net worth or annual income. And if the investors’ net worth or annual income was lesser than $107k (which is 2/3 of the U.S. population!) they could only invest up to $2.2k. Now, this figure isn’t terrible, especially when the attraction with Reg CF is that you can get into bigger deals for a lower amount of capital. But it does limit individuals’ earning potential, especially with some of the platforms that have higher minimum investments. Imagine the difference between investing larger amounts of money. Edgar Bronfman said, “To turn $100 into $110 is work. To turn $100 million into $110 million is inevitable”.

Now, Non-accredited Investors can invest 10% of the greater of their net worth or annual income. That means if an investor had a net worth of $900k but only made $50,000 a year, their investment limit in an offering would be $90k. Going from being able to invest $2.5k to $90k makes a big impact not only for investors but for sponsors who are looking to fully subscribe to their offerings. Having fewer investors in an offering also makes reporting easier for the sponsor, who is required to report progress and provide K1’s to each investor every year.

For accredited Investor’s there is now no limit on the amount of capital they can invest in a Reg CF offering. Previously, they were limited to 10% of the lesser of their annual income and net worth. This is a massive difference!

In both cases, there is no limit to the number of investors one can bring into a Reg CF offering. If the minimum investment is $1,000, you could potentially bring in 5,000 investors. You likely would not want to, it’s just a demonstration of the point.

* For a brief summary, accredited investors are those individuals who have a net worth of $1M or more (excluding their primary residence) or make $200,000 per year or more -or- a married couple with a net worth of $1M or more (excluding their primary residence) or make $300,000 per year or more combined. Non-accredited are those who fall below the net worth or annual income requirement stated above. *

Testing the Waters and ‘Demo Days’

Under the new guidelines, sponsors can now solicit investor interest prior to filing a form C or even before deciding which exemption to use. This allows sponsors to “test the waters” to gauge investor interest before starting the Reg CF filing and before choosing an intermediary platform. Furthermore, “testing the waters” does NOT have to be done on the intermediary’s platform. This means investors can generally solicit and advertise to get the word out about their offering legally. This is especially big for those who have marketing dollars to spend or those who already have large audiences on social media.

Once the form C is filed, it’s back to business as usual and sponsors will have to use the intermediary’s platform.

For a full explanation of the changes, see the SEC’s announcement.

General Solicitation and Advertising

Now, this is not new, but the consensus has been that with Regulation Crowdfunding sponsors cannot generally solicit. That is the appeal of Regulation D 506(C) offerings because under that exemption you can generally solicit and advertise, but only to accredited investors. For some, that may eliminate the potential pool of investors. But with Reg CF you can advertise to and reach both accredited AND non-accredited investors per section 227.204(b) of the Code of Federal Regulations (CFR).

Section 204(b) states that sponsors may advertise any of the terms of a deal if it directs investors to the intermediary’s platform and includes no more than the following information:

1)   A statement that the issuer is conducting an offering pursuant to section 4(a)(6) of the Securities Act, the name of the intermediary through which the offering is being conducted, and a link directing the potential investor to the intermediary’s platform; and

2)   The terms of the offering; and

3)   Factual information about the legal identity and business location of the issuer, limited to the name of the issuer and the security, the address, phone number and Web site of the issuer, the email address of a representative of the issuer, and a brief description of the business of the issuer.

For my day job as an Air Force Contracting Officer, I dig through the Federal Acquisition Regulation (FAR) quite often. It’s more than a thousand pages of dry government text, organized like the above with all of the little gems (if you can call them that) hidden away like that. I like to find those gems – and this is a big one!

For Crowdfunders this means that you can use social media or any other outlet to advertise that you have an offering so long that you point them to the intermediary and tell them only the factual information about you and your business and the terms of the offering. This is not full out general solicitation, but you can advertise all the same. As people get more comfortable doing life and investing via the internet, your chances to reach those who are likely to place money in your offerings go up. And with the lower minimums, you have a much bigger buyers pool right there on the other end of your smartphone or laptop!

This is HUGE benefit because you can advertise to accredited and non-accredited investors alike! In the Reg D world, you could only advertise to accredited investors, and in that space, it makes a lot more sense to require higher minimums.

Of course, I should include here that you should talk to an SEC attorney, specifically one with expertise with Reg CF, before starting a campaign for an offering. But I can tell you this is where I will be spending some more time moving forward. This advertising rule paired with the new changes makes Reg CF an extremely attractive vehicle going forward for raising money. Not to mention it brings the power of real estate investing in more people’s lives – which I am passionate about.

Investment Portals Where You Can Find Opportunities and Invest

Crowdfunding is of course regulated by the SEC, and in that they have dictated where investors can place their money. They established crowdfunding portals or intermediary platforms as the only place you can create and offer crowdfunding opportunities. Here are a few of the portals that relate to real estate.

·      RealtyMogul

·      Fundrise

·      EquityDoor

·      Crowdstreet, to name a few

All of these portals offer the ability to invest in large commercial real estate deals with low fees and low initial investments, starting from $1,000 up to about $25,000. Traditionally, only the elite could invest in projects like this. The reason behind this is twofold: 1) There is an educational barrier and most people simply do not know about these investment opportunities and 2) They usually take large amounts of capital to invest in. What’s great for everyday investors is that crowdfunding eliminates both of those barriers – while producing (historically) returns up to double that of the stock market.

Issuers can post opportunities and investors can search for them there. For issuers, some of the bigger platforms (I won’t mention names) stick their nose in the air to newer investors. But others are much more open to working with investors and allowing them to place their offerings on their platform. And they have all the connections like filing and compliance attorneys to help you get started and operate efficiently.

Wrapping it Up

There are big changes on the way. Changes that will make the capital landscape completely different from what we have previously known. The evolution of investing through web platforms by new technology and strengthening encryption of information made it inevitable that we got to this point. Now is the time to take advantage, like anything, before the space gets saturated. Early movers in this space may create an advantage and have access to capital previously unmatched. With the SEC raising the amounts of capital investors can deploy and how issuers can spread the word, it is going to be a considerable opportunity for both investors and issues to create massive wealth with this growing strategy.

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Blake Dailey is a multifamily real estate investor and host of the Multifamily Journey Podcast. He has reached his financial independence (Passive Income > Expenses) number through investing in real estate and aims to help others do the same. He helps passive investors impact their lifestyle and wealth by investing in multifamily real estate through his company Growth Vue Properties. Growth Vue seeks to help investors achieve the ultimate asset – Time – by making their money work so they don’t have to.

Find out about investing in multifamily with Blake at thegrowthvue.com or learn more about Blake, read his articles, or connect with him through his website at multifamilyjourney.com.

Sources

·      https://www.sec.gov/divisions/corpfin/guidance/reg-crowdfunding-interps.htm

·       https://www.law.cornell.edu/cfr/text/17/227.204

·      https://www.crowdfundinsider.com/2020/11/168682-the-sec-updates-reg-cf-reg-a-and-more-boosts-reg-cf-to-5-million-reg-a-increased-to-75-million/#:~:text=In%20a%20party%2Dline%20vote,%2410%20million%20from%20%245%20million