Crowdfunding is certainly one of the best ways to raise capital investment for your innovative ideas and project. However, little do people know that crowdfunding is not like Crowdfinance, which has been in the financial framework for quite some time. Let’s break it down for you with an example.

Jason recently gets in touch with an old associate Sam, who is deemed as a potential investor. Given the impressive business contacts and rapport that Sam boasts, Jason has decided to pay Sam 1% on the investment that he brings in.

First, Let’s Understand What A Broker Dealer Is

Now, since neither of the two is registered as a broker with the Securities and Exchange Commission (SEC), what regulations imply on this arrangement?

Well, according to the Section 15 (a) of the Exchange Act, a person acting as a dealer or broker should be registered with the SEC, unless he/she is exempt. As such, any and all activities pertaining to no-action guidance from the SEC that relate to broker state include:

  • Soliciting investors to get involved in securities and private transactions.
  • Assisting issuers in creating prospective security transactions and/or helping issuers identify prospective security buyers.
  • Participating in negotiations to bring the buyers and sellers of securities together.
  • Getting compensation based on the success of the security transactions, or according to the security transaction value.

Activities that indicate a broker/dealer status by SEC include:

  • Participating in the sales process, guaranteeing securities, and/or purchasing securities in principle.
  • Available dealer inventory, and/or willingness to buy or sell securities regularly.
  • Regular clientele, issuing securities, and offering investment advice.
  • Engaging in transactions to affiliate’s benefit instead of personal gains.

Why Is It Important?

One of the underlying differences between crowdfunding and Crowdfinance is that in order to partake in Crowdfinance, you are required by the SEC to work with a registered broker or dealer to raise capital investment. On the other hand, in crowdfunding, you can raise capital investment of no more than $1 million in 12 months from the time you post your project on a crowdfunding platform.

Now that we have that cleared up, let’s take a look at other key differences in Crowdfinance and crowdfunding to help you realize what the best option for your startup is.

Investment Advice

The JOBS Act has certainly made it easier to understand the two primary crowdfunding sources. Before crowdfunding became a legal framework, startups and small businesses would have to solely rely on the guidance by brokers. The definition of a broker/dealer is an investment professional that is registered with the NASAA, FINRA, or other regulatory bodies.

A broker dealer is accountable for assisting investor(s) in making better decisions when it comes to capital decisions. As such, he/she is required to offer accurate and true-to-value insight into an investment and put the needs of a business or investor above his/her personal objectives.

On crowdfunding portals, on the other hand, a startup can manage to raise capital from significantly smaller investments. Hence, crowdfunding portals are not required to assess the business opportunity, value, and as such, find investors; all of which are primary duties of a broker dealer. Hence, a crowdfunding portal may work legally without being registered as a broker dealer if it does not:

  • Provide investment advice
  • Find investors on behalf of the issuer
  • Compensate any agents or personnel for soliciting securities sale
  • Offer asset and securities management
  • Engage in activities disapproved by SEC

In case a crowdfunding platform performs any of the aforementioned activities, it should be registered as a broker dealer. The basic framework of a crowdfunding is to provide a platform on which a startup can pitch the idea and use third party services to transfer capital and stocks. Following this, a crowdfunding platform is eligible to provide general information on creating a campaign and advice on using the platform more effectively, nothing more than that.

So how do crowdfunding portals get compensation?

Crowdfunding portal generally charge a marketing fee on each capital transactions as compensation. Unless a portal is not owned by a registered broker dealer, it cannot charge fee based on the success of a campaign. Hence, crowdfunding portals are deemed ideal for raising small capital investment with minimum disclosure of confidential information. It is also recommended that you see the disclosure agreement on crowdfunding platforms you wish to engage in.

Raising Capital

Crowdfinance is generally perceived as a general term. According to the JOBS Act, there are two separate titles established under Crowdfinance. Title II, otherwise known as 506(c) Private Placement is currently in effect as allows an issuer to raise capital through investors, subject to terms as per the rules in the title. A startup or company may solicit its service under Title II, according to the regulations placed by SEC.

Title III, otherwise known as crowdfunding portals, is a framework in progress, and the absolute regulations are still pending. Under Title III, a startup or small business may sell securities (in small amounts) to both accredited and non-accredited investors. Title III has a maximum cap in effect for investment, where the aggregate cap is $1 million raised in capital investment in the first 12 months of posting a campaign.

Both Title II and Title III are subject to regulations implied on issues as well as investors, which pertain to:

  • Raising capital
  • Disclosure agreement
  • Types of investors
  • Compensation

The Underlying Differences

As you know by now, there are various differences in raising capital through Title II or Title III. More often than not, people will confuse crowdfunding with Crowdfinance. In simple words, the legal framework and regulations for Title II are both established and in effect. Title III also has established the legal framework, but is still subject to regulatory changes.

There is generally no limit as to the number of investors who raise capital under Title II, whereas limits apply under Title III. Knowing these differences can help you better understand what nature of crowd investment a startup should seek based on the business model.

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