Delayed, but finally here: on October 23, the SEC put forth the proposed rules for crowdfunding (as a legal concept – Title III of the JOBS Act). If you want a description of the rules without reading 500-plus pages, you can find them here. I will do my best to follow up on this post and provide a few links to a handful of quality articles and releases as I find them. For now, here are the thoughts of a securities practitioner who runs a platform on how these rules will change the fundraising process for real estate (the short answer: not much).
The proposed rules limit the amount that can be raised via crowdfunding to $1 million per year. While this sounds great, it really isn’t much for someone who aspires to become the next real estate bigwig. This is so because the limit applies to issuers and their affiliates. For example, ABC Developer will be able to raise $1 million per year across all of its projects. This is not much for real estate, even if you leverage that amount. Thus, companies like ABC will have to resort to traditional private placements to raise the full amount of equity they need in a given year.
For someone who, like ABC Developers, wants to raise over $500,000 over a 12-month period, the compliance burden is not light: besides a list of disclosures (none of which should be problematic but will force most to hire a lawyer or at least a consultant), they will need to provide audited financial statements to investors at the time of the offering and every year after closing. This is costly (upwards of $15,000 per year) and it takes time and attention from ABC’s management.
3. Investor Limits
The proposed rules (following Congress’ mandate) impose limits on how much individuals can invest in crowdfunded securities in any given year. This will limit the amount of available dollars and further increase the cost of compliance. Fortunately, a few firms (CrowdBouncer being a good example) have stepped up to provide a cost-effective service that will ensure compliance with these requirements.
In short, the proposed crowdfunding rules will probably benefit guys who want to do one-off community-focused projects (the only problem I still see is in the audits). For those seeking to build a significant portfolio, these rules are not going to cut it.
4. My Thoughts on Portals
Funding portals are a new kind of securities intermediary. They are basically firms that run websites offering securities via the proposed crowdfunding rules. The legislative intent behind the proposed rules for portals is to make them as content- and outcome-neutral as possible. Although it is unclear at this time, it appears that portals will be able to get transaction-based compensation (i.e. tied to the success of an offering). However, there are very important restrictions: portals (and their affiliates and principals) cannot co-invest or take a carry (i.e. a percentage of the profits) in a deal, offer an affiliate’s securities, or choose their “top picks” (or make any kind of recommendation whatsoever).
These are all very important restrictions and will be deal-breakers for many. Granted, obtaining and maintaining a portal license will cost less than becoming a broker-dealer (but not that much less). However, I just don’t anticipate many would sign up and run a profitable business as a portal, when they can run a much more flexible (and in theory more profitable) business as an introductory broker-dealer (the most basic broker-dealer license).
Regardless of form or shape, due to the cost of securing and maintaining these licenses, I predict some heavy consolidation of portals/broker-dealers in the coming years. ABC Developers and other deal sponsors would have their own websites and use these larger firms as their execution and marketing platforms to reach a larger audience.