Real estate crowdfunding tends to be at the forefront of new ways to raise money. While “creative” might not be a compliment in accounting, it is very much so in finance. Joint-stock companies were developed to establish British overseas colonies. The oddly named Cigar Excise Tax Extension of 1960 established the legal framework for real estate investment trusts. And today crowdfunding has attracted more attention in real estate than in any other U.S. economic sector.
So today, real estate investors have an interesting dilemma. There are two different ways that a newly formed LLC or LLP can offer securities without bearing the full regulatory brunt of filing with the Securities and Exchange Commission. Then, once prospective issuers select which way to go, they face a secondary dilemma of which of two flavors to pick within their selected exemption. These exemptions come courtesy of Title 17 of the Code of Federal Regulations, chapter 2, part 230 and are known as Regulation A and Regulation D.
The ‘A+’ team
Reg A was enshrined as part of the Securities Act of 1933, but hardly anyone used it. To make it more appealing, it was expanded as part of the Obama-era Jumpstart Our Business Startups Act and the new version is often called Reg A+. It’s designed to allow small companies to raise funds publicly without the time and expense of a full initial public offering.
Real estate “is the first segment in Reg A+ that is engaging wealthy investors in a meaningful way,” Rod Turner of Manhattan Street Capital wrote in Forbes, due to the kind of money this sector attracts. “Institutional and angel investors are generally cautious about getting into new investment types until thoroughly proven. So in most cases, we do not see much activity from them in Reg A+. At this stage, Reg A+ offerings must appeal deeply to consumers to be viable, because consumers are early adopters and will invest if they love what your company does.” Turner notes that the combination of the tangibility of real estate assets and the dependability of interest or preferred dividend payments are what make these projects most attractive to Reg A+ investors.
Tenacious ‘D’
Regs D is also intended to enable funding of small, growing firms, but it takes a far different tack. While Reg A is all about opening up the sale of securities to the public, Reg D is a path to a private placement.
When discussing Reg D, people generally refer to Rule 506, which has two key paragraphs: (b) and (c). Rule 506(b) allows up to 35 investors who are not accredited but are sophisticated. Accredited investors make at least $200,000 per year or have a net worth of over $1 million, while “sophisticated investor” is a more nebulous term that suggests this person understands finance. This rule forbids the kind of “general solicitation” — that is, advertising — the JOBS Act enables for hedge funds. Meanwhile, Rule 506(c) requires all investors to be accredited but allows general solicitation.
Unlike Reg A, there is no limit on how much a firm can raise and still be in compliance. This goes for either rule, although the commercial real estate market seems to favor 506(c). According to WealthForge, that’s because of the permissibility of advertising, lower document disclosure requirements and a lack of the 30-day lockup required under 506(b).
While We’re on the Subject …
Regs A and D at a Glance
| Reg A, Tier 1 | Reg A, Tier 2 | Reg D, 506(b) | Reg D, 506(c) | |
| Who can raise money? | U.S. or Canadian companies | U.S. or Canadian companies | Any newly formed company | Any newly formed company |
| Who can buy in? | Anyone, although Exchange Act requirements are triggered at the 500-shareholder threshold | Anyone, although Exchange Act requirements are triggered at the 500-shareholder threshold | Accredited investors and up to 35 non-accredited but sophisticated investors | Accredited investors |
| How much can you raise? | Up to $20 million total, up to $5 million per year | Up to $50 million total, up to $5 million per year | Unlimited | Unlimited |
| Can securities be resold on public markets? | Yes | Yes | No | No |
| Can I market online? | Yes | Yes | No | Yes |
| What must you file? | Offering circular, one time, including unaudited financials | Offering circular and continual reports, including unaudited financials | Form D | Form D |
| Do you still have to comply with state securities laws and federal anti-fraud laws, as well as civil liability? | Yes | Yes | Yes, although state registration is unnecessary | Yes, although state registration is unnecessary |
Sources: SEC, WealthForge, Upcounsel, Investopedia
