The next type of crowdfunding that we'll talk about is equity crowdfunding, which, as the name suggests, is essentially private equity for the masses. That is private equity investments made accessible to regular individual investors outside the ultra high net worth category. To analyze this type of crowdfunding, it helps to first look into the history of private equity. Now traditionally, the average Joe is not able to participate in private equity deals. The projects have to be sourced and organized by registered private equity funds. Those funds are only open to either institutions or, quote and quote, accredited investors, who according to the SEC definition, we either have a annual income of over $200,000 or have net worth exceeding a million dollars. This restriction was set for a good reason, compared to public equity, private equity projects are much earlier in stage, and therefore, significantly riskier. This restriction was actually loosened gradually in the early 2010's after the congress passed the JOBS Act, or the Jumpstart Our Business Startups Act of 2012. After this Act and several follow-up regulation changes by the SEC, it is now possible for startup firms to privately sell equity stake to individual investors. Subject to some restrictions, startups can meet some basic disclosure requirements. Then, instead of going to a PE fund, raise private equity money directly using online crowdfunding portals. The platforms themselves are set up similarly as the reward-based portals with very similar technology, which again is just an online marketplace that directly connects the entrepreneurs on one site and individual investors on the other side. In this case, the entrepreneur takes the money, and instead of delivering the finished products to the contributors, send them in equity stake instead. There are many types of equity crowdfunding that are now allowed by the law. They will highlight the two types that are most commonly used by new online platforms. The first type is Regulation CF or equity three crowdfunding, as the name suggests, under-regulation CF or crowdfunding passed by the SEC, startups are allowed to raise a maximum of one million dollars per year from regular individual investors. The projects can also to some degree be advertised to the public. Consequently, there are over 40 registered portals catering to these projects. Those platforms are going to be our focus for the next few slides. The second type is Regulation D or equity one crowdfunding. This type has no annual funding limits, but it's limited to only accredited investors. Online platforms catering to this type started a lot earlier, and well-known platforms include sites like AngelList. In terms of it's operations, this is also similar to the reward based platforms where the entrepreneurs will request a minimum and a maximum amount of equity funding. This graph pulls data from the SEC, and shows the total maximum regulation CF funding required per quarter, and the average amount requested per firm. As you can see, there has been some significant double-digit growth in the first few years since Reg CF passed, but the growths has since flattened a bit since 2018. Part of that slowdown could be contributed to the crypto based funding channels that we'll talk about in the next videos. But what's also important to note here is the very relaxed disclosure requirement for equity crowdfunding projects compared to a public offering like an IPO. Instead of filing a full-fledged prospectus, the startups only need to disclose some basic info using a much simpler form, the SEC Form C instead. Here is pretty much all they disclose. As you can see, the entrepreneurs are like their kickstarter counterparts. They're quite small, with an average of only three employees, and don't really have much in terms of assets and current revenue. So it's very early stage, quite risky indeed, to compound that risk, for smaller deals, the financial data that's disclosed don't necessarily have to be audited. There's very little data on what happens afterwards, whether the projects are successful, and how the subsequent financial performances are like. So here again, just like the reward-based crowdfunding platforms, the equity-based platforms also have an inherently high degree of information asymmetry. However, the equity-based platforms are different in terms of their compensation structure. The table above is from the latest SEC staff report on equity crowdfunding activities, and it shows that on one hand, just like the reward-based portals, the equity crowdfunding platforms are charging a percentage of the fund-raised as an origination fee, averaging about 5 percent. At the same time, in between 15 and 25 percent of the deals. The platforms also takes an equity stake for themselves. This is both good and bad from an investor's perspective. The good is that the platforms would have a skin in the game by taking some equity ownership directly. The bad is that this presents a conflict of interest problem, where the platforms might favor the projects that they have stakes, and devote more platform space and promotion to them in expense of the other projects. The bottom line is that as an investor, when you're evaluating each equity crowdfunding deal, you should pay close attention to the fee structure as well as potential conflicts of interests if the platform is also taking some of the offered equity.
