Forbes by Chance Barnett | July 9, 2015

Startup investing and fundraising is moving from the boardroom to the deal room (online) as new laws for equity crowdfunding in the U.S. have come into effect over the last two years.

Prior to this, traditional fundraising has been a fractured process that takes place across hundreds of private emails, calls and in person pitch meetings. But now, early stage venture capital is being disrupted and moving online in a more public way.

The data shows that of the 8+ million qualified (accredited) investors in the U.S., only an estimated 3% have ever invested in a private startup. But now the opportunity has opened up for more of this group to invest online with experienced professional investors.

Alongside this, tens of thousands of startups are opting to use the web and equity crowdfunding to find, pitch and close investors.

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Yet as CEO of Crowdfunder.com and an early participant in JOBS Act legislation, I’ve watched a surprising “private market” trend develop where startups choose a more closed and non-public route of equity crowdfunding, even though they have more public option available to them.

To understand this trend and what it means for startup founders and investors, you’ll need a brief background.

Public vs. Private Equity Crowdfunding Laws

It was September of 2012 when the SEC finalized Title II of the JOBS Act, bringing with it new equity crowdfunding laws that allow startups (private companies) to publicly advertise their fundraising activities, while limiting investment to accredited investors only.

This brought startup investing squarely into the Digital Age as fundraising online for startups has burgeoned on top equity crowdfunding sites. What’s more…trends show that as an overall funding source by 2016 crowdfunding will be bigger than VC.

But while equity crowdfunding has enabled startups to publicly fundraise online, some startup companies have not chosen to take this new public fundraising route available to them under Title II equity crowdfunding.

Instead, a majority of startups have opted to do their equity crowdfunding in a more private way – electing to limit their fundraising to the private accredited investor communities pre-registered and qualified inside equity crowdfunding platforms.

The technical specifics of Public vs. Private fundraising mean that startups use the Reg D 506(b) exemption for private fundraising and the 506(c) exemption for public fundraising, also known as general solicitation. (SEC info)

This private trend begs the question: if fundraising is part of the lifeblood of startups, why are some companies not using the same public promotions they use to find customers online, to find investors?

Related: [Breaking News]: Certain Canadian securities regulators to adopt start-up crowdfunding exemptions

Why Use Private Equity Crowdfunding?

One reason some startups are fundraising privately could be due to a lack of perceived or real need. Equity crowdfunding platforms are doing the work of aggregating larger pools of active accredited investors inside their private communities.

With that, fundraising strictly within these private accredited investor networks can put a company in front of thousands of potential investors and has the capacity to drive millions in funding. But not all startups are successfully funded under the private fundraising route, and they miss out on potential investors they might have found publicly.

It’s also likely that startups opt for private fundraising due to a lack of education and clarity about the rules and regulations of public fundraising. With crowdfunding laws taking years to be passed by regulators after being voted in by Congress, some companies are simply confused or unaware that general solicitation is SEC-approved, or furthermore unclear what’s required to utilize it.

>>> Register for the Equity Crowdfunding Bootcamp on July 28 in Toronto <<<

Why Use Public Equity Crowdfunding?

Startups that don’t use public fundraising miss out on the true social and collaborative power of the web, social media and PR to tell their story and attract potential investors. Without this, there can’t be a far-reaching campaign that finds and attracts investors who didn’t already know the company or who weren’t already on an equity crowdfunding platform or connected to the company.

Rewards-based crowdfunding depends almost entirely on this dynamic.

It’s also the case that some startups are more predisposed to wanting and understanding the benefits of a more public fundraising process – as they aim to recognize benefits from added marketing and brand-building and customer engagement that can come from allowing the public and your fans to also become investors.

The Legal Requirements of Public Fundraising

As someone who runs an equity platform, I see firsthand that many startup founders are unclear on what really is required when deciding to go the public fundraising route.

In short, there are two basic requirements to public fundraising (506c offerings):

1. File a Form D online and denote that you’re using the 506(c) exemption within 15 days of taking in first funding into a given offering.
2. Take reasonable steps to verify that all investors are accredited. This can be done via income/tax statements from the investor or a letter from an investor’s accountant or attorney attesting to their accredited status. Many equity crowdfunding platforms perform this as a service for startups publicly fundraising.

The risks of this are that if the SEC were to look into your fundraising activity and found that a non-accredited investor participated in a publicly marketed round, the startup would be banned from fundraising for one year.

It’s also worth noting that the SEC also finally ruled on Reg A+ offerings that can be publicly solicited and can accept non-accredited investors as well. Unfortunately, the time and costs associated with doing this are too prohibitive for this route to be a fit for nearly any early stage startup without a lot of money already in the bank.

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