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Fundrise, the JOBS ACT and how 'crowdfunding' came to mean everything and nothing at the same time

posted Sep 20, 2014, 11:05 PM by Siamak Ebarhimi   [ updated Sep 20, 2014, 11:05 PM ]
At some point, can't say exactly when, the definition of "crowdfunding" became vague enough to describe just about any investment platform that involves the Internet. The word has become a convenient but imprecise shorthand, an umbrella that covers both equity- and donations-based financing vehicles; those available to every Joe-six-pack investor and those limited to the wealthy; those rooted in long-standing regulations and those reliant on the two-year-old JOBS Act.

"Crowdfunding" is fantastic for headlines, terrible for understanding how any given platform actually works.

Fundrise, a D.C.-based real estate investment site with more than 30,000 members, is a perfect example of how a cheery term like crowdfunding can oversimplify a much more complex model. Fundrise allows groups of investors, those that might not normally have access to a commercial real estate deal, to pour resources into apartment buildings and other projects, with investments as small as $100 apiece. Those investments boast an average annual return of 12 to 14 percent, according to co-founder Ben Miller.

Here's where things get complicated. Fundrise is bound by existing securities law in who they can allow to invest, while two provisions of the JOBS Act with the potential to expand that population are still grinding their way through Securities and Exchange Commission rulemaking. With several important exceptions, Fundrise's investor base is limited to the accredited, those who meet a wealth standard set by the SEC. This is not the "crowd," in the strictest sense.

"That's limiting," Miller said. "And it's also not in the spirit of what we're doing to be so limited. But there is still a very interesting business nonetheless."

Miller, you might guess, possesses a far more sophisticated knowledge of securities law than your average founder. He seems resigned to using the term crowdfunding to describe his company. After all, everyone, the press included, seems to call Fundrise a crowdfunding platform, even if it's a flawed term.

Regulation A: "Unbelievably burdensome"

The above "important exceptions" are three D.C. real estate investments that Fundrise conducted through something called Regulation A , which allows a sort of "mini public offering." In each case, Fundrise was able to tap a larger population of backers — coming much closer to true crowdfunding — but with significant drawbacks. Reg A offerings are limited to $5 million, and must conform with state securities laws, called "blue sky" laws, creating a complicated patchwork of state regulatory frameworks to navigate.

"We put our back into public offerings once in a while so we can make it truly democratic and let people participate," Miller said. "But it's so hard and it's so slow that it's not economical."

Reg A, as written, is "unbelievably burdensome," Miller said. Which is why the JOBS Act sought to rework it two years ago. Under the law, Regulation A+ (see what they did there?) expands that dollar limit to $50 million — albeit with more extensive filing requirements — and would preempt those blue sky laws. The same changes that make Regulation A+ more attractive, however, have left the measure jammed up in SEC rulemaking, with no end in sight.

Regulation A was originally billed as central to Fundrise's model, and ended up being the exception. Even when Reg A+ comes down the pike, it probably wouldn't become the primary vehicle for Fundrise, which does several deals a week. Conducting what amounts to an IPO-lite is not something that can be done every day.

"It's something you would do probably for bigger, more high-profile deals," Miller said.

Putting the crowd back in crowdfunding

Most of Fundrise's offerings are conducted through Regulation A's more popular neighbor, Regulation D, a provision that startups across the country use to raise venture funding while skirting SEC registration (SEC registration being massively expensive and unworkable for a startup). Specifically, most of Fundrise's deals make use of the widely-used 506(b) exemption, available to their accredited members only, and would be a stretch to call "crowdfunding."

That's not Fundrise's fault. The law, after all, places huge limitations on raising funds from the unaccredited. Platforms such as Kickstarter and IndieGogo get around this by allowing only donations; Kickstarter backers, who can be of any net worth, are rewarded with gadgets or T-shirts instead of company shares. Meanwhile, other startup-funding sites like SeedInvest are restricted only to the wealthy.

Which brings us back to the JOBS Act, which contains a much-touted measure that would enable equity-based crowdfunding for the masses, brokered through heavily regulated online portals. As in, Regulation A+ — however, the SEC has been slow to move.

JOBS Act crowdfunding (or, Title III crowdfunding, referring to the specific section of the Act), has the potential to open up Fundrise's offerings to the general populace, increasing both the dollar amount of a deal and the number of investors, while at the same time creating new complications. Miller, however, offers up a restrained prediction.

"At one point, I thought it would be transformative, but the more I've gotten into it, the more I see Title III is a very difficult regulation to use," he said. "I'm not sure how powerful it will be in practice."

Until then, however, we're stuck in an awkward period of transition, where "crowdfunding" means everything and nothing at the same time.

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