Crowdfunding 101: ‘Reg-D’ vs. ‘Rewards’

By Lora Kolodny

Small U.S. investors can donate money to a startup on a crowdfunding site such as Kickstarter, but they won’t get a stake in the company in exchange.

Despite changes in federal law, Americans can’t yet legally put money into a startup in an “equity crowdfunding,” an investment method that is open to ”accredited investors” only.

The Jumpstart Our Business Startups Act, enacted and signed into law in April last year, was meant to enable this. It eased accounting and disclosure requirements on smaller companies to help them go public, aiming to spur growth and create jobs.

The idea was that eventually, investors of every kind would be able to find startups or small businesses that they want to back online, hammer out deal terms and complete the transaction, all digitally.

Under the new leadership of Chairman Elisse B. Walter, the Securities and Exchange Commission is overdue in delivering the rules that will make it possible for startups to attain crowdfunding for equity from “ordinary Americans” (to borrow a phrase from President Obama).

Here’s a quick guide to the two main types of crowdfunding out there right now:

‘Reg-D’ Crowdfunding

For now, only broker-dealers licensed by the Financial Industry Regulatory Authority, and those regulated by the SEC and FINRA can legally conduct these transactions between startups and investors online in the U.S. Likewise, only accredited investors–as defined by the SEC–can use those sites to invest.

This subset of equity crowdfunding is referred to as “Reg-D” crowdfunding, a nod to the SEC’s existing Regulation D and the forms that a privately held company must fill out and file when it sells its securities.

Some sites offering Reg-D crowdfunding in the U.S. today are: AngelList in partnership with SecondMarket; Microventures; FundersClub in partnership with a large national bank that the company declined to name; CircleUp in partnership with W.R. Hambrecht; and Fundroom with securities offered through Wealthforge.

With Reg-D crowdfunding, accredited investors pool their money to provide a seed- or venture-capital round to a promising startup. In exchange, the investors get some stake in that company’s business of course.

The deals done through Reg-D crowdfunding sites may be convertible debt or equity deals, as with early-stage funds from venture firms and angel groups.

‘Rewards-Based’ Crowdfunding

Those more popular (and less regulated) sites offer “rewards-based” crowdfunding. They let almost anyone–not just accredited investors–contribute a few bucks (instead of thousands) to a project or person they like on the site.

Almost anyone can post a project for funders’ consideration, too.

In return for their money, project backers there get a reward, like a logo T-shirt, or a ticket to an event where they can meet the project’s creators.

Write to Lora Kolodny at lora.kolodny@dowjones.com. Follow her on Twitter at @lorakolodny

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