SEC Considers Legalizing Finders Fees, Commissions for Crowdfunding

The U.S. Securities and Exchange Commission (SEC) was originally opposed to crowdfunding and actively encouraging legislators to reject proposed regulations. However, in recent months, all indications are that a U-turn has taken place—crowdfunding is being strongly supported by the SEC.

A recent announcement adds to a summer of deregulation that we will review in this article. But first, some background.

There are many different institutions governing the ways in which real estate syndicates operate, and the Securities and Exchanges Commission is among the most important. Even real estate companies not active on any public exchange (NYSE, NASDAQ, etc.) are still affected by the various rules and regulations the SEC puts forth on a regular basis.

This is because when a company syndicates a deal, they are not selling real estate, per se. They are selling shares in a company that owns the real estate—usually an LLC. So, they are selling securities, and hence, the SEC make the rules.

Consequently, it is the SEC that creates the legal framework through which crowdfunding can take place. Crowdfunding, while distinct in many ways, is in other ways comparable to issuing an IPO. This is in the sense that a developer is able to generate stakeholders and raise capital.

The ways that the SEC defines crowdfunding, regulates crowdfunding, and regulates the various industries that can benefit from crowdfunding (including the real estate industry) can have dramatic impacts on how capital is acquired and used. Let’s take a look inside some of the SEC’s most remarkable changes and recent announcements that have occurred thus far this year and are likely to bring substantial changes in the near future. We’ll also discuss what this means for the industry as a whole.

Article author Adam Gower discusses the latest changes to crowdfunding with crowdfunding attorney Mark Roderick of Lex Nova Law in this short video:

Increasing Sponsor Limits

Real estate syndication is not possible without a sponsor. The sponsor is the real estate professional who takes on the day-to-day responsibility of buying, developing, and managing or selling a project. They also play the key role in attracting new investors—those whose contributions are strictly monetary and who take no role in the everyday managing of a deal.

Naturally, whenever a sponsor is able to get more flexibility from looser regulations, their real estate syndicates can grow faster.

The first move in this deregulatory environment came in March 2020, when the SEC increased the limit a sponsor can raise from $1 million to year to $5 million per year when using Regulation Crowdfunding (CF). Reg CF is the section of the 2012 JOBS Act that allows for sponsors to raise money (via funding portal like SmallChange, for example) from accredited and non-accredited investors alike.

This increase had a huge impact on sponsor’s ability to execute projects because it represents a 500% change. Sponsors can now operate at much higher volumes, meaning that projects that might have once been considered out of reach are now becoming more viable crowdfunding options.

Plus, by encouraging more sponsors to use Reg CF to raise capital by increasing the maximum they can raise, they also increase the pool of projects that non-accredited investors have access to—a win-win.

Furthermore, the rules for Reg CF originally capped the amount an accredited investor could invest in a single deal. Another remarkable change issued by the SEC this year has been the elimination of these limits. With accredited (wealthy) investors now able invest as much as they want to, the attraction for sponsors to bring more deals to Reg CF funding portals like SmallChange increases, which further increases opportunities for non-accredited investors also.

Reaching Non-Accredited Investors

What makes crowdfunding so different from traditional methods of raising capital in real estate is that while traditional methods rely on privately appealing to a large institution or select group of wealthy individuals, crowdfunding relies on publicly appealing to many small investors. To put it simply, by allowing non-accredited investors to participate in this sector, the pool of possible investors can suddenly be expanded from nearly 14 million accredited investors to also include over 200 million non-accredited investors in the United States.

Ultimately, these changes combine to create a mutually beneficial situation: Sponsors can now raise capital more easily due to having access to a larger pool of investors. At the same time, more investors can gain the right to play an active role in these important markets, which increases their personal level of financial freedom and opportunity.

Overall, the changes to how the SEC applies and interprets the JOBS Act are far from surprising. The JOBS Act was a major piece of legislation and, at just eight years old, is relatively new. Markets, attitudes, and legal interpretations have all experienced significant shifts since the legislation was first passed, and future changes to these laws are seemingly inevitable.

Watch this short excerpt from the podcast discussion author Adam Gower had with attorney Mark Roderick about the most impactful proposed change just announced by the SEC:

Legalizing Finders Fees

One of the most notable changes has been how existing law is applied and how the SEC just proposed it will change. For years, people would use a rolodex, reach out to their network, and direct commissions to finders in exchange for investment dollars raised. While this practice (for non-registered broker-dealers) has always been illegal, it has played a significant role in shaping capital markets.

The most significant proposal in the recent SEC announcement is to recognize this “fact on the ground” and to permit finders to both raise capital for a sponsor and receive a commission for doing so. There will be some conditions, the two most important of which are as follows:

The finder and the sponsor must have a written contract between them articulating the terms of the commissions to be paid, and,
The finder must disclose to investors that they are being paid a commission subject to the contract with the sponsor.

Crowdfunding Goes Mainstream

Perhaps accelerated by the COVID-19 pandemic, these changes have helped real estate crowdfunding continue its steady movement from the periphery of the investment world to a mainstream wealth-building vehicle. Real estate investing is no longer reserved for the few; rather, it is now much more open to the many.

Aligning the law with the realities of this dynamic market will take time, but it is clear that things are moving in a productive direction. Applying principles of fairness and democratization to the real estate investment market has helped create long-needed, positive change—and in its recent announcement, the SEC is playing a pivotal role in deregulating the industry.

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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.