A Data-Driven Approach to Verifying Accreditation Status For Crowdfunding
Online equity crowdfunding platforms offer early stage companies a less complicated and less expensive alternative to the traditional IPO approach. With access to both “accredited” and non-accredited ("sophisticated") investors, startups can quickly raise the money that they need to take their ventures to the next stage while complying with SEC private placement regulations like 506(b), 506(c) and Title III of the JOBS Act. However, before this can happen, the crowdfunding platform must verify a potential investor’s financial standing. If important information is overlooked or it takes too long to verify accreditation, both the startup, the investor, and the crowdfunding platform could miss out on an invaluable opportunity. A turnkey API-enable data aggregation tool, can connect investors and startups faster and more accurately than ever before.
Private Placement Regulations
Statista reports that there are 375 crowdfunding sites in North America alone, with equity the most common investment model in the U.S. The SEC has specific regulations concerning private placements or the sale of company equity in exchange for business capital. Rules 506(b) and 506(c) are two of the most relevant for equity crowdfunding. While investment regulations have been in place since the creation of the Securities Act of 1933, those concerning online capital raising have only recently come into play with the 2013 JOBS Act. Each of these regulations has its own demands that crowdfunding platforms and startups alike must meet, including the verification of a potential investor’s accreditation status, defined by the SEC as an investor with a minimum income of $200,000 or a net worth of $1 million or more, excluding home equity).
506(b)
Under this regulation, startups can raise an unlimited amount of capital from both accredited and non-accredited investors. However, only 35 investors from the latter group can take part in an investment round. Likewise, while this group does not need to have a “substantive relationship” with the platform before they can be approached with an investment opportunity, they do need to submit to an external financial audit. This places a significant burden on a platform, in the form of time and operational costs, and can add to the number days that it takes for the startup to close a round.
506(c)
Regulation 506(c), the more recent of the two SEC Rules, limits funding to accredited investors. While solicitation of capital is allowed, allowing platforms to reach out to potential investors via social media, email, print advertising or even in person, the level of investor verification required for this type of equity funding goes beyond 506(b), as the existing substantive relationship requirement is no longer required. This ability to solicit investors opens up the pool of potential investors a bit, but crowdfunding platforms are required to obtain substantial financial paperwork from potential investors in order to verify that they are accredited.
Title III
Legalized in 2016, this regulation gives almost any US-based startup the ability to raise funds from accredited and non-accredited investors (capital must be raised from both groups), up to a total value of $1 million, so long as the round occurs through an online mediator like a crowdfunding platform. However, investors are restricted from investing based on their income and net worth, which must be verified by the intermediary.
Current Processes
In 2017, in the crowdfunding segment, the number of funding campaigns totaled 177,269 and is expected to increase by at least ten percent each year until 2020. This number represents a significant amount of time and money dedicated towards verifying the financial data of potential investors. The leading crowdfunding platform (*based on number of offerings) currently follows a verification process that includes the following:
- A potential investor registers on the site and answers questions about income and net worth, including income expectations for the current year (with financial certification of expectations)
- The platform attempts to verify the potential investor’s accreditation within a specific time frame (usually two or three business days)
- The platform attempts to verify the investor’s identity via a third-party verification service
- The potential investor is asked to provide additional documentation to prove accreditation status (e.g. a letter from investor’s lawyer, financial advisor, CPA, registered broker/dealer etc.)
- Other documents that may be required include tax returns, W2’s, bank or security statements and a credit report (i.e. an exhaustive demonstration of net worth)
A Better Solution
Account aggregation and transaction level data open the door to a more simplified net worth and income verification process for crowdfunding platforms and a more user-friendly experience for potential investors. After a potential investor enters some basic information into the turnkey interface, financial information is pulled from across the user's financial accounts to create a holistic view of their net worth. Likewise, transaction-level data verify accreditation based on income can be parsed to isolate income streams such as salaries, dividends, bonuses, and recurring payment receipts such as rent inflows.
Most importantly, because these integrations are built using cutting-edge RESTful API technology, they are durable as well as reliable, allowing crowdfunding platforms to verify the data that they need in seconds not days. In addition, investors enjoy the ease of a more streamlined accreditation verification process and don’t need to worry about taking additional time out of their busy schedules to take advantage of an investment opportunity.
Fundly reports that more than $17.2 billion dollars of crowdfunding revenue has been raised in the US. As crowdfunding continues to play an important role in the funding of new startups, the demand for better, faster, and more reliable methods of verifying potential investor data will also increase. Account aggregation and income verification technology are ready to answer this demand.
