Is “accredited crowdfunding” a lemons market? Evidence from 506(c) filings

ABSTRACT

The United States Congress passed the JOBS Act of 2012, which allowed small private companies to advertise the sale of their securities to accredited investors. However, this new fundraising method is subject to criticism that it might lead to a lemons market in crowdfunding platforms due to limited information disclosure requirements. This article thus examines this concern, and the results do not support the development of a lemons market. Conversely, we identify a separating equilibrium in which quality companies choose to raise capital from the accredited investors. Firms’ operating characteristics and VC monitoring provide effective signals in the accredited crowdfunding markets.

KEYWORDS:

• Private equity
• crowdfunding
• 506(c)
• venture capital

Notes

¹ Rule 506(c) allows companies to raise capital from accredited investors in the form of debt and/or equity. In this article, we use the term accredited crowdfunding to refer to both types of capital being raised.

² Based on the SEC’s definition, accredited investors are defined as having a minimum net worth of US$1 million (excluding their residence), income of US$200,000 a year (or US$300,000 with their spouse), or are officers and directors of the issuer or various institutions having more than US$5 million in assets. It is estimated that there are 8.7 million U.S. households (7.4 percent of all households in the United States) that qualify as accredited investors.

³ To put the magnitude of this new rule into perspective, the total venture capital (VC)/angel capital invested in 2012 was around US$26.5 billion. Further, the Rule 506 Reg D private placement market was US$800 billion, and the 144A market was around US$700 billion.

⁴ An alternative explanation for experienced VCs investing in equity crowdfunding might be that they possess the oversight and funding to explore this new investment channel. We would like to thank the anonymous reviewer for this insight.

⁵ We would like to thank the anonymous reviewers for the suggestions on future research directions.