Break out the champagne…
After three long years, the SEC has finally issued provisions that will allow everyday Americans to invest in private startup companies and small businesses.
As one CEO told NPR, “This is a tremendous breakthrough in the ability to finance businesses.”
Go figure… a CEO is applauding easier access to capital!
More relevant to our interests here, though, is the fact that industry pundits swear that these new equity crowdfunding rules will be a game changer for investors. Why?
Because they’ll finally permit the masses to invest like venture capitalists.
But don’t believe the hype. Not yet, at least. Here’s why…
Pour Some Sugar Cold Water on Me
Far be it from me to deflate enthusiasm over the SEC finally getting off its duff to issue some long-awaited rules for equity crowdfunding. But before we start waving the pom-poms, let’s see what this actually means for investors like you and me.
By quickly recapping the history of crowdfunding legislation, and the specifics of the latest rules, only then will the shortcomings become obvious.
April 2012: President Obama signed the JOBS Act into law. Among other things, it notably contained the framework for equity crowdfunding. But before equity crowdfunding could become a reality, the law required additional legislation to allow companies to advertise their funding needs, as well as laws that allowed “non-accredited” investors (those with a net worth of less than $1 million or an annual income lower than $200,000) to get involved.
September 2013: Title II of the JOBS Act was implemented. This allowed companies to publicly advertise that they were looking to raise money. However, it still left everyday citizens out in the cold, as only wealthy investors (accredited ones) were permitted to participate in the offerings.
Shortly after issuing Title II, the SEC came out with a proposal for Title III. This would allow everyday investors (i.e., non-accredited ones) to participate. Anticipation and excitement spiked.
Today: After dragging its feet, to this day, the SEC still hasn’t issued the final rules for Title III – even though the JOBS Act called for it to have rules in effect by early 2013. The new target date is October 2015. But the SEC is widely expected to miss that, too.
Rewind to March 25, 2015, though…
The Next Best Thing?
On that day, the SEC dropped a crowdfunding “bombshell” on investors, as Kiran Lingam of Crowdfund Insider put it.
The SEC issued final rules for Title IV. This provision of the JOBS Act allows for everyday citizens to invest in private companies via long-underutilized Regulation A offerings.
And when I say “underutilized,” I mean it. From 2012 to 2014, only 26 companies raised money via Regulation A offerings.
However, the SEC is hoping to revive the use of Regulation A offerings by putting a new spin on them…
- Crank up the Spin Machine: First, the SEC is changing the name to Regulation A+ offerings. (How clever!)
- Funding Limit Raised: Second, the SEC is significantly increasing the maximum amount of money that a company can raise – from $5 million to $50 million. That’s enough for such offerings to be considered mini IPOs.
- Everyday Investors Welcome: Last, but not least, the SEC is letting companies use Regulation A+ offerings to solicit investments from “the crowd.” In other words, for the first time ever, non-accredited investors can invest up to 10% of their annual income or net worth in each deal.
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The SEC hopes these changes will spur a wave of fresh investment – much like we witnessed after Title II was passed. In the first year, money raised online from accredited investors in Title II equity crowdfunding deals shot from zero to over $250 million.
But don’t expect history to repeat itself anytime soon with Regulation A+ offerings…
Four Major Shortcomings to Regulation A+
“These new rules provide an effective, workable path to raising capital.”
So says SEC Chair, Mary Jo White.
That might be true. But the process needs to be seamless and cost-effective for it to gain widespread popularity. And it’s anything but. For example…
Regulation A+ Shortcoming #1: Expensive. It’s estimated that a Regulation A+ offering will cost companies upwards of $100,000 or more to prepare the necessary documents. Then there’s the added expense of accountants’ fees, in order to comply with reporting obligations, as well as state regulatory fees, depending on the size of the offering.
Regulation A+ Shortcoming #2: Time-Consuming. Per the Title IV rules, the SEC must review a company’s offering documents and audited financials before giving it the green light to raise money. Industry observers expect the SEC to apply the same level of scrutiny to Title IV offerings as it does to companies preparing for a traditional IPO.
Translation: It’s going to take a long time for a company to get approval. In fact, from 2012 to 2014, it took the SEC an average of over 300 days to approve Regulation A+ offerings. That’s an eternity for a small business looking to raise capital.
Regulation A+ Shortcoming #3: Lack of Infrastructure. Regulation A+ securities will be freely transferable (i.e., liquid). That means we can buy shares and sell them to others. The only problem? A secondary market isn’t set up yet to facilitate such transfers. Until one is, the full potential of this clear benefit can’t be realized or marketed to encourage investment.
Regulation A+ Shortcoming #4: Better Alternatives Exist. While Regulation A+ offerings allow companies to raise money from the everyday crowd, it’s easier, cheaper, and faster to stick to accredited investors and raise money via Regulation D offerings.
Case in point: In 2014 alone, 11,228 Regulation D offerings were completed, raising over $1 trillion from accredited investors.
The SEC estimates that approximately 95% of these offerings would be eligible to raise money under the revised Regulation A rules. But why bother? As Scott Purcell of FundAmerica says, “Compared to [Regulation D], Regulation A+ takes way more time to launch an offering, and is far more costly in terms of legal fees, accounting costs, and annual reporting obligations.”
Bottom line: The SEC’s new Regulation A+ is a promising step in the right direction. For the first time ever, everyday Americans can invest in private companies.
But it’s not the crowdfunding Holy Grail just yet. And it’s not suddenly going to usher in a startup investing boom. For that to even stand a chance of happening, the SEC needs to wake up and prioritize the final rules for Title III.
As I said, they were supposed to be in place in early 2013. So there’s no telling how much longer we’ll have to wait for that.
Ahead of the tape,