Last week, the future of funding and investing in startups and small businesses underwent a subtle but significant sea change with the implementation of Title IV of the JOBS Act. These changes were announced in late March, and went into effect Friday.
With the changes now officially in effect, the SEC is allowing — through a provision called Regulation A+ — companies to raise up to $50 million via a mini-IPO. The mini-IPO process will be less rigorous and work–intensive than a traditional IPO. Though small scale public offerings have existed legally for some time (via Regulation A) they have historically been a high complexity vehicle with a low $5 million ceiling that few companies ever bother to make use of.
And while the move to shrinking the scale of IPO for some SMBs is significant, the regulatory change that has gotten much more attention has been the big shift in the available investor pool for startups. Going forward, through Regulation A+, the SEC is letting companies solicit investments from “average Joe” investors by allowing them to buy into equity stakes through crowdfunding.
That reverses the trend of the last 80 years, wherein the public could only invest in non-public companies under few and far between special circumstances (such as the little tapped original Regulation A). The rules of the last eight decades represent an attempt to protect the average consumer from unknowingly making high risk investment bets on untested ventures by limiting “high risk” startup investment to accredited investors — those who earn over $200K a year or have $1 million in combined (non-primary residence) assets.
Regulation A+ investors do not need to be accredited — and though there are limits to how much an individual can invest (only 10 percent of their net worth or annual income), anyone who wants to take part is more or less qualified as an investor under the new rules.
And though the provisions went into effect somewhat quietly on a summer Friday afternoon, the reactions to the change have been steadily pouring in as the first week of a world with mini-IPOs and average Joe investors gets underway. Indiegogo’s founder Slava Rubin was bullish on the opening up of the market — unsurprising given his long support of the expansion of his crowdfunding platform into equity funding.
“We’re encouraged by the SEC’s new equity crowdfunding regulations,” he said. “They enable startups and small businesses to secure additional funding, while providing strong investor protection. We will continue to explore how equity crowdfunding may play a role in our business model.”
Massachusetts Secretary of State William Galvin is also pretty excited about the rule change, though not in a good way. The Secretary has officially filed a Petition with the D.C. Court of Appeals to request a reversal of the new SEC regulations. Galvin contends that state regulators and overseers’ abilities to protect middle class investors from bad deals is fundamentally and dangerously undermined by the new laws.
Galvin is not alone in his concerns about the risks to businesses and investors the rule change may pose, but it is a bold vote of confidence in state oversight of individual investors from Massachusetts, the state that famously protected its citizens from the scourge of investing in Apple in 1980.
So who’s the bigger winner here? Big loser? Do we know yet?
And three days in to the new world order, it is hard to say much of anything about it definitively, since, with very few exceptions, almost nothing succeeds or fails instantly. However, there are some big and small fish swimming in the alt FinServ sea who can expect a little bit of current at their back (or head) as the marketplace adjusts this summer.
The consensus from experts on Regulation A+ is that it will likely have a greater impact on the investor world than it does on SMEs and small business owners’ abilities to access funding. Most small businesses, they note, are not of the right variety to really capitalize on a crowdfunded model.
Meanwhile, some of the changes can be complex to navigate from a legal and compliance standpoint. Restrictions around who can invest are relaxed, but documentation that is to be made available has also increased — as the SEC has several rules already rightly in place to prevent fraudulent offerings. Conforming to those rules will cost firms, which may be out of the reach of many cash-strapped SMBs.
CohnReznick LLP partner Alex Castelli for example, recently warned businesses that they must have reinforcements ready if they are to partake in this type of crowdfunding.
“Be prepared to have a large number of small-dollar investors,” he said, “[and] act like a public company. This means being transparent. Hire experienced professionals to help guide you and make sure you stay in compliance with the rules and regulations.”
Hiring these professionals and focusing on regulatory compliance, however, may not be feasible to the youngest of new businesses, or firms that do not go into this process well capitalized.
VCs invested almost $50 billion in startups last year – 7 percent of which were run by women and an even smaller percentage went to (non-Asian) minorities. While the “why’s” behind that are much debated, what seems certain is that it is not lack of interest — women and minorities start businesses at twice the rate of other groups — nor is it lack of ability — female-led tech firms tend to pull in 12 percent more revenue than their male-led counterparts.
Some experts, however, are now forecasting that the ability to go straight to the people to solicit funding — trading on a track record of revenue — might help women and minorities break through the funding gap.
Some entrepreneurs are looking to cash in directly on that opportunity. Kim Folsom has just co-founded FundAthena, as a Reg A+ marketplace established to directly address the female funding disparity.
While it is easy to laugh in retrospect at Massachusetts’ desire to protect people from investing in Apple, the reality is nearly every single startup will never be Apple (neither will most businesses for that matter). In fact, the vast majority of startups fail, which means a lot of consumers will soon find they own ill-liquid equity in something valueless.
“The vast majority of people are still not saving adequately for retirement, so why would we push them into highly speculative investments in small companies?” says Barbara Roper, Director of Investor Protection at the Consumer Federation of America. “There’s a reason why this market traditionally hasn’t been opened up to average investors, who can’t recognize that the vast majority of companies will fail.”
“Investing in private companies is extremely risky, and is not liquid investment,” Alex Feldman, the CEO and founder of crowdfunding review service CrowdsUnite, affirmed in an email conversation with PYMNTS.
Given the cost and time requirements of a Regulation A+ filing, various analysts question whether there is really any incentive to be an early adopter of this just yet – since many of the companies that can clear the high bar necessary to make use of the option of crowdfunding their way to equity might have other, easier to access options.
When all is said and done, it might just be easier, cheaper, and faster to stick to accredited investors and raise money via good old-fashioned Regulation D offerings.
After all, in 2014 alone — via 11,228 Regulation D offerings — accredited investors handed over $1 trillion. According to reports, almost half of those offerings would also have been possible under Regulation A now modified, but it is hard to see why those companies would have pursued it with accredited investor money fairly accessible.
“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,” noted Scott Purcell of FundAmerica.
So will the world change now that Regulation A+ is in effect? It seems like the answer will likely be “no” for most businesses.
But it is notable because it is one more alternative financing stream for small businesses opening up where previously there was nothing. And one more piece of evidence that the future of funding a small business may soon almost resemble the past in no meaningful way.
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