SMEs Begin To Test The Regulation A+ Waters

The largest anxiety critics of the alternative lending space have today is a lack of regulation. Without investor protection and without regulation on the cost of financing, small and medium-sized businesses, those critics say, may be left in a tighter cash bind than they were before.

But what if an alternative lender was born out of regulation? That’s the case for GrowthFountain, one of the newest SME financing players on the block. The company, which officially launched earlier this month, connects small businesses to financing via equity crowdfunding, and the platform is only possible through the JOBS Act and one of its provisions, Regulation A+.

The Securities and Exchange Commission-led legislation, which itself only went into effect in 2015, enables the “average Joe” to invest in their local small businesses by buying into equity shares, with firms allowed to raise up to $50 million. GrowthFountain provides a platform through which these businesses can solicit that crowdfunding and through which individuals can invest.

And while the platform is born out of Regulation A+, CEO Ken Staut told PYMNTS that the origins of this process actually go back way further.

“If we travel back to the 1930s, in the wake of the Great Depression, that’s where it sort of begins,” he explained. The Depression revealed all those “naked swimmers” — a lack of investor protection and fraudulent corporate behavior, which gave rise to the SEC and the notion that individual savings cannot be invested in local businesses.

“Yet, some 50 percent of our economy is comprised of small businesses,” Staut said. “Almost 60 percent of new job growth comes from small businesses. So, in 2008, 2009, when lending ceased, Congress convened again and said we need to update this antiquated law.”

The efforts led to the JOBS Act, and under the SEC, that legislation gave rise to Regulation A — the first iteration of the rule that provided a few ways individuals could invest in non-public companies. Its revamp, Regulation A+, opens the floodgates for individual investment in the mom-and-pop stores down the street.

Staut said the alternative ways SMEs can access financing — taking a loan from friends or family, raising venture capital, putting up collateral to get a bank loan or taking out a credit card — simply “aren’t great.” But Regulation A+ went into effect pretty quietly in the summer of 2015, so don’t expect equity crowdfunding to be the hot new thing in SME financing — at least not yet.

“This being so new, it’s going to require a tremendous education role on our part to spread the word to people that this is something that exists,” the executive said. “We’re doing our best to start to do that.”

Still, Staut added, there has actually been a lot of “pent-up demand” for this kind of a service; he noted that businesses were approaching GrowthFountain before it officially launched in search of this financing avenue.

GrowthFountain, and the regulation that made this kind of solution possible, may offer yet another alternative to not only bank loans but the slew of alternative lenders that similarly emerged in the wake of the 2008 financial crisis as banks backed away from SME borrowers. The industry continues to gather support and investment, despite a shaky year last year; EY, for example, concluded in one of its more recent reports on the topic that alternative regulation is here to stay and has massive growth potential. While EY did agree in an interview with PYMNTS that the industry will likely come under regulation, senior managers Rohit Kumar and Rashmi Singh agreed that those regulations, combined with an improving market and liquidity position, will sort out the kinks associated with the risks and costs of alternative finance.

While Staut noted that he couldn’t comment on the legal situation of the alternative lending industry, he did say that GrowthFountain and other platforms that enable investors and SMEs to act on Regulation A+ may be in a better position with government authorities.

“I’m not an expert in the peer-to-peer space, but I would say the difference is that we are regulated, and I’m not sure they are, yet,” he stated. “I can’t really comment on the legality or regulatory challenges [alternative lenders] might face, but from our perspective, there are an awful lot of congressmen, regulators and government officials that have a de-seeded, vested interest in seeing the JOBS Act succeed.”

But Regulation A+ isn’t without its critics, too. Some analysts have warned that democratization of the SME investment space may not be able to prevent investor fraud, while investors will be particularly exposed to failed startups. Others argue that some small businesses may no longer see a need to go public thanks to this option to raise money.

And just like the alternative lending industry, it may take time to see how equity crowdfunding platforms like GrowthFountain emerge, develop and perform. Still, Staut remains confident the sector will take off, especially with federal support already under its belt.

“And the speculation is that it’s only going to bet better from here,” he continued. “We have a new administration that’s even more pro-business and anti-regulation than the previous administration, so the speculation is that it will get easier and better for small business.”