The recently soaring level of unemployment in the U.S. is a stark reminder of the impact COVID-19 is having on our economy.
And while the worst of the disease outbreak is likely yet to come, the length of the economic downturn could be considerably longer.
This devastation underscores the importance of recent rule changes proposed by the Securities and Exchange Commission to encourage capital formation for business startups, in particular, raising the cap on the amount private companies can raise online via an investment portal under Regulation CF to $5 million a year. Early-stage and small companies have been the net creator of new jobs in our economy for years, and are destined to continue to be so as we rebuild in the wake of the current crisis.
Congress in 2012 passed the Jobs Act with a goal of fostering capital formation for young companies by opening to all investors an opportunity previously restricted to high-net worth individuals. But in setting a low ceiling on the amount of such capital raises–currently $1.07 million a year–legislators arguably limited the effectiveness of the measure.
Since 2016, more than $300 million has been raised by private businesses that may have otherwise struggled to access capital. While that is a significant amount, those who believed in the Jobs Act expected more.
Many industry proponents have argued that the SEC was overly conservative and set the initial limit too low, noting that regulators in the U.K. and other countries that have had longer experience with this form of capital raising have set significantly higher caps.
One may point to the number of offerings that have hit the cap–only 85. However, that does not tell the full story. The unfortunate byproduct of such a low cap is that it discourages issuers from even considering portals as a serious and viable means to raise capital. In 2020, $1.07 million is not even a proper seed round and therefore many mature successful businesses simply do not see the opportunities to raise capital under these new regulations as appropriate for them.
The unfortunate result is many private market investment opportunities have not been made available to the market opened under Reg CF–the 95 percent of U.S. households that do not meet the minimum standards for accredited investors of annual income ($200,000) or net worth ($1 million).
Beyond the important step of raising the annual ceiling to $5 million, the proposed SEC rule revisions include a host of other changes that would be constructive for capital formation. Key among them are a relaxation of the restriction on how much an investor could invest under Reg CF.
For non-accredited investors, the SEC proposes basing investment limits on the greater of their income or net worth, rather than the current standard of the lesser of these two factors. The proposal also would remove the current limit on investment under Reg CF for accredited investors. Here, the rationale is that accredited investors are sophisticated enough to understand the risks, and in fact already do so under Regulation D, which does not have limits.
The SEC is to be applauded for these proposed rule changes, which would do much to remove impediments to entrepreneurs looking to access capital to fund their innovations, while preserving investor protections.
To build on the momentum of this SEC proposal, it’s time to reconsider the very nomenclature government adopted in naming the regulation–Reg CF (as in “crowdfunding”), which creates a certain misleading impression around this form of investment opportunity.
The idea in the Jobs Act was to foster capital formation for companies in an automated fashion by encouraging investment from lots of people in any amounts. Unfortunately, by naming it crowdfunding, it evokes a feeling of a Kickstarter campaign used for such purposes as an artist funding their latest project, where backers are rewarded with merchandise or early access to a company’s product, not the opportunity to invest in and own actual shares in a company.
In fact, an offering on an investment portal is much more akin to an initial public offering. A company is following rules and regulations, filing forms with the SEC, and authorizing and selling shares which are being made available to everyone. Yet somehow, when a company follows such rules to sell shares on an investment portal it is a “crowdfunding campaign” and when they do such an offering and the shares are a listing on the NYSE or NASDAQ it is an IPO.
The unfortunate association created by the term crowdfunding only serves to undercut the credibility of a new industry trying to build a reputation as a serious means for companies to sell securities in order to raise capital, and it creates potential confusion in the minds of investors and these companies.
If the investment portal industry can successfully capitalize on the increase in the amount that can be raised under Reg CF as proposed, differentiate itself from the blanket term crowdfunding, and establish the value that technology can play in building a more inclusive, open and efficient market for private securities, it should be able to live up to Congress’ expectations in enacting the Jobs Act.