Examining Private Market Exemptions as a Barrier to IPOs and Retail Investment

By SBE Council at 11 September, 2019, 2:09 pm

Committee on Financial Services

Subcommittee on Investor Protection, Entrepreneurship and Capital Markets

U.S. House of Representatives 

Statement for the Record

Karen Kerrigan, President & CEO

Small Business & Entrepreneurship Council

September 11, 2019 

The Honorable Carolyn B. Maloney, Chairwoman

The Honorable Bill Huizenga, Ranking Member

On behalf of the Small Business & Entrepreneurship Council (SBE Council) I am pleased to submit the following statement for the record for today’s hearing, “Examining Private Market Exemptions as a Barrier to IPOs and Retail Investment.” Since our founding in 1994, SBE Council has been active in supporting regulatory and legislative initiatives to foster U.S. capital formation and access to capital for startups and small businesses.

SBE Council is an advocacy, research and education organization dedicated to protecting small business and promoting entrepreneurship. Our network of supporters, including entrepreneurs and small business owners, state and local business organizations, and associations work with our team to strengthen the environment for robust entrepreneurship, investment and small business growth. SBE Council has been pursuing its mission for more than twenty-five years, and we have had the honor and opportunity to work with many Financial Services Committee members during these years.

The entrepreneurs and small business members of SBE Council are pleased to see today’s subcommittee hearing address capital access and capital formation issues, and specifically some of the bipartisan legislative measures that our organization supported as part of the Jobs and Investors Confidence Act (JOBS Act 3.0), which overwhelmingly passed the U.S. House 406-4 in the 115th Congress.  Access to startup and growth capital remains a challenge, and it was unfortunate that the powerful JOBS Act 3.0 hit a wall in the Senate in the previous Congress.

Hopefully, beginning with today’s hearing, legislative solutions that strengthen our capital markets will begin to advance in the House, and the bipartisan work of the last Congress will not go to waste. The strong bipartisan effort that went into all the individual provisions included as part of JOBS Act 3.0 produced solid bills (including the individual bills being reviewed for today’s subcommittee hearing), which would have had a significant and positive impact for entrepreneurs, startups and small businesses if the original package was enacted into law.

Obviously, entrepreneurs prefer that a bold JOBS Act 3.0-type package be resurrected in the current Congress, and it is out hope that legislation being discussed and reviewed today will be just as robust as their JOBS Act 3.0 predecessors. Legislation that potentially erects barriers to capital formation and access would be a big departure from the strong bipartisan consensus, articulated in recent years, that U.S. capital markets must be strengthened, streamlined and modernized, and that technology is playing a critical role in efficiency and preventing fraud and bad actors. It would be discouraging to see new barriers put in the way of entrepreneurs who need capital to scale and take their businesses to the next level in order to compete in the global marketplace.

As committee members well know, startup activity and entrepreneurship in the U.S. has improved since the Great Recession, but it still remains weak – or flat – by historical standards. At SBE Council, we do not believe America’s entrepreneurial culture has been permanently damaged. A review of current survey and trends shows it is alive and well, and merely requires encouragement and solutions that address the impediments people cite as to why they are not starting businesses despite their strong interest to do so.

For example, according to the 2019 Freshbooks Third Annual Self-Employment America Report, “large numbers of American workers are thinking about abandoning their full-time jobs in favor of self-employment,” they estimate the number to be about 24 million. However, they estimate that approximately 2 million will actually take the plunge, and the 4,000 surveyed for their report identify key barriers that prevent them from taking the risk. Namely, access to capital (and paying down debt), the need for education and training, and the fact that many do not want to give up their health benefits.

Indeed, access to capital remains an enduring challenge, and that is why specific bills being reviewed by the committee today is a welcome sign for entrepreneurs. These specific bills strongly supported by SBE Council include:

The Fair Investment Opportunities for Professional Investors Act, which would modify the definition of an accredited investor to include qualifying education and experience, or someone licensed as a broker or investment adviser. These common sense changes would increase the pool of accredited investors, and bring more capital into the market for entrepreneurs and startups to access.

The Crowdfunding Amendments Act, which would allow for special-purpose vehicles (SPVs) so that investors can pool money into a fund (advised by a professional advisor), which would streamline reporting, tracking and communication for a startup or entrepreneur who may be faced with potentially hundreds of investors as a result of a crowdfunding campaign. SPVs would strengthen the appeal of regulated crowdfunding for investors and issuers alike.

The Main Street Growth Act, which builds upon the first JOBS Act by creating new exchanges tailored for smaller companies. These venture exchanges will improve the liquidity for the securities of small companies and will have a transformative influence on the capital-raising process.

The Small Business Mergers, Acquisitions, Sales, and Brokerage Simplification Act, which would reduce the regulatory costs associated with the sale and purchase of small, privately held companies by clarifying, simplifying, and reducing regulatory costs associated with these transactions. High transaction costs (associated with registration) serve as an impediment for many entrepreneurs who want or need to sell their businesses. This legislation would exempt from registration the brokers performing services associated with the sale of these small, private firms.

The Family Office Technical Corrections Act, which clarifies that family offices and family clients are accredited investors under Regulation D of the SEC.

Again, we hope the above legislation is just a start, as there are many other fine pieces of bipartisan legislation included in JOBS Act 3.0 from the previous Congress that deserve attention and support.

With respect to regulated crowdfunding, SBE Council believes this method of fundraising has great potential, but reforms are needed to leverage its early success. No fraud has been committed to date.

According to an August 19 report in Crowdfund Insider, which cites data from Crowdfund Capital Advisors (CCA) and the firm’s principle Sherwood Neiss regarding the $250 million in capital that has been raised to date in successful and unsuccessful offerings:

“CCA states that in the 3 years since (May 2016) Reg CF became actionable, 1800 companies have filed to raise capital online. Over 271,000 investors have participated in these funding rounds.

The average Reg CF raise stands around $237,000. This amount is said to ‘firmly addresses the Valley of Death issue.’ Most successful offerings close in under 90 days reports CCA.

In contrast to what some regulators and observers predicted, the Reg CF marketplace has experienced no fraud. While firms may fail that is part of the natural process of entrepreneurship and early-stage companies.”

The report goes on to note that:

“Additionally, there has been broad appeal across a wide sector of industry and geography. 48 out of 50 states have seen issuers register to raise funds under Reg CF. Neiss predicts that the number of jobs supported will increase to 20,000 or more in the next 2 years. But that number could jump exponentially if the funding cap was raised from the restrictive $1.07 million to $20 million recommended by many industry advocates.”

Approximately 1,000 companies have had successful raises using regulated crowdfunding, and the average success rate for crowdfunders hitting their fundraising goal was 53.7 percent in 2018.  Reforms supported by SBE Council that would unleash the power and potential of crowdfunding, and make it less costly and more appealing for startups and entrepreneurs, include:

● Increasing the amount that can be raised from $1.07 million to $20 million. (See: 10 Reasons the $1 Million Crowdfunding Cap Should Be $20 Million, Venture Beat, by Sherwood Neiss.)

● Allowing issuers to “test the waters.”

● Providing clarity for funding portals, making it clear that portals are not liable for the misstatement of issuers.

● Repealing restrictions on “curation” by portals. (Prohibited from offering “investment advice,” thus such vetting issuers may be interpreted as investment advice.)

● Repealing the requirement from audited financials for issuers raising $500,000 or more.

● Reducing the complexity of the initial and ongoing mandatory disclosure requirements on issuers (25 currently).

● Simplifying Reg CF Form C. Currently a 25-page document.

● Allowing for single purpose vehicles, which may mitigate issuers concerns about a potentially large number of shareholders.

● Allowing for lead investors or syndicates to help guide investors.

● Making adjustments to how much non-accredited investors can invest on Title III campaigns.

Let me add that SBE Council joined a group of crowdfunding industry leaders in 2018 urging Securities and Exchange Commission (SEC) Chair Jay Clayton to increase the funding cap to $20 million. We believe raising the cap is the single most important reform that can be made to regulated crowdfunding. Raising the cap would fill a gap in the funding marketplace, strengthen regulated crowdfunding as a vehicle to raise capital for the entrepreneurs and small businesses that need it the most, and provide investors with additional opportunities to support the entrepreneurs and local companies they believe in.

SBE Council appreciates the work of the subcommittee and the leadership provided by Chairwoman Maloney and Ranking Member Huizenga.  Please let us know how we can assist you in your efforts, and support the important work of strengthening U.S. capital markets and unleashing needed capital for America’s startups, entrepreneurs and small business owners.