Recently I’ve been noticing a lot of hype in the entrepreneurial community regarding Reg A+ and there have been a lot of cheerful pitches about the new regulation that would allow young companies “to raise up to $50 million without the expense and complexity of a traditional IPO”.
I am afraid that the emperor has no clothes and what we got is certainly nothing like the equity crowdfunding that the JOBS Act instructed the SEC to create.
To date, only about 30 deals under Reg A+ were filed with the SEC and after a few being withdrawn, there are currently 24 deals that are under review. There are some companies that have filed Form 1-As with the SEC and others that are in the “testing the waters” phase, but no offerings have closed and none have begun to trade.
It is clear that Reg A+ is off to a very slow start and I would leave it to my friends – securities lawyers to discuss what went right; meanwhile as an economist I see two major issues I would like you to ponder on.
First – it turned out that raising capital under Reg A+ is much closer to becoming a public company than anyone might want to admit with too many disadvantages typical for a publicly traded company (high cost of reporting and high level of disclosure and scrutiny from regulators) but no visible benefits that a publicly traded company typically enjoys – which is an attention from institutional investors who are also capable of boosting a rich coverage and triggering a demand from a retailer market aka crowd.
Which brings me to the second issue – there is no evidence yet that institutional investors are interested in companies that exploited a “Do-It-Yourself” aka “mini-IPO” routine without getting a credible investment bank on the payroll. Anecdotally, none of the 30 Reg A+ deals that were filed to the SEC were submitted by an investment bank.
To drive my point home, I need to clarify that securities trading of large companies and small companies has an entirely different route – and this is why Reg A+ is falling out of favor in the first place.
While an ownership of a large public company (over $1 billion in market capitalization) typically consists of over 80% of institutional investors; a small company (less than $100 million in market capitalization) traditionally has very few institutional investors and relies almost entirely on high-net worth individuals and other retail investors.
This has resulted in disparity of research coverage. A large publicly traded company has on average 14 analysts covering its every move; while 40% of small companies have no research coverage at all and those are primarily companies with a market capitalization of less than $50 million (typically referred to as nano-cap stocks). Smaller companies have less public float, resulting in less trading volume — which explains much smaller dollar amounts involved and the lack of analyst coverage.
So the Holy Grail here is to be able to communicate your story directly to potential shareholders since fewer broker-dealer firms (or “market-makers”) operate in this space. A catchphrase for those who are on the case: Marketing is King.
For example – have you ever wondered why there are so many “unicorns” these days? As of time of my writing, there are 140 of them with a total cumulative valuation of $505 billion.
Yes, we can talk about the fact that the Fed has increased the money supply via QE and has simultaneously manipulated interest rates down to unsustainable levels which is a very basic element of an absolutely deadly combination. Since all this excess money supply has to find a home somewhere, some of it has found its way to the most absurd investment vehicles such as, for example, overvalued private company investments lovingly named by VCs unicorns (see my previous article “How To Milk a Unicorn” here).
But the important point of being named a unicorn is marketing – getting attention from the media, creating the hype and driving investors home.
And this is when a highly appraised in the Reg A+ department “testing the waters” comes out of the closet.
See, any experienced marketer will tell you that in order to sell a product, you would need essentially at least 100 people that are generally interested (they clicked, they signed up, and they liked you on FB) and only 2 out of those 100 people will end up buying your product.
So a process of “testing the water” when the company asks for hypothetical commitments from potential shareholders might be producing very wrong over-hyped numbers to compare with amount of actual money that the company will be able to raise once the party is over and the cake is eaten. Wink-wink, StartEngine.
That’s when we might start to realize that the whole Reg A+ thing comes down to securing professional market-makers, researchers and getting first and foremost on the radar of institutional investors. That’s quite an unfortunate finding, as we thought that we should just have the most enthusiastic network on Facebook.
Summing it up, while I remain optimistic, I believe a danger here is that with new regulations we forgot that there is not an “after-market” for small companies while encouraging further a culture of hype that celebrates companies based on their following and valuations (and whether they’ve crossed that magical line of $1 billion) – instead of focusing on their impact, whether the business is profitable, the company is well-managed and can actually pay a modest but sustainable and possibly growing dividend to its retail investors.
Whether you feel the same way – or entirely different – feel free to share with me your thoughts and join the discussion.
Victoria Silchenko, Ph.D. is an alternative funding expert, Founder & CEO of business consultancy Metropole Capital Group and Creator & Producer of the Global Alternative Funding Forum. She sits on the Board of Los Angeles Venture Association (LAVA) and is also an Adjunct Professor on “Entrepreneurial Finance” at CalLutheran University. LinkedIn:www.linkedin.com/in/victoriametropolecapital/, Twitter@MetropoleGlobal