The Securities and Exchange Commission (SEC), under the auspices of the Division of Economic and Risk Analysis (DERA), published a white paper on Regulation Crowdfunding (Reg CF) earlier this week. The report, written by Vladimir Ivanov and Anzhela Knyazeva, is basically a point in time update on the first few months of issuers using the new securities exemption created by the JOBS Act of 2012. Businesses began using Reg CF in May of 2016 and the report quantified utilization from that date until December 31, 2016.
Under Reg CF, companies may crowdfund up to $1 million from both accredited and non-accredited investors. Reg CF joins the other current crowdfunding exemptions: Reg A+ (up to $50 million) and Reg D 506c (accredited crowdfunding). Reg CF is also in competition, to some degree, with the growing number of intrastate exemptions. Reg CF is viewed as a first step in the capital ladder for early stage companies. The intent was to create a low barrier to capital formation thus empowering businesses to raise sufficient money to get their company off the ground. These same companies frequently are boxed out by banks and may not be sexy enough for traditional VCs.
So what did DERA uncover? The highlights are below:
- From Mary 16 to December 31, 2016, there were 163 unique offerings by 156 issuers for a total of $18 million
- The median ask was for only $53,000
- The median amount raised was for $171,000
- 28 filed Form C-U indicating a successful funding round
- There are 104 offerings with the 2016 calendar year deadline dates, (including 18 offerings that had been withdrawn) and 86 offerings that had not been withdrawn. Of those 104 offerings, 32% (33) reported offering success – proceeds of at least the target amount – on Form C-U as of January 15, 2017.
- There has been an average of 22 net new offerings initiated per month (163 offerings / 7.5 months)
- In the five months, from August to December, there were 28 reports of completed offerings, or 5.6 reports per month, with the average of $290,000 per offering, or approximately $1.6 million per month ($290,000 x 5.6)
- Clustering is occurring around the $100,000 and $500,000 mark, perhaps due to different reporting requirements (the more money you raise, the more work and disclosure you must provide)
- A typical issuer will close the crowdfunding round in 4 to 5 months
- Equity is the top security of choice (36%) followed by SAFEs (26%) and then debt (20%)
- The median offering involved an issuer with three employees and approximately $43,000 in assets, with one-quarter of offerings by issuers reporting zero
- The majority of offerings were by issuers that were pre-revenue (60%) and not yet profitable (91%)
- The median offering was by an issuer with a loss of $17,000 (the average loss was close to $150,000)
It should be noted that a single platform, uFundingportal, was yanked from the approved list of intermediaries by FINRA as allegations of bogus offers came to light. Honestly, it was a bit surprising that uFundingportal was ever approved, but that is a discussion for another day. The net effect is that FINRA did the right thing and shut down the platform and not a single investor backed a fraudulent campaign. In fact, there has not been any fraud in the Reg CF space in juxtaposition to what some detractors predicted.
The DERA authors understand that early Reg CF utilization is not necessarily indicative of future results;
“These initial results may not be representative of future crowdfunding activity for several reasons. In particular, the early adopters that sought to issue securities in the newly formed crowdfunding market as observed during our sample period may not be representative of the subsequent crowdfunding market entrants. As the market matures, issuers, investors, and portals are likely to gain experience that shapes and potentially changes behaviors in ways that the evidence from this short sample period may not capture. Moreover, potential future changes in the crowdfunding market, such as the entry of new intermediaries, adoption of alternative funding methods by issuers (e.g., intrastate and regional crowdfunding), industry shocks, or changes in aggregate market conditions may cause crowdfunding activity to vary significantly in future periods.”
There is plenty more in the DERA white paper (embedded below) but what does this all mean?
The UK is the best market for comparison, and it would be interesting for someone to do a quantifiable comparison on growth trajectory. In many ways, the UK has a far better regulatory regime aligned with a generally supportive government, but this is balanced by a far smaller economy. The UK sector finance has emerged as a robust capital formation ecosystem. Crowdfunding has evolved into a true alternative to both early and later stage funding for companies thus challenging traditional VCs.
The DERA authors are spot on in stating the US industry is still very much evolving and today’s activity is probably not wholly indicative of future outcomes. Both issuers and platforms are learning quickly what they can and cannot do. New programs are being tested. The ones that work are kept – the ones that don’t are quickly jettisoned. Crowdfunding success is never a given and securities crowdfunding is a lot of work.
Additionally, Congress is pushing forward with an update to Reg CF (something attempted last year by Congressman McHenry) that may provide the fuel the exemption needs to drive utilization to a truly meaningful level.
If Congress gets it right, Reg CF may evolve into powerful job creation and innovation catalyst for the economy. Raising the exemption cap to a more realistic level will certainly attract more quality issuers. Allowing special purpose vehicles (SPVs) will make it easier for issuers to manage shareholders and align interests with both big money and small. By now, hopefully, there are no more obstacles for Congress to take the action and do what is necessary to get the job done.
What we do know is that companies that have a strong, committed community perform better and this may be the key to success. Crowdfund Capital Advisors did do some quantifiable work on this highlighting the fact that a “bigger social network = more money raised crowdfunding“. So build your crowd first before you launch a Reg CF crowdfunding offer – otherwise, you may regret it.
In the overall scheme of things, Reg CF is tiny. Reg D, the most popular path to raise private capital is huge at around $1 trillion a year. The incorporation of “general solicitation,” or allowing an issuer to crowdfund their offer, will keep Reg D at the forefront for most companies raising private capital. But Reg CF has potential as the first step in the capital ladder. One prominent Reg CF platform predicted that $100 million would be raised under this exemption during 2017. If policymakers act and fix Reg CF – this number may end up being far larger.
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