Sherwood “Woodie” Neiss is one of the creators of Title III of the JOBS Act of 2012 – the legislation that legalized Regulation Crowdfunding (Reg CF) and launched a new sector of financial innovation. Neiss also co-founded Crowdfund Capital Advisors along with Jason Best – a company dedicated to tracking this nascent sector of finance.
In a recent update regarding Reg CF, CCA reported that the second-quarter results showed “impressive gains over the prior year”. CCA said that more issuers, more capital, more jobs, more revenue-generating companies are seeking capital, steady valuations, greater investment in certain industries. Average raises increased too as the new $5 million cap implemented by the SEC in March went into effect.
Recently, Crowdfund Insider connected with Neiss for some perspective on the evolution and growth of online capital formation in the US as well as his thoughts on how the sector could be improved. Our conversation is shared below.
In your most recent report, you indicated that offerings were up 3% over Q1 but investor commitments were down 15% and the number of investors was down 21%. Why is this?
Woodie Neiss: For the first point, awareness about Regulation Crowdfunding (Reg CF) and the Online Investment Industry continues to increase. We believe this is due to a few factors a) small businesses are in dire need of capital to stand up post-COVID and are turning online, b) more startups that have viable business models and are outside of the reach of venture capital are turning online to access capital, c) awareness among lawyers and accountants, who play a big role in capital formation, is driving more issuers to platforms and d) more mainstream media coverage of offerings, which increases awareness among other companies that may need capital, is driving more issuers online. All this is leading to general offering growth.
For the second and third points, we believe they are tied together. We saw a spike in capital commitments when the SEC increased the cap to $5 million in March. This was driven by 8 offerings that all raised over $1.07 million (the old cap).
Keep in mind, according to our data only around 14% of active issuers changed their maximum raise to $5 million, those that hit the new cap, closed, and we are left working with issuers seeking up to $1 million. That’s a $4 million delta per issuer and by default less ability to raise large sums. In addition, covid vaccination rates increased meaning more investors were out doing things other than being homebound and this was compounded with summer arriving and investors taking holiday vacations (meaning less eyes on computers/dollars into offerings)
Reg CF was bumped up to $5 million in March. We quickly saw issuers jump in to raise more than the prior funding cap of $1.07 million. Are you surprised as to how the market reacted to the improved environment?
Woodie Neiss: I’m not.
If you study capital formation like we do and interview issuers you constantly hear of the challenges related to access to capital. This particularly affects women and people of color (POC). In our last report we interviewed issuers that had raised over $1 million and we found that 40% of them were run by women and POC.
Those that are most negatively impacted have to find alternatives and Reg CF is clearly one of them. We knew when we created this framework that the $1 million cap was the starting point for the industry. We needed to get everyone comfortable with online capital formation, show them how investors are protected through the system and have data to back it up. We also knew that the $1 million cap was insufficient for many hyper growth startups and small/medium businesses. So when the cap was increased it only made sense that those issuers who needed more capital or those minority entrepreneurs that are shunned by the traditional capital markets would turn to Reg CF as their solution.
You indicate that a majority of issuers are generating revenue (as opposed to being pre-revenue). Does this bode well for the industry? Investors?
Woodie Neiss: The skeptics love to point out risk. So I love to address risk where they see it as well. (However, I prefer to back my statements up with data as opposed to baseless claims not based on fact but fear).
One of the areas of identified risk is pre vs post-revenue companies. In the eyes of many skeptics, pre-revenue issuers are riskier than revenue-generating ones mainly because revenue-generating issuers have customers, that prove the business model by buying the products or services. Pre-revenue companies don’t have customers and hence it is uncertain if their business model is valid.
As the number of revenue-generating issuers increases, this means the risk of failure may decrease as well. Anything that decreases risk will bode well for both the industry and investors. That being said, I believe there are many pre-revenue startups using Reg CF that will be able to turn their investors into customers once their products/services are ready to go to market. Why else would these investors put their money where their mouth is?
What are your expectations for the rest of 2021? Are specific industries using CF more than others? Is it more consumer-focused offerings?
Woodie Neiss: I think we will continue to see more issuers enter the space. I also believe we will start to see our first exits from the industry. With 5 years of successful growth by many early issuers, the time is approaching for us to see some of them get acquired.
Outside of that, we’ve seen a huge explosion in Software Applications, Internet Connection & Information, Agriculture, Manufacturing, Electric Gaming, Specialty Finance, and Recreational Vehicles. I have to be honest, when we went to Washington with the framework for Reg CF I never would have thought there would have been over 450 industries represented in the data.
To see traditional ones like Agriculture, Manufacturing, and Finance be at the top proves that Reg CF wasn’t built for only Main Street but Startups that will change the way we live our lives because I’m seeing companies that may disrupt industries across the board being funded.
I would agree, most of these offerings have products or services that target consumers and will benefit them via market efficiencies (software to increase personal savings), technology advances (better ways to build), and better information (healthcare technology to improve patient outcomes).
What are the biggest challenges for the Reg CF sector? Do you ever get concerned about valuations?
Woodie Neiss: The biggest challenge in my mind remains market awareness.
Quite frankly I’m dismayed that Bloomberg, CNBC, FOX Business, and the like haven’t started divisions to start covering this industry. For decades people have complained that there’s no transparency in the private capital markets. For the first time in history, we have that, the industry is closing in on $1 billion in investments and we still have yet to see any of these major news networks or financial service providers initiate serious coverage.
I’m not concerned about valuations. While I am seeing the frothiness of venture valuations running over to Reg CF offerings these past 12 months, the data shows that the average valuations have remained within a 10% spread.
Many of these offerings are seed/friends and family/series A and I’m seeing valuations similar to what has been seen outside of Reg CF proving logic in the marketplace. And to further prove this, the data shows issuers who throw out valuations that can’t be backed up see their offerings fail and not get funded. Just the fact that issuers need to keep this in mind when putting an offering together I think levels the valuation hype.
The SEC has exempt offerings at the top of its regulatory agenda. Do you have any concern that the Commission may reverse course on securities crowdfunding exemptions? (Reg CF, Reg A+, Reg D 506c)
Woodie Neiss: I have enough experience in Washington to know not to take anything for granted so I do share concerns.
That being said, it would represent a fundamental misunderstanding by the Commission to reverse course on these securities crowdfunding exemptions given a few facts (all that once again flow from the data):
1) Women and POC are some of the biggest beneficiaries and hence would represent the biggest losers. The SEC would essentially be taking a dagger to all these minority-run businesses that have found no luck in other parts of the traditional capital markets (and without providing viable alternatives for them).
2) The exemptions have proven what they were meant to do, democratize access to capital. The majority of beneficiaries of these exemptions reside outside of capital-intensive areas like Silicon Valley, New York City, and Boston. Reversing course on these exemptions just means it will be harder for these issuers to access capital.
3) Which plays into job creation. Interviews with successful issuers prove that one of the first things they are doing with the capital they raise is hiring. Reversing course on these exemptions just means less job creation. I find it hard to believe the Commission wants to be seen as the “Job Killer in Chief.”
4) As the stimulus programs wind down, the smallest companies are still the most impacted. Reverse course on these exemptions and the Commission stifles local economies.
5) Stifle local economies and the Commission risks being responsible for the rebound our nation has seen. With fears of the Delta variant potentially leading to future shutdowns any reversal would not be good for our national economy. 6) Why reverse course when there has been no issues, no fraud, no bad press? These exemptions represent what is good and potential not just about Washington but Main Street.
How else could the securities crowdfunding sector be improved?
Woodie Neiss: I think if we could tie all the pieces of the puzzle together we would have something the rest of the world would envy. Meaning we have entrepreneurs, we have investors, we have these platforms that connect them and regulation to provide the guardrails and transparency. Heck, we even have the data that signals where capital is flowing, where investors have interest in deploying capital and what the right valuations for the industry at different stages of growth should be, and more.
We even have new means of liquidity available via Alternative Trading Systems for investors to exit pre-IPO.
We need to pull it all together in a way that allows any entrepreneur to enter the capital formation funnel and step by step guide them through funding. This would lead to more companies coming online to use securities crowdfunding, more opportunity for investors to diversify into this space, and more transparency into private companies for analysis and education.
Right now there’s a lot of confusion from entrepreneurs as to where do I go, how does it work, what are the steps I need to complete, what happens next, how do I use technology to handle things like disclosures and investor relations, and more. All the pieces are there. They just need to be brought together. In doing so it will not only benefit entrepreneurs and securities crowdfunding but all the underlying businesses that support the industry via explosive growth.
Does your data show improving geographic distribution of access to capital? What about underserved markets?
Woodie Neiss: I created a set of data to include Silicon Valley, San Francisco/Marin, Manhattan, Boston, Cambridge, and inner suburbs. According to Bloomberg, these represent the leading areas for Venture Capital deals.
Then I compared this to the overall dataset and this is what I found. 92.4% of all Reg CF offerings took place outside of the dataset.
So obviously, the biggest benefactors of Reg CF are issuers outside of areas where VCs deploy capital. If VCs aren’t going to do it (mainly because they only invest within a 2-hour drive of their office), someone else has to.
Interestingly, the success rate for issuers within Silicon Valley was only 4% greater than those outside. There were 32 cities represented in the Silicon Valley dataset. There were 1,175 represented outside of that. By charting offerings and investments by file date, I can see the amount of capital increasing dramatically in areas outside of the Silicon Valley dataset.
And yes, underserved markets are big beneficiaries. We ran a study on the impact of Reg CF in Rep Maxine Waters (CA-D) District. Her district is overwhelmingly underserved in many different aspects. We were able to see how Reg CF is serving entrepreneurs right in her own backyard by highlighting success stories. This is what should be driving policy in Washington, DC, and seeing that the JOBS Act was one of the most bi-partisan pieces of legislation when it passed, it only makes sense to bring further attention to it as a viable source of capital for underserved communities!