Last month, at the CfPA [Crowdfunding Professionals Association] Summit, a presentation was delivered that highlighted the demand and need for access to capital and the growing sector of online capital formation.
Investment crowdfunding mainly covers three separate securities exemptions in the US. Reg D 506c, Reg A+ and Reg CF. Each of these exemptions was created or updated under the JOBS Act of 2012. Two of these exemptions enable smaller (retail) investors to purchase private securities online. While Reg D allows an unlimited amount to be raised from Accredited Investors, Reg A is capped at $75 million and Reg CF at $5 million.
The presentation, primarily utilizing data from KingsCrowd, highlighted the two exemptions that allow non-Accredited Investors to purchase securities for private firms – Reg A+ and Reg CF.
According to the report, these two paths to funding smaller firms raised $8.7 billion from 2.6 million investments and 8,477 funding rounds from October 2016 to October 2024.
Reg CF investment volume increased by 6.8X from 2018 to 2021, aided in part by an increase in the funding cap from $1.07 million to $5 million in 2021. While down from a high of almost $500 million in funding in 2021, the last three years have seen an average of $446 million raised each year using this exemption.
From 2023 to October 2024, 19 offerings raised from $4.5 million to $5 million using Reg CF.
Issuers using Reg A+ filed $6.3 billion in funding goals for qualified offerings in 2021. The average funding target is $20 million, and the median is $10 million. Most firms using Reg A (80%) seek to raise under $50 million.
For Reg A+, from 2023 to October 2024, 25 issuers sought to raise between $4.5 million and $75 million using Reg A+.
The success or failure of firms pursuing an online funding round using Reg A+ and Reg CF is key to the success of the entire industry. Investing in early-stage firms is risky, and expectations are that most will fail. Investors may lose all of their money. At the same time, some firms will generate successful exits for investors, where the returns outweigh the failures. This is similar to how professional VCs operate.
The presentation reports that since 2016, there have been 87 exits (without providing aggregate returns) for investors. This compares with 389 company failures, or 4.6% of the 8477 offerings under the two securities exemptions. To extrapolate, it appears that many firms continue to operate, but it is not known in what capacity.
Equity offerings have seen a 7.9% rate of failure and debt offerings a 4.7% rate of failure. The report states:
“Even a ~10% failure rate among online offering companies is significantly lower than failure rates seen in VC-backed startups (75%) and BLS data for SMBs (50% fail after 5 years).”
Online capital formation continues to provide opportunities for underserved communities. Regarding Reg CF offerings in 2024 (as of October 21, 2024), there have been 1097 deals, with 334 involving minority founders and 331 representing female founders.
Other interesting data includes the rise in average valuation. In September 2024, the average valuation of a Reg CF issuer was reported at $51.1 million, a dramatic increase from just a few years ago.
Enabling online capital formation and access to private securities for smaller investors addresses two pressing issues.
First, many smaller private firms need access to capital to survive. Ninety percent of new firms need money to launch a business. Many businesses fail simply due to a lack of access to capital. The majority of financing comes from personal funds, but 42% of funding originates from external sources.
Also, today, promising private firms strive to remain private for as long as possible. This is mainly due to overly aggressive regulations that deter companies from going public until necessary. This means that much of any capital gain is already hoovered up by larger investors before they become public firms.
In 2000, there were 6342 exchange-listed firms. That number dropped by almost half by 2020 to 3641 listed firms. The median age of firms going public is 9 years (2020) compared to 6 years in 2000. Remember the story about Apple (then called Apple Computer)? Apple went public in 1980, raising $100 million, selling equity at $22/share. Even back then, regulators sought to save investors from themselves as Massachusetts blocked access to the IPO as it was deemed too risky. I guess the regulators won again, and retail money was the loser.
Smaller investors may now access specific private security offerings, but policymakers can do more to improve the market. For example, changing the definition of an Accredited Investor to allow a sophistication qualification is a no-brainer. This could open up Reg D to a more inclusive audience.
Expectations are for private markets to continue to grow and public markets to shrink – minus a significant policy change. During the last four years, there have been more obtuse policies regarding capital markets. Hopefully, in the next four years, capital markets will experience a change for the better.