The SEC Office of the Advocate for Small Business Capital Formation has published its annual report which includes data on access to capital as well as policy recommendations. The Office is relatively new, created under the SEC Small Business Advocate Act of 2016 – legislation that sought to support smaller firms that too frequently are ignored or hit with regulations that are not appropriate for smaller firms.
Most businesses need access to growth capital to launch and grow. Many smaller firms are supported by founders with credit cards and loans. More prominent firms may benefit from Angel investors or VCs. But the story remains the same: access to capital is vital, and tapping into it can be hard.
The US is home to one of the most vibrant innovation ecosystems in the world. Most all successful big firms, like Apple, Google, Facebook, etc., started out small. The availability of capital, risk-taking entrepreneurs, and a market-based economy are the key components driving wealth, prosperity, and jobs. Policies supporting smaller firms’ growth are vital to the nation’s economy.
The Advocate’s report notes that since 2011, 80% of net new jobs were created by smaller firms. This is a clear benefit of capitalism.
Yet, early-stage firms face massive challenges. The report states that 93% of these firms struggled in 2023, with the top challenges being:
- The rising costs of goods, services, and wages
- Paying operating expenses
- Uneven cash flow
The report also explains that 77% of small firms are worried about access to capital, with lack of money being the number one reason for business failure.
Beyond friends and families and more sophisticated investors, there is also online capital formation under various securities exemptions. Of course, there are also registered offerings.
The report provides data on exempt securities offerings from June 2023 to June 2024. To summarize:
[excluding pooled funds that raised $112 trillion]
- Reg D 506b – $170 billion [only accredited investors]
- Reg D 506c – $12 billion [allows advertising, only accredited investors]
- Reg A – $1.5 billion
- Reg CF – $249 million
- Rule 504 – $246 million
These numbers compare to initial public offerings during the same period of $28 billion.
Reg D 506c, Reg A, and Reg CF are the securities crowdfunding exemptions allowing an issuer to promote a securities offering online.
The report digs deeper into Reg CF (2023) – the smallest exemption with a funding cap of $5 million, sharing:
- 19% of issuers previously raised equity capital
- 61% of businesses employ 2 to 5 individuals
- Just 0.3% have generated an IPO exit, according to the Advocate
- On average, there are 2.5 years between a funding round and an exit or a failure
- The average raise was $368,000 and the median was $106,000
Over the last three years, Reg D has accounted for about 97% of the total capital raised by rural small businesses, while Reg CF has raised $42 million and Reg A $54 million, per the Advocate’s report.
Both the number of firms using Reg A and the aggregate amount of funds under exemption have continued to decline. Reg A enables issuers to raise up to $75 million, but offering documents must be qualified by the SEC, a process that can take multiple months. Many issuers are compelled to use Reg D to avoid the delay.
The number of IPOs and the amount raised remain significantly below the 2021 peak. Regulatory costs and M&A opportunities are said to be driving the overall decline of publicly listed firms.
The report provides several recommendations to improve the environment for smaller firms to access to capital. First on the list is better education and tools, including mentorship. Other suggestions include:
- Support for small businesses that rely on Reg CF to raise capital is important because it can enable funding for issuers who lack a network.
- Help small businesses establish networks with sophisticated investors to raise capital.
- Support diverse capital allocators, including a change to the definition of an Accredited Investor, and support for funds in backing private firms, including support for emerging funds.
- Make public markets more accessible, including scaling obligations and phasing in compliance for smaller firms and public companies.
This past fall, the SEC’s Small Business Forum published its report outlining recommendations for the Commission to improve support of smaller firms. These recommendations were more comprehensive and were derived with the participation of individuals engaged in the private securities ecosystem.
There is a fair amount of overlap regarding recommendations from the prior Advocate’s report published in 2023. It is unfortunate to note that the Commission has failed to act and pursue many of these recommendations aimed at helping smaller firms. In fact, the current leadership of the Commission wanted to make Reg D more difficult to utilize – a move that would have undermined capital formation for both smaller and more mature private firms. Let’s hope the Commission in the next Administration will better serve smaller firms, including underserved segments of the country – something covered in the report.
The report is available below.