Reg CF Success Should Spur Further Deregulation
Reg CF, the innovative tool that allows ordinary people to invest in early-stage companies has now topped $1.1 billion in investment. Growth has been exponential with 50% of all investment occurring in 2021, according to data analytics company Crowdfund Capital Advisors (CCA). Total investment may double in 2022, equaling all previous years combined.
The numbers give hope for capital-starved startups and retail investors alike, as it upends traditional vectors for who receives and invests startup capital. As previously reported, in the past two years Black founders received 1.2% of venture capital funding and women just 2.3%. But those same cohorts were 40% of Reg CF startups that raised over $1 million.
Similarly, CCA found 92.4% of all Reg CF offerings took place outside known venture-capital meccas.
Reg CF success multiplied after SEC deregulation
The numbers validate last March’s loosening of Reg CF rules by the Securities and Exchange Commission (SEC). In the past ten months, issuers have enjoyed a higher offer limit ($1.07M to $5M), the ability to consolidate retail investors into one legal bucket through a Special Purpose Vehicle, and greater freedom to gauge interest before hiring legal and accounting professionals with the ‘Testing the Waters’ provision.
Similarly, on the investor side, the SEC removed accredited investors limits removed and raised limits for retail investors.
Reg CF success came only after SEC hostility
Reg CF’s widespread success starkly contrasts the SEC’s initial hostile approach. This included then Chair Mary Schapiro and Commissioner Luis Aguilar predicting widespread fraud and scams. In fact, Edward Knight, Executive Vice President and General Counsel of NASDAQ, testified in a congressional hearing: “From the outset the SEC’s view of [equity crowdfunding] was they were not for this they and made it, shall I say, needlessly complicated and did not approach it except as this this was something where the public is going to get harmed and we need to narrow it as much as possible.”
Whilst the SEC’s newfound Reg CF love is welcome, it should not stop. Further deregulatory moves would spur more opportunities for those with business ideas and investors looking for new opportunities.
Ways to make Reg CF more successful
In a 2021 law review article, I suggested several ways the SEC could make Reg CF more attractive to both entrepreneurs and retail investors:
Exempt Secondary Trading: Lack of state preemption for secondary trading stifles Reg CF issuers and investors. Shares in Reg CF companies become fully tradable federally after one year, but practically remain illiquid through state rules. These restrictions serve no public policy purpose but depress value. If Congress or the Commission preempted state secondary trading laws Alternative Trading Systems would instantly emerge to serve this waiting and vibrant market. Secondary trading also has massive future implications. Blockchain-based endeavors and tokenized systems are incompatible with state-by-state secondary-trading regimes. As tokens express multiple, it is imperative states with their stifling and dissonant rules cannot interfere.
Preempt state filing requirements and notice fees: State filing and notice fees serve as an unnecessary tax on entrepreneurs. Fees and filings eat time and raises capital costs. State regulators have no jurisdiction over Reg CF issuers other than to prosecute fraud. All Reg CF filings are publicly available on the SEC database EDGAR, making these requirements superfluous.
Exempt Reg CF from the 12(g) Rule: The 12(g) Rule states issuers that meet certain requirements for number of investors and assets must register with the SEC, in essence, ‘Go Public.’ The SEC conditionally exempts Reg CF issuers from the 12(g) Rule, but it should make this exemption permanent. Most Reg CF issuers are nowhere near ready to face the rigors of registration and need many more funding rounds, making 12(g) a constant and unnecessary worry.
Raise the Reg CF Offer Limit to $20 million: Whilst raising the offer limit to $5 million was a good start, the SEC should go further. This would fill the gap that currently exists between Reg CF and Reg A+ Tier II.
Eliminate investment limits for retail investors: The SEC smartly removed limits for Reg CF accredited investors. It should follow suit for all investors. The SEC should allow people to assess opportunities and risk tolerance without limits. Bureaucrats have no special acumen to assess opportunities. Whilst some people may act foolishly, they should be able to do so with their own money. Conversely, the Commission is precluding wealth opportunities for savvy investors that do not meet Accredited Investor criteria.
Reg CF has succeed beyond what the SEC ever imagined. After years of hostility, the Commission warmth has benefited entrepreneurs and investors alike. But more must be done. The SEC can show true vision by continuing their deregulatory posture with the suggestions above.
By Jossey PLLC A version of this post originally appeared on the blog of the Competitive Enterprise Institute on January 12, 2022. https://cei.org/blog/equity-crowdfunding-success-should-spur-further-deregulation/
