By Henry Truc
At a capital raise workshop for startup entrepreneurs this week, industry professionals discussed some of the more nuanced growing pains of the early stages of Reg A+ and Title III Equity Crowdfunding. Hosted by OTC Markets Group, theConsumers as Investors: Redefining Financing Options for Entrepreneurs event provided some candid discussions on factors that companies looking to raise capital through these new avenues need to consider, and a few ideas on how the rule realizes its potential impact. The tempered enthusiasm, as it were, reflects the broader sentiment shift of the industry regarding the key JOBS Act rules now finally taking effect: Now that Reg A+ and Title III are here, it’s time to stop celebrating their inception and really get down to business.
Generally, all the participants agreed that Reg A+ overall is a net positive by virtue of it offering startups more options when trying to raise capital. “I think the financing of these companies is going to change the future,” said Nimish Patel, Partner, MSK and a panel moderator at the event. “Who would’ve thought you could even do General Solicitation? And now it’s here. I think this is probably the tip of the iceberg.”
What Reg A+ in Action Looks Like
“I think there’s a big potential market here,” said Gil Luria, Managing Director, Wedbush Securities. “The trend in venture capital is concerning in many ways. Venture capital is becoming ill-equipped to support all the entrepreneurial ventures that it once did. Venture capital is now so focused on getting unicorns out the door that it’s not necessarily doing a great job of cultivating businesses in other parts of the growth cycles, businesses with growth trajectories but not hyper-growth trajectories, and businesses like retail and commerce. So it’s created a gap… which means there’s a whole bunch of good companies, growing companies that don’t have a venue. So there’s a very big opportunity here.”
That said, a significant portion of the market is waiting for more validation before dipping their toe into this space. While Title III is literally just a few days old, Reg A+ isn’t much older, having been around for just a little over a year now.
“I think from our angle, Reg A and Reg A+ has been a game where the game has started but no one is really sure of the rules as they’re trying to play,” Jared Schramm, Managing Director, ROTH Capital Partners. “From the banks’ perspective, from ROTH’s perspective, I can tell you that we’ve backed away from those right now. There’s not a good amount of case studies out there to deal with, and no one wants to be that first one to dip their toe into the water. Maybe there are alligators, maybe there’s not, but we don’t want to be the first one to get bit.”
Granted, the only case study to date is Elio Motors (ELIO), which successfully raised $17 million earlier this year through its Reg A+ mini-IPO. Its shares currently trade on the OTCQX. But more case studies are on the way. In fact, prestige cosmetics online retailer BeautyKind is expected to complete its Reg A+ IPO within the coming weeks. BeautyKind Founder and CEO John Hilburn “Hil” Davis was one of the panelists at the workshop, and offered deeper insights into the process thus far.
“What’s interesting is the broker-dealer network is not ready for it yet,” Davis said. “We’ll end up hitting the minimum, which is fine. Four weeks ago, we were oversubscribed, but then compliance departments came in and said they weren’t comfortable with their companies doing this. I think that’s part of why you saw Elio go from $12 to $80, because of all these people waiting on the sidelines because their compliance said no. I don’t know if the broker-dealer network is ready, and I don’t know if the crowd platforms are ready yet. I think it’s early. I think if you are going to do a Reg A+, you’re better off being at least $100 million market cap, because you’re going to attract micro-cap investors, and anything above that will be beneficial. So I think you really have to pick your spot.”
While Reg A+ was designed to work for all companies, there’s a growing consensus that for the first few pilot companies, essentially, that need to come through first to prove the concept to the broader market, there are certain characteristics that are needed. For one, a certain market cap, as Davis alluded to, in order to appeal to larger investors. Second, consumer-facing companies that already have a built-in support base such as customers, partnerships, and even friends and family. Third, the company’s products and culture should lend itself to viral marketing. Elio Motors had that for its campaign, and BeautyKind has it as well.
“When I look at the Kickstarter market and crowdfunding, it’s too big. It’s going to move here because there’s $3.5 billion a year that flows through there and there’s no equity. It’s crazy. It’s going to move to Reg A, it’s just [a matter of] when. I think it’s going to happen. The question is, what are the events that need to break it open, and how long does it take for that to happen?”
Return of the Mini-IPO
“Like anything in the political world, it’s a swinging pendulum,” said Katherine Blair, Partner, Manatt, Phelps & Phillips. “Twenty years ago, mini-IPOs were a standard thing. We were doing a lot of those. They were small companies and there was a small company regime. Then you had the Enron fiasco happen, andwelcome to Sarbanes-Oxley world and a lot of regulations. So you didn’t see the smaller middle-market companies under $75 million capital raises anymore. Obviously, they saw that as an issue, and that’s why you see the pendulum swinging a little bit back, and now you have the JOBS Act. Helping these small companies not be burdened by our wonderful regulations. They’re there for a purpose, but it’s starting to be too constraining for the entrepreneurs and small-company growth, and they saw that.”
Increased regulations meant that the costs associated with being a fully reporting public company became too arduous for startups and small businesses to access the capital markets. Reg A+ and the JOBS Act looked to alleviate some of those constraints for the segment of the economy that needed it most.
“Crowdfunding is a social phenomenon,” said Kim Kaselionis, Managing Partner and Founder, Breakaway Funding. “It represents a huge opportunity for business owners and entrepreneurs in any place in their life cycle to go to their community—customers, suppliers, friends, family, and anybody who’s aligned with the company—because they’re already emotionally engaged with that particular entrepreneur. If you look at the way most companies have been funded throughout history, you’ll see it’s crowdfunding. I would argue that the social and economic framework in this country and around the world is crowdfunding.”
But as things currently stand, some wonder if it’s enough, especially for Title III companies. There’s still a debate on where the balance between enough regulations to protect investors but not so much that it suffocates small businesses.
“With Equity Crowdfunding, this isn’t Kickstarter or Indiegogo, but it is just the same amount of work in marketing your offering, times probably 100x for doing the legal and regulatory and financial reviews,” said Vincent Bradley, CEO and Co-Founder of FlashFunders. “I’m very optimistic and I’m excited about the future of this industry… but my biggest concern for this industry right now is the regulatory. And I understand that if companies are going to act public, if they’re going to solicit to the crowd, if the SEC is going to open this up to 230 million Americans, it’s important that the information and the financials that the companies are providing have been scrubbed and validated. But today, where we sit right now, I think a lot of the regulatory [restrictions] will prevent this industry from becoming as big as we think it will be. So regulatory is a challenge at the moment.”
Who is Reg A+ and Equity Crowdfunding For?
Another question raised was whether Reg A+ and Equity Crowdfunding needed the participation of the institutional ecosystem. There’s no questioning the value of what that could bring, but the concept of creating a vehicle in which companies could crowdsource capital was in response to the lack of institutional support startups and small-cap companies had been suffering from due to increased regulations squeezing out profit margins for financial firms. But as Jeremy Glaser, Co-Chair of Mintz Levin’s Venture Capital and Emerging Companies Practice and one of the moderators of the event, pointed out, there’s an old adage on Wall Street that says, “Securities are not bought, they’re sold.”
“I think that’s part of the reason that there’s been frustration about the ability to get a Regulation A+ deal done at the institutional level,” said Salomon Kamalodine, Managing Director, B. Riley & Co. “There needs to be some element of a recommendation and diligence done by an investment bank that has relationships with institutional clients. What sometimes gets lost when we talk about crowdfunding and bringing technology in and the process of soliciting investments, is it still very much remains a relationship business. When you start talking about the institutional world and raising money in the context of Reg A+, you really need a bank to sponsor you and argue that the investment makes sense. I think the problem that we have is the banks are not taking a principle role in these offerings. For us, that’s what really got us interested in Reg A+ early on.”
Kamalodine and B. Riley’s stance on the uncertainty and opportunity of Reg A+ certainly contrasts with Schramm’s and ROTH’s from the earlier panel. But that speaks to the varying viewpoints and outlooks of the speakers at the event. While some argued that the regulatory requirements were too stifling for companies, others argued that the increased liquidity and transparency for investors could even be embraced to better position the company’s corporate and investor relations messaging.
But Jason Paltrowitz, Executive Vice President of Corporate Services for OTC Markets Group, helped to put it all into perspective.
“This is going to be transformative. It’s just going to take some time,” he told Equities.com in a phone interview after the event. “The reality is that the market for small company capital raising is broken and this was a way to try to address it and fix it. Also, IPOs in general became less and less about raising money for companies to grow their business and more about some wealthy people and some big funds being able to cash in quick on a company. So our view here at OTC Markets is that this is three-to-five years out. This process, with tweaks, still is probably the best thing to happen in recent memory to help small businesses raise capital, and it does it in a way that allows it to be open and transparent. It’s open, it’s democratic, it’s social and it’s online, it’s all these great things. If you look back in three to five years, this will be a transformative event and have changed finance in many ways.”