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SEC Small Business Capital Formation Advisory Committee

Securities and Exchange Commission

Small Business Capital Formation Advisory Committee Meeting

Tuesday, August 2, 2022

Topline

  • Committee members discussed Regulation Crowdfunding (Reg CF) and Regulation A (Reg A) in relation to investments in small businesses and startups.
  • Committee members voted 9-1 to advance a proposal for a pilot program to preempt state regulations for Reg A transactions for companies that have been reviewed and are deemed compliant.

Opening Statements

Chair Gary Gensler

In his opening statement, Gensler noted that many financial technologies are being used not only at startups, but also by financial incumbents and big tech. He asked how this would impact the availability of capital and whether this should change the way the SEC oversees markets.

Commissioner Hester Peirce

In her opening statement, Commissioner Peirce said that Reg CF and Reg A would allow individuals to invest in companies at an earlier stage of growth than traditional Initial Public Offerings (IPOs). She noted that investor protection is a top consideration and cited crowdfunding rules and secondary market liquidity as areas for further reform. She added that a liquid secondary market would benefit investors who want to realize gains or move their money and called for a spotlight on secondary market liquidity.

Commissioner Caroline Crenshaw

In her opening statement, Commissioner Crenshaw asked if disclosures adequately help investors and non-accredited investors weigh risks up front before committing capital. She questioned whether these disclosures inform investors of likely exit opportunities and timelines and whether the required Reg CF intermediary disclosures are working as intended. She concluded by asking if investor testing could serve as a useful tool.

Commissioner Mark Uyeda

In his opening statement, Commissioner Uyeda said that small business owners need a stable and predictable regulatory framework for capital formation. He said that investor testing is an underutilized tool, adding that there is much to be gained from the robust testing of disclosures made available to investors.

Commissioner Jaime Lizarraga

In his opening statement, Commissioner Lizarraga called for exploring new and innovative regulatory solutions to address existing disparities. He said that the Commission’s proposals must level the playing field for all market participants and concluded by stating that addressing the unique challenges that women and minority owned businesses face is critical to fulfilling the SEC’s capital formation initiative.

Agenda Items and Discussion

Committee Members’ Outlook: What’s on the Horizon for Small Business Capital Formation?

Committee members discussed future trends surrounding small business capital formation. Multiple members cited concerns about the economy. Gregory Yadley, a Partner with Shumaker, Loop, & Kendrick, LLP noted that the environment is challenging for startups, and predicted the market for small business capital would be choppy.

Jason Seats, the Chief Investment Officer at Techstars, said he is counseling portfolio companies to be cautious about the current market, and mentioned uncertainties surrounding investment behaviors and capital availability for venture-backed startups. Sapna Mehta, the General Counsel and Chief Compliance Officer for Rise of the Rest Seed Fund, added that there has been an increase in top-up rounds, rather than new priced investment rounds. She added that companies are focusing on business fundamentals instead of growth. Robert Fox, the National Managing Partner of Grant Thornton LLP, agreed that initial funding is suffering, and that capital flow is going to follow-on deals.

Donnel Baird, the Founder and CEO of BlocPower LLC, discussed how capital formation is compelling for companies and investors who are required to file climate disclosures. Baird asked if it would be possible to create a secondary market focused on monetizing social and environmental impact.

Hank Torbert, the President of AltaMax, LLC said supply chain disruptions and labor shortages have led to a tightening of capital, adding that increased interest rates are making it difficult for smaller businesses to operate and function.

Catherine Mott, the Founder and CEO of BlueTree Capital Group and BlueTree Venture Fund, said the middle of the country is underserved by capital, adding that roughly 80% of capital funding is concentrated on the coasts. She called for addressing this funding gap through alternative methods and structures, noting that angel funds have failed to critically serve the capital gap.

Sue Washer, the President and CEO of Applied Genetic Technologies Corp., discussed how biotech companies are struggling with fundraising. She said that the biotech index is down 30% this year and cited discouragement in the investment community around biotech companies.

Secondary Market Liquidity for Investors in Regulation A and Regulation Crowdfunding Companies and for Smaller Public Companies

Ryan Feit, CEO and Co-Founder, SeedInvest

In his testimony, Feit discussed how crowdfunding allows millions of Americans to invest in startups and small businesses for the first time and provides thousands of entrepreneurs with a new way to access capital. He added that startups can scale purely through online fundraising but cited diversification and liquidity as the two major outstanding hurdles to making online fundraising and investing a viable asset for the masses.

Feit said that startup and small business investors often get burned out after making a few investments because they frequently have to wait years before realizing any returns, which leads to less available capital for small businesses and startups. He added that U.S. trade ventures ae not built for early-stage companies because they lack the necessary liquidity and research coverage. Additionally, Reg A preempts state security laws only for primary sales, which forces buyers and sellers to find exemptions on a state-by-state basis.

Feit suggested four improvements, including calling for Reg A issuers to be preempted for secondary transactions. He called on the SEC to provide additional clarity for brokers and clearing firms that Reg A reporting satisfies Exchange Act rule 15c2-11. He also said the SEC should provide regulatory guidance around ways for issuers and broker-dealers to leverage digital assets and distributed ledger technology to make secondary trading more efficient and should amend the Investment Company Act to enable retail investors to invest in diversified venture capital funds through Reg A.

Andrea Seidt, Ohio Securities Commissioner, Ohio Department of Commerce

Seidt said the committee is considering action and policy that she strongly opposes, namely the support for a preemption of her agency’s authority and the authority of all state security regulators to oversee secondary sales of Reg A and Reg CF. She said that while capital formation is important work, it is not the only work the committee is charged with. Seidt noted the committee charter states that it is supposed to provide the SEC with advice on its mission of respecting investors and maintaining fair, orderly, and efficient markets. She claimed that preempting state authority over secondary sales of Reg A and Reg CF offerings would not protect investors or lend itself to fair, orderly, or efficient markets.

Seidt said she and other state security regulators are concerned that company insiders and wealthier, sophisticated investors would exit bad deals by dumping their shares on more vulnerable and unsophisticated investors. She added that eliminating state registration requirements would make an opaque part of the U.S. securities market even darker and increase the potential for fraud and abuse of insider sales. Seidt added that preemption could lead to harsher and more negative enforcement outcomes.

Seidt concluded by reaffirming that she believes it would be a mistake to preempt state regulation of secondary sales of Reg A and Reg CF offerings and asked the committee to defer any vote on a preemption proposal until another speaker who can present the state argument is heard.

Vote

Carla Garrett asked members if they were in favor of recommending proposal for a pilot program to preempt state regulations for companies that have been reviewed to the SEC. Nine members voted in favor, while one voted against. A quorum was reached, and the recommendation passed.

 

For more information on this hearing, please click here.

For an archive of past SIFMA hearing coverage, please click here.