Securities & Exchange Commission: Small Business Capital Formation Advisory Committee Meeting

Securities & Exchange Commission
Small Business Capital Formation Advisory Committee Meeting
Tuesday, February 27, 2024

Topline

The Committee voted to require a risk awareness statement for unaccredited investors.
The Committee discussed how decreased IPO activity and market shifts are impacting smaller companies and related capital raising challenges.

Call to Order & Introductory Remarks

SEC Chair Gary Gensler

In his opening statement, Gensler explained that Americans have benefitted from an agreement struck by Congress in the 1930s, which requires IPOs to be registered with the SEC. He noted the agreement is a basic bargain where investors provide certain information to the SEC, and in exchange, the SEC ensures the stability of the securities markets. Gensler said the IPO market ebbs and flows with the economy and valuation in the private and public markets, which is why the SEC made specific rules regarding Special Purpose Acquisition Companies (SPACs).

SEC Commissioner Hester Peirce

In her opening statement, Commissioner Peirce stressed the importance of getting capital to places like Pittsburgh and Cleveland. She warned that the proposed accredited investor definition would limit the flow of capital to these markets. She noted there are risks in investing in small companies but explained that education for investors and founders is essential to build up the private market. Peirce encouraged further discussion of IPOs, citing the sharp decrease in the number of US-registered companies since the 1990s. She concluded that in order to encourage companies to go public earlier, the SEC should investigate existing obstacles for IPOs and potential changes to the IPO process to make it easier for young companies to go public.

SEC Commissioner Caroline Crenshaw

In her opening statement, Commissioner Crenshaw described the participation of accredited investors in capital markets as essential but noted only 8% of businesses turn to equity investments, which she said must be considered while revising the definition. She explained that the SEC is inviting firms to submit a self-assessment of their diversity and inclusion goals, which she said is voluntary but helpful. Crenshaw concluded by noting her concern that an undue focus on the accredited investor definition will fail to address all the issues facing small business capital formation.

SEC Commissioner Mark Uyeda

In his opening statement, Commissioner Uyeda said that it’s time to move away from the accredited investor approach to raising private capital for small businesses. He encouraged the committee to consider the themes of not allowing the definition to be tied to inflation or to assume that net income reflects an individual ability to enter private offerings. Uyeda emphasized that any regulatory approach to private offerings should be focused on opportunity, rather than a parental approach where the government decides who can and cannot invest.

SEC Commissioner Jaime Lizarraga

In his opening statement, Commissioner Lizarraga noted that 78% of small business owners expressed concerns about their ability to access capital over the past year. He also raised concerns regarding small businesses in rural and underserved communities who lack access to the right business ecosystems and a network of high-net-worth investors for capital.

Stacey Bowers, Director, Office of the Advocate for Small Business Capital Formation, SEC

In her opening statement, Bowers explained that while her office’s legislative mandate requires her to issue a report for Congress every year, she considers it an opportunity to issue an update on the broader small business market. She noted that during FY2023, the Office of the Advocate for Small Business Capital Formation held over 30 events to educate investors across the country. Bowers explained that she would not vote on committee matters because her office interacts with external stakeholders, and she wanted to prevent any conflicts of interest.

Update from the SEC’s Office of the Advocate for Small Business Capital Formation

Julie Zelman Davis, Senior Special Counsel

Davis introduced their office’s 2023 annual report which can be accessed on the OASB’s website and talked about highlights from the report. She explained that the Office believes that capital formation is a lifecycle between grants, crowdfunding, and IPOs. She noted that the majority of small businesses raise capital through personal funds and cash reserves, while only 8% seek equity investments. Davis said the median distance between companies and investors in a seed deal skyrocketed to 591.3 miles in 2022. She explained that women now account for 39.5% of angel investors in the private capital market and noted that the number of women seeking angel capital increased in 2022. Davis also noted that just 1.5% and 1.1% of venture capital dollars went to Latino and Black-owned businesses in 2022.

Jenny Riegel, Policy Manager

Riegel discussed how registered offerings continue to raise the largest amount of capital in the current market. She explained that for US private companies, 17,000 public offerings occurred under Regulation D. Riegel said fundraising by funds continues to decline, and discussed how emerging managers are struggling to fundraise in the current environment. She noted that small exchange-listed companies have been responsible for most of the decline of the IPO market. Riegel concluded that the SEC’s Office of the Advocate for Small Business Capital Formation is focused on expanding educational resources, making changes to Regulation D and regulations for crowdfunding, and clarifying regulations for emerging fund managers.

Accredited Investor Definition

Committee members deliberated different proposals related to the accredited investor definition.

Erica Duignan, the Chair of the Small Business Capital Formation Advisory Committee, said the Committee is focused on possible adjustments to the thresholds for investor income as it pertains to joint worth and net worth. She noted that 18.5% of households qualify under the proposed definition and that in 1989, when the Accredited Investor definition was first enacted, only 3% of households met the definition. Duignan noted three options that the Committee could consider: the first was to adjust the definition for inflation based on the adoption date in 1989; second, leave them for now and adjust them going forward, for example once every 5 years; or, third, do not adjust the definition for inflation at all. She explained the Committee’s second proposal, which would allow natural persons to invest up to 5% of their net worth. Duignan also discussed the Committee’s third proposal, which would allow investors to demonstrate competency through an exam.

Vincent Cordero urged the Committee to broaden, not restrict, the amount of people who can participate in the market. He said that the best framework would provide support for investors to make the determinations themselves. He said he would not vote to not increase the current thresholds. Marcia Dawood explained there should not be a threshold that relates to wealth without any discussion of education. She said that the definition should stay where it is for the time being.

Aren Sharifi warned that every year the definition is not changed to keep pace with inflation, ordinary investors are exposed to undue financial risk. He added that 64% of people would be exposed to additional risks that they cannot absorb if the Committee does not change the thresholds. He said that he would be in favor of indexing the requirements to inflation starting now.

Jasmin Sethi said that if thresholds are not adjusted for inflation, they become meaningless. She noted that indexing going forward would allow the thresholds to reflect current market conditions. Sethi also noted the current thresholds would allow people to qualify because of their retirement account assets, which could cause seniors to be targeted for scams.

Wemimo Abbey said he would not vote to adjust the threshold for inflation. He urged the Committee to remain focused on educating investors about identifying risk and updating the required disclosure forms.

Committee Chair Duignan moved the conversation to ask whether natural persons who do not meet the accreditation requirements can invest up to 5% of whichever is greater between their income or their net worth.

George Cook suggested exploring the idea of a sliding scale but warned that putting the burden on an accreditation regime would be dangerous.

Committee Chair Duignan said 5% is the most reasonable standard put forth by financial regulators for investing. She said these guidelines would strike a balance between protecting and empowering people.

The Committee discussed who would be responsible for tracking this without coming to a consensus. George Cook said that in Regulation Crowdfunding, it is self-reported.

Committee Chair Duignan moved the conversation to discussion of whether there should be an education alternative or an education addition to the wealth and income thresholds.

Cordero suggested that instead of a test, the SEC should offer a course and provide accreditation once the SEC verifies that an individual has completed the material. He said that he does not want to create extra burden. Herbert Drayton said he liked the idea of providing information online to investors. He also noted that he never asked anyone for their tax forms to ensure that they were accredited and warned that the Committee should be wary of establishing a new accreditation regime. Drayton suggested that in the proposal, the Committee should change “risk warning” to “risk awareness.”

Diego Mariscal asked George Cook about his experience with education under Regulation Crowdfunding at the crowdfunding platform Honeycomb Credit. George Cook said that there is information and multiple checks provided to investors throughout the process. He said that the investments that platform participants get are typically small with the average investment being $1,000 and the most common investment being $100.

Duignan noted the term accredited investor implies that one has done something to achieve accreditation. She explained this would create an opportunity for people to do something online that demonstrates their understanding of the asset class.

Dawood warned there is an existing perception that one must be a CPA to be an angel investor and urged the Committee to focus on allowing greater access to investing. She explained that she didn’t want to make this burdensome on the companies but wants to help them understand how to make their portfolios better. Dawood offered a recommendation for the first proposal, suggesting the return to the original adoption date and allowing people to invest under the current limits. Dawood also noted that if the Committee didn’t adjust the thresholds for inflation, the rest of their proposals would become meaningless.

Cordero suggested a compromise would be to not touch inflation for the accredited investor definition, but then ensure unaccredited investors must abide by the 5% threshold.

Vote

The Small Business Capital Formation Advisory Committee voted not to adjust the thresholds in the proposed definition.

The Committee also conducted a straw-poll vote to prohibit an investment of 5% or more of net worth in 12 months for non-accredited investors. The recommendation was to require an education program for those investing below the 5% threshold.

The Committee voted to require a risk awareness statement for unaccredited investors.

Where Have All the IPOs Gone? The State of the IPO Market

Speakers:

Brian A. Johnson, Partner, Vice Chair, Corporate Practice Group, Co-Chair Capital Markets, WilmerHale
Elizabeth Reed, Partner and Global Head of the Equity Syndicate Desk at Goldman Sachs

Discussion

Cordero asked if the Reddit IPO signaled a possible uptick in IPOs in 2024. Johnson said he couldn’t say whether Reddit would be successful but clarified that Reddit’s move could convince other companies that IPOs can be successful. He noted more companies are about to submit registration statements, and predicted there would be more IPOs than in 2023. Johnson cautioned that the market won’t look anything like it did five years ago.

Duignan asked if the lack of IPO activity could be attributed to larger private funding rounds. Reed explained that if you’re raising capital in 2021 but don’t go public until 2024, corporate boards will vote to stay private and wait until the macro environment improves. Johnson noted that the companies who can are waiting for the market to improve. He added that he hopes some of the companies that have been able to utilize private capital will open to the public market.

Bart Dillashaw asked how much of the decision to go public is based on the macroeconomic and regulatory environment. Johnson explained that the bigger decision tends to be the cost of the IPO itself, rather than the ongoing costs of going public. He noted companies do consider the regulatory environment, but the cost of the IPO itself is the most important factor. Dillashaw then asked how much it costs to go public. Johnson explained that it costs roughly $7-8 million for a company that is doing a $200 million IPO.

Herbert Drayton asked about the impact on new entrants to the public market. Johnson said the best thing for the companies to understand is that there are options, either from a traditional IPO or private funding.

For more information on this meeting, please click here.

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