The Continuing Work of Enhancing Small Business Capital Formation

Luis A. Aguilar is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on Commissioner Aguilar’s recent public statement at the SEC Government-Business Forum on Small Business Capital Formation; the full text, including footnotes, is available here. The views expressed in the post are those of Commissioner Aguilar and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.

As everyone participating in today’s [November 19, 2015] Forum knows well, our nation’s small businesses spur innovation, produce technological change, and drive job creation across the greater economy. In fact, from mid-2009—or what some pinpoint as the end of the “Great Recession”—to mid-2013, small businesses accounted for approximately 60% of net new jobs. More recently, statistics compiled through the first three quarters of 2014 show that our nation’s 28 million small business owners have been responsible for an even greater share of overall job creation, accounting for between 73% and 84% of net new jobs during that period. There can be no doubt that facilitating an environment that nurtures and breeds successful startups and small companies is critical to the health of our greater economy.

The SEC’s annual Government-Business Forum on Small Business Capital Formation recognizes this fact, and once again brings participants together to discuss how regulatory regimes may impact or facilitate the growth of small and emerging companies. After all, small businesses need ready access to capital to grow and flourish. To that end, small businesses continue to rely heavily on owner investment (including loans from “friends and family”) and traditional bank credit for their financing needs. However, sometimes this traditional financing is not enough, or is not available, to help small companies make ends meet or expand their businesses. As a result, the Commission has used its statutory authority over the years to adopt rules to help small businesses raise money by issuing securities to both public and private investors. Indeed, as today’s agenda highlights, since the passage of the Jumpstart Our Business Startups Act (“JOBS Act”), the SEC has implemented multiple rulemakings intended to facilitate the ability of small businesses to access the capital markets and some of our efforts go beyond what the JOBS Act mandated. For example:

  • Less than three weeks ago, the Commission adopted rules permitting small businesses to raise capital from investors in Crowdfunding transactions. Under these rules, qualifying Crowdfunding transactions will provide an exemption from federal registration for internet-based offerings of up to $1 million in a 12-month period;
  • On the same day the Commission adopted the Crowdfunding rules, the agency also proposed various amendments to the intrastate transaction safe harbor under Rule 147 and to Rule 504 of Regulation D. These proposed amendments aim to revitalize Rule 147 and Rule 504 securities offerings by increasing their efficiency and usefulness for small businesses;
  • Earlier this year, the Commission adopted rule amendments to Regulation A (known as “Regulation A-plus”), which permits companies to raise up to $50 million in any 12-month period without requiring registration under the Securities Act, provided certain requirements are met; and
  • In July 2013, the Commission adopted final rules amending Rule 506 of Regulation D, to remove the prohibition against general solicitation and advertising, provided that all purchasers are accredited investors, and also proposed additional amendments to enhance investor protections.

Together, these Commission rulemakings are intended to form a tapestry of options for small businesses to obtain financing from investors in our capital markets. However, these rulemakings alone are not a panacea for the financing challenges faced by small and emerging companies. As I have mentioned on other occasions, a vibrant capital formation process requires a vibrant secondary market for the securities of smaller businesses. For investors to make money, buying the securities is just the first step. They also need to be able to sell them.

The long-existing problems in the secondary market for small company securities are well known. With the new and expanded exemptive regimes, they are likely to get worse as more unregistered and unlisted companies will find themselves with a larger number of shareholders than ever before. Moreover, these shareholders will need to find liquidity in the secondary markets—markets which as of now are less fair, less liquid, and less transparent than the secondary markets for listed securities. Ultimately, if investors in these companies are unable to transfer their shares in an active secondary market, then small business issuers may find less appetite from investors for future offerings.

Accordingly, this is an issue that requires a solution before the capital market for smaller companies is adversely impacted and should be part of any discussion on what to do in a post-JOBS Act world. In that vein, I would like to offer some questions that I hope will be considered today, and in future discussions, concerning small business capital formation:

  • I have previously suggested that reforming Rule 15c2-11—commonly referred to as the broker-dealer “piggyback” exception—would enhance the integrity of market quotations for small business securities, and thereby lend an assist to the secondary market for these securities. Would such reforms be enough to address abuses in the microcap securities market sector and facilitate trading in such securities, or are other reforms also necessary?
  • In addition, as I have suggested before, finding a path for smaller company securities to gain access to the Depository Trust Company’s services and for improving the regulation of transfer agents with respect to such securities could enhance the capital formation eco-system for these companies. If so, how could these goals best be accomplished?

There are, of course, other aspects of the eco-system for the offering of the securities of smaller companies that warrant attention. For example, developments in the investment banking industry have resulted in fewer investment banks focused on underwriting smaller offerings. Accordingly, what can be done to sufficiently incentivize investment banks to participate in these offerings, such as Regulation A-plus offerings? In essence, what are feasible and cost-efficient ways to encourage investment banks to underwrite more of these deals?

Of course, in thinking through the best ways to facilitate capital formation for small businesses, the challenge is to develop processes that enable businesses to raise capital efficiently while also, importantly, providing for ways to benefit and protect investors and the markets generally.

The path to successful capital formation for small businesses must lead through an investment environment that works for both issuers and investors.

Thank you.

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