Fifty Shades of White: Raising Equity from the Public by Start-ups

Arming the mid-size companies with a new funding channel might trigger the valuations hike further, imposing the notorious "bubble" the VCs like to talk about. Don't underestimate the power of billboards or TV commercials with investment offerings.
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Curious? I don't blame you - especially if you are an entrepreneur or an indie-producer in search of capital and have been patiently waiting for the JOBS act rules to come to life.

In a rather surprising recent move, the Securities and Exchange Commission (SEC) chaired by Mary Jo White (who I believe has the hardest job in the world), "adopted final rules to facilitate smaller companies' access to capital".

The main catch is that after almost three years of being in a legislative limbo, Title IV of the JOBS Act (aka Reg A+) gave a green light to the notion of raising equity from unaccredited investors, in other words from the public (restrictions apply). Given the fact that until now private placements have been limited to the accredited investor universe only, it is easy to understand the excitement in the startup community which followed the news.

But is this anything to write home about? Let's see.

Key updates

-The rule, which should be legally enforceable in 60 days, divides capital seeking companies or issuers into two tiers.

-Tier 1: You can raise from $1M to $20M per year from unaccredited investors, offering requires SEC review and approval, plus registering your securities in every state that you make an offer or sales (state fees are applied accordingly).

-Tier 2: You can raise from $20M to $50M per year from unaccredited investors but they are subject to investment limits of 10% of their net worth or 10% of their net income (per self-certification - no validation from the issuer necessary), offering requires SEC review and approval, along with two years of audited financials, plus a further ongoing audit.

-Issuers can publicly advertise their offerings via social media and other advertising channels.

-Title III of the JOBS Act, which would let you to raise up to $1M per year from unaccredited investors, is still in limbo.

What's in it for you?

While analyzing the new legislation, it is easy to recognize that it has no visible benefits for start-ups looking for seed money or early rounds of capital.

If you are a start-up or a young venture with let's say less than $1M in revenues, it would be too bold to go for more than $1M raise utilizing Reg A+. The costs will be high relative to your financial position, you will lose in valuation and every unaccredited investor might hit you where it really hurts via a lawsuit.

The last statement should be taken especially seriously by movie makers. I live in Los Angeles and have plenty of friends in the entertainment business who went on hype after finding out about the new rule but let's remember that most movies with low budgets are not generating any cash.

I believe the new developments are specifically benefiting the established mid-size market companies looking for $20M-$50M. So while start-ups are in some sense are subject to catch-up, the mid-size market companies have gotten an additional channel of alternative financing in the form of a "mini-IPO".

Which begs the question - are we reinventing the wheel?

Blast from the past: here comes the OTC

In today's ever-connected world, common knowledge about everyone's reputation is the main driver for collaboration. This quietly existing since 1913 (!) channel of raising capital from the public - in the form of a secondary market - is something most entrepreneurs don't talk about.

In my view, the OTC fell short on its mission to provide capital and liquidity due to its long standing association with Pink Sheets markets, which was a source of a disturbing amount of fraud. Frankly, I am not sure why Pink Sheets are still allowed on OTC platform.

Why I am bringing up the OTC now? OTC market which hit $238B in volume last year up from $200B in 2013 is just too big to ignore, but most importantly based on my research and discussions I've recently conducted with over a dozen of the leading security attorneys in the country, the OTC market group is working hard on cleaning up its reputation and is becoming a workable channel. I've listed the key points below.

-As of now, OTC-traded securities are organized into three marketplaces: OTCQX, OTCQB and OTC Pink;

-OTCQX is a marketplace for established global and growth companies; OTCQB - for early and developmental companies, and OTC Pink is an open marketplace for brokers to trade in all types of securities without requiring the involvement of the company.

-OTCQX and OTCQB markets are particularly the markets where companies are being reviewed and verified by OTC Market Group

-According to OTC, from more than 700 companies submitted OTCQB applications during 2014, only 311 were approved

-The main obstacle for start-ups is the legal costs - $100K - $120K based on my surveys

-"Slow PO" - is a new option that combines the SEC exemptions with the OTC requirements and makes your shares "tradable".

"Slow PO" is my favorite finding since this channel, if implemented correctly, might be a new Holy Grail for start-ups in search of financing and liquidity.

Concluding thoughts

Arming the mid-size companies with a new funding channel might trigger the valuations hike further, imposing the notorious "bubble" the VCs like to talk about. Don't underestimate the power of billboards or TV commercials with investment offerings.

Being able to raise capital from public utilizing Reg A+ is something start-ups might be looking forward to but it is not going to be a viable option due to the imposed legislative metrics, high risks and costs. The last one is particularly the obstacle for start-ups being able to utilize the OTC (along with its still un-sexy reputation).

But who is holding the gun? I am being an optimist and encourage entrepreneurs to build a viable business first and foremost, keeping in mind a fundamental thought: all that you are seeking is also seeking you. Stay tuned.

Victoria Silchenko, Ph.D. is an alternative funding expert, Founder & CEO of business consultancy Metropole Capital Group and Producer of the Alternative Funding Forum. She is also an Adjunct Professor on "Entrepreneurial Finance" at CalLutheran University., Twitter @MetropoleGlobal

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