On May 16th of last year, the SEC granted privately-held US companies the ability to raise money from non-accredited investors for the first time since 1933. Non-accredited investors represent 97% of all Americans.
Title III of the Jobs Act, commonly referred to as Regulation CrowdFunding or Reg CF, allows US companies to raise up to one million dollars per year from an unlimited number of investors. Plus, the issuing company and its securities are exempt from traditional registration.
Since last year, only $27M has been reportedly raised through Reg CF.1 To examine the potential impact Reg CF will have on US capital markets in the future, we’ll take a look at the preliminary participation and history of what has transpired in the UK, which approved crowdfunded investing regulations in 2011.
In Europe, the first year of investment crowdfunding volume occurred in 2013, when $28M was raised. In 2014, CrowdCube became the first regulated portal with FCA approval, marking a significant investor protection and market acceptance milestone. It’s no surprise that with added regulatory clarity, investment volume grew to $84M in 2014. In 2015, volumes continued to climb to more than $245M.
Preliminary estimates indicate that in 2016, about $400M was raised2, essentially tripling the crowdfunding volume in Europe over the first three years. Effectively, the compound annual growth rate of investment crowdfunding over this initial time period is 114%.3
See the graph below charting European investment crowdfunding volume.
Compare the above graph to the graph below showing the growth in volume of Regulation CF transactions over the first eight months in the US. The compound monthly growth rate in the US is lower at 90% compared to the higher sustained CAGR in Europe.4
A potential reason for the slower beginning growth rate in US crowdfunding vs the UK is significantly different crowdfunding regulatory environments. In general, UK crowdfunding regulation is less restricted with no cap on the total amount an issuer can raise in any given year and no limit to the amount any investor can invest. The US restricts crowdfunding companies to a maximum of $1M annually and the amount an investor can invest is limited to 10% of their investment portfolio or up to $100k annually for accredited investors.
The US places an additional burden on Reg CF issuing companies by requiring the company to complete an annual accounting audit if they raise over $500k. This is often a significant expense to early stage companies and increases the cost of raising capital.
Additionally, there are tax incentives for European small business investors under the SEIS and EIS. These two schemas allow investors to avoid paying capital gains tax. Investors that invest in US based crowdfunded offerings are subject to traditional capital gains taxation.
One result of these regulatory differences is that the UK has seen larger crowdfunding rounds completed. The UK has had over 10 companies raise more than $2M in a single offering, compared to the 5 companies in the US that raised the maximum of $1M (with the majority of offerings having goals set well below the cap).5
In several aspects, the UK framework allows for greater participation and volumes, however this is offset by the smaller UK economy. The US has a much larger base of potential issuers, with about 40,000 companies raising capital each year.6 The UK has far fewer companies that raise capital annually, but the percentage of these companies that raise money via crowdfunding is growing, with some stating that crowdfunding investment campaigns accounted for about 20% of these raises in 2016.7
Another important difference in examining the potential size and growth prospects of the US crowdfunding market compared to that in the UK, is the size and prevalence of other sources of capital for small and growing businesses, such as angel investing and venture capital. The US has a deeper and more robust traditional corporate financing market with $60B annually invested by venture capitalists and estimates of annual accredited angel investment volume of around $50B.8 Europe has comparatively much less traditional funding with around $5B of annual venture capital investment volume, and $6B in annual angel investments.9
Putting aside potential macro-economic conditions and making some assumptions based on current market data (i.e. market volume predictions on US crowdfunding growth rate over the next three years and using the UK market growth rate as a comparable), it is reasonable to expect that the US Regulation CF market could see $500M of volume in 2020.10
In the big scheme of US capital markets, that’s not a whole lot compared to the $1.3T that gets invested every year via Regulation D. Thus, I don’t believe Reg CF, in it’s current form, will live up to its expectations of being a hundred billion dollar market.11 There are just not enough issuers who can only raise up to a maximum of $1M annually for crowdfunding to become an enormous market. The $1M cap would need to be removed, or the threshold would need to be raised. The current regulation does not create the necessary growth in the number of companies that will raise capital, with just over 200 companies completing Reg CF offerings in the US to date.
In terms of how many intermediaries the market can support, if US CrowdFunding volume is $500M in 2020, and the average commission for intermediary portals is 5% of the dollar volume, then that’s $25M in fees for the intermediary portals to split. That’s unfortunately a small distributed revenue opportunity for the 25 current FINRA-registered investment portals. These portals are unlikely to be able to sustain operations on only $1M of revenues per year. With most of the early volume being completed on just a few portals, more consolidation or small niche portals with specialization are the only possible means for viability if regulations do not change.
Compare this intermediary market to the estimated $20B of commissions earned by several thousand broker-dealers that facilitated Reg D transactions.12 There has been consolidation and contraction in the broker-dealer industry even at those volume levels because of regulation and oversight. It’s a tough business for incumbents in a robust market.
Only time will tell if Reg CF in the US realizes its highly publicized hype to create jobs, increase middle class wealth and significantly impact US capital markets. My hunch is that in its current form, it will not live up to these aspirations for reasons of regulation, limited participation, high relative costs of capital, and adverse selection. Quite frankly, for most companies in America, a Regulation D capital raise is a better, more flexible, less restricted, more immediate and more cost effective means of investment and capitalization.
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1 See NextGenCrowdfunding.com.
2 See http://www.nesta.org.uk/blog/another-year-growth-p2p-lending-and-crowdfunding-uk.
3 According to WealthForge internal calculations.
4 See Id.
5 See http://ww2.cfo.com/capital-markets/2017/02/whats-wrong-crowdfunding/.
6 According to SEC Form D filings.
7 See http://www.sbs.ox.ac.uk/sites/default/files/Entrepreneurship_Centre/Docs/OxEPR2/equity-crowdfunding-uk-british-business-bank.pdf.
8 See https://www.statista.com/statistics/424846/venture-capital-investments-usa-by-stage/ and http://www.angelresourceinstitute.org/research/halo-report/halo-report.aspx.
9 See www.ey.com/Publication/...venture-capital.../ey-global-venture-capital-trends-2015.pdf and www.eban.org/wp-content/uploads/2016/06/Early-Stage-Market-Statistics-2015.pdf.
10 Based on WealthForge calculations.
11 Based on Fred Wilson's prediction, http://www.avc.com/a_vc/2013/07/let-the-games-begin.html.
12 Based on WealthForge 2016 Form D Research.
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