By Tiana Laurence, Partner at Laurence Innovation, a pre-seed investment fund focused on early-stage tech companies in the 4IR verticals.
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For many years, the rules imposed by the U.S. Securities and Exchange Commission (SEC) around early-stage fundraising have been needlessly complex and restrictive. This is why the SEC’s 2020 decision to update these rules is one of the most significant developments for founders and investors in early-stage companies.
From the simplification of confusing requirements around SEC registration exemptions to higher limits for various types of fundraising, the updated framework will make it easier for companies to raise money while providing new investment opportunities. The framework also allows founders to advertise and solicit investment more openly without having to worry about potential securities violations. These changes could lead to a renaissance for startups and investors who want to bypass the traditional funding model.
By making the process of early-stage investing more streamlined and accessible, the SEC has opened the door for innovative companies to scale their business and introduce their products to the world. But how many founders and investors are aware of these changes? Considering the implications of the SEC’s new rules for startups, investors and the economy more broadly, let’s take a closer look at the most important changes.
Raising Larger Sums Of Money
There are several categories of exemptions for companies that want to raise money without an SEC registration: Regulation A, Regulation D and Regulation Crowdfunding. The amendments increase the maximum amount that can be raised under Tier 2 of Regulation A from $50 million to $75 million, while the total for secondary sales in the same category jumped from a total of $15 million to $22.5 million. For Rule 504 of Regulation D, the threshold increased from $5 million to $10 million.
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Although the above changes are interesting, they are nothing compared to the radical changes to Regulation Crowdfunding that are shaking up seed investing. The SEC increased the crowdfunding limit from $1.07 million to $5 million and removed limits for accredited investors. For non-accredited investors, the limit is now based on the greater of their annual income or net worth. Finally, when the crowdfunding total is less than $250,000, founders have an extra six months to generate a financial statement. Investors, founders and consumers will benefit from all of these regulations, which will ensure that more innovative products reach the market and generate healthy competition in many industries.
As former SEC Chairman Jay Clayton explained: “For many small and medium-sized [businesses], our exempt offering framework is the only viable channel for raising capital.” The expansion of this framework could lead to surging investment and a more dynamic economy.
Democratizing Fundraising
Many startups lack access to investors, which is why it’s essential for them to be able to showcase their offerings without running afoul of SEC rules. Founders may not know which particular exemption they will seek from the SEC early in the fundraising process, which is why the updated framework includes an amendment that allows them to “test-the-waters” of investment prospects with generic solicitation of interest materials.
For startups, “demo days” organized by incubators, universities and other external entities are vital for generating interest among potential investors. The revised SEC framework clarified the rules around demo days, which now allow founders to communicate with investors in ways that won’t be deemed general solicitation or general advertising. Meanwhile, the new rules around Regulation Crowdfunding will displace the angel and seed venture capital stage by giving companies an opportunity to directly appeal to a wider array of investors — and the higher valuations mean founders will be able to keep more of their companies.
By empowering founders and making it easier for companies of all sizes to attract investment, the SEC has democratized the fundraising process. This will hopefully spur innovation, drive economic growth and give far more people a chance to invest in promising companies.
What’s The Real-World Impact?
In March 2021, Gumroad, a platform that helps creators sell their content, raised $5 million from 7,434 investors in a matter of hours. Gumroad CEO Sahil Lavingia said he believes in this democratized form of fundraising: “I think if we can start to see more startups raise money from their customers, from their communities, from the average person, or non-accredited investors–I just think that’s good for the world.”
The crowdfunding market was already exploding when the SEC implemented its amendments. StartEngine is an online service that facilitates crowdfunding campaigns, and it generated $12.5 million in revenue in 2020 — a 190% spike from 2019. However, in the first six months of 2021 (after the more permissive SEC rules took effect), StartEngine brought in more revenue than it did in all of 2020: $13.3 million. Technavio recently published a study that anticipates that the global crowdfunding market will grow by more than $196 billion from 2021 to 2025.
But crowdfunding is just one element of the transformative rules approved by the SEC. It’s now possible for startups to raise millions more without submitting to onerous SEC requirements, while investors of all kinds have a wider range of options than ever before. This is poised to lead to a revolution in capital generation that will have a dramatic impact on the economy for decades to come.
