On January 23, 2020, the SEC’s Office of the Advocate for Small Business Capital Formation (the “Office”) hosted its first Capital Call, during which the Advocate for Small Business Capital Formation and Director of the Office, Martha Legg Miller, and members of the Office’s Staff discussed the latest trends relating to capital formation.  During the call, the Staff highlighted data points from the recently published Annual Report to Congress, some of which we covered in a previous blog post.  These included:

  • The decline in number of community banks. The number of FDIC-insured community banks has declined from 7,442 in 1998 to 4,979 in 2018.  This decline, combined with more banks reducing or eliminating loans under $100,000, which are less profitable for the banks, presents an issue for early stage companies.
  • Role of angel investors. Angel investors continue to play a significant role in funding early stage businesses.  While dollars of investments by angel investors are dwarfed compared to amounts raised in public offerings, in aggregate, over $23.1 billion was raised from angel investments in 2018, with an average angel funding round size of approximately $350,000.
  • Financial sponsor-backed companies. Venture capital and private equity continue to provide capital for growth companies. The Office estimates that 700 of over 13,696 financial sponsor-backed companies are expected to become the next immediate generation of public companies.
  • Smaller public companies. The Office recognized that the number of publicly traded companies has declined from 8,090 in 1996 to 4,397 in 2018.  Company market caps, however, are increasing.  Between July 1, 2018 and June 30, 2019, small public companies have completed 294 public offerings, raising an average of $47 million in proceeds.  The Office acknowledged that lack of research coverage causes smaller companies to struggle in the public markets.  To this end, 61% of exchange traded companies with a market cap of less than $100 million receive no research coverage.  This directly negatively impacts the liquidity of a company’s traded securities.
  • Women and minority owned small businesses. The number of women-founded companies accounted for 21% of startups in 2018, compared to just 4% in 2001. However, the Office found that these companies are not finding as much success in finding funding with an investment yield rate of 17.5%c compared to 23.2% baseline rate. Similar issues affect minority founded businesses, which the Office found are three times as likely to be denied a loan and are charged an average interest rate of 7.8% versus 6.8% rate for non-minorities.

The Office also briefly covered policy recommendations it made to Congress during the call. The recommendations, which were based on feedback the Office received from founders, investors, and other market participants, include:

  • Modernizing, clarifying, and harmonizing the exempt offering framework in order to avoid higher costs and barriers to capital access created by confusion and conflicts between exempt offering rules;
  • Refining the accredited investor definition and allowing retail investors access to pooled investment vehicles, as discussed in the SEC’s recent Concept Release;
  • Providing a clear regulatory framework for “finders” in order to engage investors and address challenges that certain demographics face when trying to raise capital;
  • Updating Regulation Crowdfunding in order to increase investment caps, revise disclosure thresholds, allow the use of special purpose vehicles and examine portal investment compliance; and
  • Scaling obligations for smaller, less complex reporting companies. During the call, Director Miller acknowledged that the Office was encouraging companies to go public earlier in order to promote access the benefits associated with being a public company.