Like the entrepreneurs on Kickstarter trying to raise money to sell hot-chocolate cubes, cut an album, or manufacture a wireless dive-log device for scuba divers, later-stage private companies may soon be finding investors online. But will crowdfunding for firms that are more established and have a solid operating history be the bonanza it is for some start-ups?
It’s possible, given that the Title II section of the JOBS Act gives companies and their broker-dealers the ability to market Regulation D Section 506(c) private placements on a widespread basis. Some broker-dealers are launching an online portal to do just that, in an attempt to open the floodgates to “sophisticated pools of equity capital funding.”
Reg D offerings, which exempt the issuer from securities-registration requirements, are a popular form of raising capital from accredited investors — those who can invest in such higher-risk investments as hedge funds and angel-investor networks. But companies and broker-dealers weren’t allowed to advertise to them — at least until the JOBS Act was passed.
In launching ConfidentCrowd, an online portal for these transactions, middle-market broker-dealer Dinan & Co. is betting it can make the market bigger by bringing Reg D placements from multiple broker-dealers to the attention of more investors and collecting them on a single platform.
Only accredited investors can invest in Reg D offerings, and they are hard to find. Currently, “a broker-dealer is significantly handicapped because it is limited to speaking to only accredited investors with which it has a preexisting relationship,” says Mike Dinan, chief executive officer of Dinan & Co. Companies are even further removed. “There’s not really a place [for issuers to go] to know which investors are accredited,” says Mike Hermsen, a former Securities and Exchange Commission lawyer and now a partner at Mayer Brown.
To be sure, ConfidentCrowd may lure more investors to a company’s securities offering, but it isn’t necessarily going to bring the company any closer to the end investor. The only way to get on the portal to raise capital is to be sponsored by a broker-dealer (although companies will be able to advertise their offering to accredited investors directly). Interested investors will be able to access a secure data room to dive down deeper into financial statements and can execute purchase agreements through the portal.
The bar for a Reg D private offering will be just as high as it ever was, though. Dinan says his firm looks for established, more-mature companies with at least $2 million in trailing-12-month operating income, and placements range from $5 million to $50 million. Dinan is highly selective and says he “rejects most of the issuers that come to us to raise capital.” ConfidentCrowd may set up an investment committee to make sure that companies sponsored by other participating broker-dealers have standards just as rigorous.
In addition, greater marketing efforts and online portals may attract more investors, but they still may choose not to partake. “A Reg D offering is private, which means there is not really a ready market for the securities,” says Hermsen. “It may not be a risk an investors want to take. The rules don’t change the fact that these securities are not readily tradable, so you have to be willing to hold them for a while.”
Meanwhile, broker-dealers and ConfidentCrowd are in limbo until the SEC finishes the rule-making process surrounding private placements. The stickiest issue is how broker-dealers, issuers, or both are going to verify that an investor is accredited. Currently, investors self-certify, but the JOBS Act calls for “reasonable steps” to be taken to verify an investor’s status, putting the onus on the issuer and the broker dealer. “It’s likely going to be a different standard than what [firms] are using today,” says Hermsen.
Broker-dealers are worried that investors will be scared off if they have to provide private information like their net worth and liquidity. But they are also eager to get clarity, whatever the rules: “We are hopeful [the rules will come out] before the end of the year,” says Dinan, “but with significant changes at the SEC, we’re concerned it may not happen until 2014.”