Early Investing

SEC Limits on Startups Raising Money Will Be Eased in 2021

SEC Limits on Startups Raising Money Will Be Eased in 2021
By Andy Gordon
Date October 28, 2020

The slow-moving, overly cautious SEC is finally doing the right thing. It’s reportedly raising the limit on Reg CF funding from $1 million to $5 million. 

That means when a startup raises money through crowdfunding, they can raise up to $5 million. And that’s a big break for investors (like you and me) and founders alike.

Founders will be able to raise enough money to give their startups substantially more room to operate and breathe before raising money again.

And for investors, a $5 million round reduces funding risk (the possibility the startup won’t be able to succeed or operate without raising capital in the future).

Nothing is official quite yet. The SEC just announced that it’s meeting next Monday morning to “consider whether to adopt rule amendments to facilitate capital formation.” That’s our SEC — opaque and bureaucratic  Washington-speak at its finest. 

The $1 million limit was never considered a sufficient amount. Ryan Feit — founder and CEO of startup-raising portal SeedInvest — was an early participant in the discussions that lead to the 2012 JOBS Act. He says the $1 million limit was considered merely a starting point. 

And rightly so. While startups can do a lot with $1 million, it’s nowhere near the amount they need to grow and become sustainable. Venture capital firms typically write much bigger checks to their seed stage companies — it’s just good business sense. The last thing VC firms want to hear is “we didn’t succeed because our funding was too small.” 

It’s taken eight years since the passage of the JOBS Act and five years since the issuance of Reg CF rules for the SEC to do something about this. I thought for sure it was going to raise the cap last year. Initial reports now say the raise is expected to go live on January 1st 2021. 

In its announcement for next week’s meeting, the SEC stated that “the [Reg CF] exemption has been viewed as a success even with excessive constraints.” But it also said that it’s acting now because “to date, Reg CF has experienced no fraud” and “has long been deemed anemic due to strict rules that hamper its utilization.” 

I can only conclude that the SEC is saying that Reg CF has been an “anemic success.” And that we should feel good about the success part and bad about the anemia part. 

The SEC has a point. Reg CF has generated hundreds of millions of dollars for small companies that probably weren’t going to access that money any other way. The new raise limits will be a boon to early stage companies. Starting next year, it’ll be faster and cheaper to crowdfund much more money than before. 

But how about investors? How will the higher raise limit benefit them? Here are my three takeaways on it.

Less funding risk. I mentioned this earlier. But it’s worth repeating. With more money, startups will have a bigger budget to reach the milestones needed to successfully raise again. The difference between having 10 months to do this as opposed to 20-30 months can’t be overstated. Given the longer runway, the milestones themselves will likely be raised a notch or two. But the trade-off in having more time and money more than makes up for it. Put another way, startups will be given plenty of rope to do well or hang themselves. 

Greater diversification. The current $1 million is suited for pre-seed and seed-stage companies at best. With a $5 million cap, more mature startups will be drawn to CF fundraises. Up to now post-seed and Series A companies have only occasionally utilized Reg CF. I think we’ll see their numbers go up significantly next year. Investors will have the opportunity to construct a portfolio with companies showing a wider range of risk/reward profiles.

Better deal flow. More worthy companies will go the Reg CF route. Even without the new $5 million limit, Reg CF was gaining in popularity and luring/drawing high-quality startups away from the VCs. Raising the cap will accelerate the process immensely. At the age of five, Reg CF is about to experience a growth spurt.

Crowdfunding is taking a big step forward. The resulting regulatory framework represents a big improvement. It’ll be harder than ever for investors to ignore the crowdfunding option. 

Thank you, SEC. Better late than never.

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