Grading the First 18 Months of Regulation A+

Interested in learning the score in the bottom of the first?

Baseball season started this week. And both my teams – the underrated O’s and pegged-for-first Red Sox – are 1 and 0.

So life is good.

Of course, a score at the bottom of the first doesn’t tell us much, right? It’s very early and hardly worth checking.

The same can be said for equity crowdfunding. Everything is so new. Unlike our national pastime, however, it’s definitely worth checking.

The upside to this kind of equity investing is too great to ignore – more than ever now that the stock market is steadily losing its ability to give shareholders the kinds of gains that could make a difference in their lives.

The culprit? Startups.

They’re waiting longer to go public. It used to be that the average time it took companies to join the stock market was around seven years. Now it’s 11.

Unfortunately for public stock investors, those four years usually see hypergrowth. As revenue soars, so does the company’s value.

So go ahead and blame startups for the serious quandary stock investors find themselves in.

Just don’t ignore their potential to be the solution.

They’re your ticket to discovering an extremely effective way to re-introduce large (sometimes unbelievably so) gains into your portfolio.

That’s why last week my Co-Founder Adam gave you some very positive news on the “early returns” for accredited investors using such equity crowdfunding websites as FundersClub and AngelList.

But let’s back up a bit. We now have three new sets of rules for equity crowdfunding. The ones for accredited investors came first, on July 10, 2013.

It took nearly two years for the SEC to issue Regulation A+, the crowdfunding rules for everybody (including non-accredited investors). They went live in June 2015.

The last set of rules – called Title III – came into effect in May of last year. They were also meant for everybody. But the fundraising amount allowed was much smaller – up to $1 million per raise per year.

I’m going to be talking about the early track record of companies raising funds under Reg. A+. These deals or offerings can go as high as $50 million.

The data I’m using today comes from an SEC White Paper called “Regulation A+: What Do We Know So Far?” It was published last December. More recent research comes from this  Forbes magazine article.

Taken together, they give us an early snapshot of how many companies have been able to raise a successful Reg. A+ round so far and what those companies have in common.

Or, put another way, what companies have to do – and what milestones they have to achieve – to get everyday investors (the crowd) to back them.

A 26% Success Rate

The fundraising activities of Reg. A+ companies are tracked up to the end of February. That gives us a runway of a little more than a year and a half.

In that time, 77 companies have tried to raise funds using the part of Regulation A+ that allows for up to $50 million raises.

They’re called “Tier 2” offerings. We’re much more interested in them than we are in “Tier 1” offerings, which require state-by-state approval and appeal mostly to banks.

So, back to the 77 companies…

Just over a quarter of them – 20 companies – were able to raise all or nearly all of their targeted amounts. They received $316 million, averaging $16 million each.

It’s too early to say how good or bad this is. There’s nothing to compare it to. The 26% success rate will be used as a benchmark to evaluate future activity.

What makes the most sense now is for us to consider the obstacles startups have to overcome to achieve a successful raise.

Let’s work backward from the finish line to see where startups fail along the way.

They did everything right except the most important thing: attract investor interest.

These companies ran through the gauntlet of audits, SEC approval and other requirements.  But they failed to close.

Capturing the imagination (and money) of prospective investors is the endgame.

We’ve come across companies who were making no headway until we recommended them to members of one of our premium services, First Stage Investor. Only then did their fundraising take off.

But we’re the only research service we know of that does this.

Remember, there are no brokers issuing “Buys” for these shares. And media publicity is scarce.

Companies will get better at this.

It takes not only technology and an exciting product, but also a well-conceived pitch deck and captivating back story.

They couldn’t convince their portals of choice to list them.

The SEC says about half of these companies raise through intermediaries. They list brokers-dealers, investment advisors, promoters and others, but not startup investing portals (except in a footnote). This is a remarkable oversight, in my opinion. They’re widely used in Reg. A+ raises, and they’re the intermediaries that make the most sense.

Some of these sites and portals are very selective. Others, not so much. And because this is reflected in the portals’ quality of deal flow, investors should know which is which. (See our previous posts here and here to learn about the portals that impress Adam and me the most.)

They failed to get SEC approval.

So far, the SEC has taken an average of 58 days to approve a company’s application to raise under Reg. A+. This was one of the biggest question marks early on: Would the SEC logjam the process?

We’ve got our answer: No. A two-month approval rate is one to two months faster than I expected.

One more thing. About 60% of companies that embarked on a Tier 2 raise (by submitting an “offering statement” to the SEC) got SEC approval. That’s pretty good.

They found testing the waters revealed a lack of interest.

This is a strictly voluntary step. About 35% of companies “test the waters.” The data does not show how many companies bow out at this point, however. By the way, companies can test the waters either before or after giving the SEC an offering statement.

Apart from these obstacles, companies raising under Reg. A+ should be investment-worthy. That means different things to different people.

So it’s interesting to note that only 32% of them generate meaningful revenue. For me, that alone would give me pause.

Only 15% are cash flow-positive. Not a problem. I’m not looking for profitable companies this early.

These companies average 30 employees, according to the Forbes article. The SEC says 73 (a discrepancy here). The SEC also says they average $51 million in assets.

This indicates that these companies are in their Series A or Series B rounds, still early but at a point where sales and growth metrics become more important.

Still Evolving

As I said, these are early days. Both investors and startups are still figuring things out. And the rules governing these investments will continue to evolve and hopefully make it easier for both sides to engage in this kind of fundraising.

Right now, grading on the limited data I have on progress to date, I give Regulation A+ a B+.

The obstacles should diminish. Investors should gradually become more comfortable and knowledgeable.

And as some big winners emerge that were once Reg. A+ fundraisers, the legitimacy of equity crowdfunding should become more established.

Invest early and well,

Andy Gordon
Founder, Early Investing

P.S. Our research service First Stage Investor specializes in exactly these types of early-stage deals. In fact, we have a number of current recommendations where the companies are valued from $4 million to $15 million. If you’ve ever been intrigued by the idea of investing in private startups, see our presentation here.