Arriving at the price of an Initial Public Offering and the price of a stock sold in secondary markets have two different outcomes. An IPO is the final stage in the funding pipeline that restructures the makeup of the company’s investors. In an IPO, private capital sources can exit their investment allowing for a more distributed group of investors to take ownership of the company.
Trading on secondary markets provides an ongoing governance structures so that investors remain informed. The performance of a company can be linked to the performances of its share price, which fluctuates based on quarterly reporting and regular disclosures about events that could impact the company’s performance.
Recently, crowdfunding platforms are beginning to offer both primary and secondary markets in the sale of securities. Many significant regulations around investing in and trading securities are either mitigated or removed altogether. It is worth acknowledging the infrastructure that this nascent industry needs in order to facilitate healthy and transparent trade.
What is important about SEC’s security regulations?
Times have changed. The internet allows potential investors, and other interested parties such as the press to instantly verify claims. Such information might include financial statements, resumes and background information on the founders and executive management, and market information that can help inform the business plan’s viability. Technology allows the SEC to rollback regulations related to the sale of securities. Equity crowdfunding is on the rise.
What were the SEC’s regulations? How have they been mitigated or removed by crowdfunding rules?
In the past, financial information was not instantly viable. Unscrupulous business people could rip investors off selling them shares in a bad deal or even worse no deal.
First, the SEC regulated who could invest. Investors with a certain annual income or amount of asset-based wealth could invest. The logic is simple, if somebody accrues a certain level of wealth, by nature they have the experience and capabilities of exercising discretion in the deals they invested in. They are less likely to lose their life savings on a shady deal.
Second, the SEC regulated the valuation and legal requirements associated with raising money from the general public. Only registered brokers can conduct these transactions. Brokers prepare detailed financial disclosures, financial forecasts, and are best equipped to communicate the potential viability of the company. Investment banks often take financial responsibility over an Initial Public Offering to ensure a shared incentive between valuator and investor.
Third, the SEC regulated ongoing reporting of material damage associated with investments in public companies. Companies must issue press releases when a material damage occurs. Disregard of any of these regulations can result in legal action taken on behalf of shareholders against the company. Companies must also update investors quarterly on their financial performance.
The regulations put in place by the SEC not only prevents the dissemination of shady deals, but also creates a rigorous, ongoing governance mechanism.
Equity Crowdfunding removes those regulations. Any can invest a percentage of their annual income. While crowdfund backed companies must still release financial information and other items publicly, there is considerably less analysis around the process. Crowdfunded companies must disclose their financial statements annually as opposed to quarterly for publicly traded companies.
Additional guidance can be found via the SEC. Below is taken from the SEC’s website and outlines financial disclosure requirements for crowdfunded companies:
The Infrastructure of an Industry
Crowdfunding still needs complementary companies to ensure an infrastructure capable of managing investor risk. There is no guarantee that crowdfunded companies will succeed. Crowdfunding companies are riskier than small cap stocks, which have an 8%+ historical risk premium.
Companies seeking crowdfunding have a lack of resources to put toward valuation
Young companies likely have a resource shortage when it comes to providing detailed valuations and financial projections. Despite the lack of resources, there is still a possibility to identify how much risk a company is exposed through online verification. The granularity of today’s market research databases combined with comparisons of similar companies, provides an opportunity to improve the due diligence process.
If the industry can set up entities that do this, new ideas can be adequately vetted and sustainably resourced in locations and industry sectors that are currently undercapitalized.