Equity crowdfunding is a nascent industry with the first portals launching in 2016. The JOBS Act put forth specific regulations surrounding these portals. What regulations should we expect in the future as the industry matures? 

Right-Size Regulation Requires a Right-Sized Regulator,” published in 2016 by Entrex Capital Market explores a regulated capital market system for entrerpeneurs. 

Entrex Capital Market outlines three categories of businesses. The first is the approximately 17,500 publicly traded companies (at time of writing) regulated by FINRA, broker dealers, and exchanges. The second group of companies is VC backed. This group contains 24,000 companies. The third group is privately held companies with annual revenue of $5 million or greater, which is estimated at 458,000 companies.

Entrex points out that each of these categories needs slightly different self-regulatory mechanisms to ensure market integrity. For example, startup and scale-up companies cause inefficiencies because of information asymmetry associated with the nature of early-stage companies. Startup companies that undergo due diligence from the best venture capital firms work hard to identify their market position.  

The JOBS Act eliminates accredited investor requirements for portals, which is aspirational in the age of the Internet. However, there is a lack of regulation applied to the transaction. Crowdfunding portals are not the same as market exchanges such as Nasdaq. In fact, they are regulated as if they were offering an initial offering, not as if they were creating an exchange platform for these types of investments.

Equity crowdfunding portals provide a firehouse of information related to the company. In a way, the portal treats the investor as if they were an accredited investor operating through an angel syndicate or venture capital firm. This implies that the investor is spending tens or hundreds of thousands on the investment, and pouring over the fundamentals of the company.

Individual, non-accredited investors are investing much less capital and time. The institutional investor might pour through the resumes of each members of the founding team. The individual investor will look at quick signals such as the market uncertainty or the prestige of co-investors. More importantly, individual investors need to see the company’s market position in relationship to other investment opportunities. This is not information that portals currently provide.

A regulated exchange like Nasdaq, but specific to the stage or other characteristics of the listed companies, is an important aspect of self-regulation that should be implemented by the crowdfunding industry. 

Primary and Secondary Markets

As some of the major platforms begin to launch secondary platforms, there is an even greater need for the exchange. The first need is for real-time regulatory reporting. Different information is needed to ensure the market integrity of investments in early-stage companies than publicly traded companies. More transparency is needed given the risky nature of these companies. Also, the volume of these early-stage investments could be smaller than the small cap markets such as the AIM, which we’ve written about before. Markets will need mechanisms to guard against pump and dump and other similar schemes. 

In any case, we agree with the position set forth by Entrex. Capable exchanges with powerful technology are needed to ensure safe and fair transactions for the crowd. 

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