SEC 2012 Forum on Small Business Capital Formation

The following is a (more or less) speaker-by-speaker summary of the two morning session panels at the SEC's 2012 "Government-Business Forum on Small Business Capital Formation."

I found this year's morning Forum panels to be a mish-mash, and not as interesting as last year's. No one wanted to get into the general solicitation rules. No one wanted to critique the highly regulated approach to equity crowdfunding. Maybe the afternoon breakout sessions (not webcast; live and phone dial in only) on those two topics will be more engaging.

I do think Jean Peters did a great job laying out for everyone just how critical (I would venture to say, "primary") angel investing is to the startup ecosystem. And Professor Bartlett from UC Berkeley had some provocative slides about secondary trading (though isn't his slide showing valuation disparity undermine his own point - there's the disclosure you are looking for, right there in the slide you put together!).

Walker940AM Pacific / 1240AM Eastern
Ann Yvonne Walker, Partner at Wilson Sonsini Goodrich & Rosati in Palo Alto, last up in the second panel. Talking about moving to a more principles-based approach to Regulation S-K. Cross interjects, some issuers really want to be told, categorically, what they have to address.

Talking now about the "material contracts" disclosure item. Contracts can have sensitive pricing terms. With third parties who probably have no interest in your IPO.

Bottom line: Walker thinks S-K should be simplified.

Bartlett920AM Pacific / 1220AM Eastern
Professor Bartlett: if you re-sell Twitter on SharesPost, that is not a covered security, so, that transaction is subject to state securities requirements, absent another state exemption.

There is not much coordination among states on re-sale requirements.

There is also concern that many of these exemptions don't make sense.

And in practice, attorneys don't seem to be giving blue sky opinions on these resales. Problems for later being set up?

Bartlett asks: "Is there evidence that these markets systematically overvalue these shares?" He looked at price paid for a company's shares on SharesPost, as against the internal valuations done by the same company, and found there is a huge disparity. Secondary trading platforms price way higher than do the companies themselves (which of course tend to want to depress their valuations for compensation purposes).

Valuation disparity slide

Solution to the mess? Allow preemption, based on the sophistication of the purchasers! This could bias market toward institutional purchasers, he says, and he has no problem with that.

905AM Pacific / 1205AM Eastern
Professor Robert Bartlett, University of California, Berkeley School of Law, speaking now. He's talking about the distinction between public and private companies, and how that may not work exactly with regard to some companies. Here's a key slide from his presentation:

Public private slide

Twitter is kind of private, but it is kind of public. Lots of non-related, outside shareholders.

The JOBS Act lifts the number of shareholders a company can have without having to register as a public company. We require no disclosure of these "in between" companies. Is this okay?

If you have companies that are effectively public operating in a private place, e.g. Twitter, or any of the SecondMarket companies, is it okay that they don't have periodic reporting requirements?

9AM Pacific / 12AM Eastern
Borer wonders how the direct registration alternatives he is talking about might mesh with equity crowdfunding. 

These are life sciences companies, he says, but you can do it with other companies. Turn the IPO process upside down, raise capital first, and decrease the timeline.

855AM Pacific / 1155AM Eastern
Borer says, as an alternative to an IPO, you can do a Form 10 reverse merger. (This stuff is not easy for me to follow.) He's talking of company called Cougar Biotechnology and another called Puma Biotechnology.

A Form 10 shell is a way to become public with the snap of a finger, he says. It can be a 139 day process, and you can have your money before starting the process.

Or, instead of filing a Form 10, file an S-1, then file a Form 8-A.

845AM Pacific / 1145AM Eastern
John Borer, Head of Investment Banking at The Benchmark Company LLC in New York, is speaking now.

"The market for traditional IPOs is 'broken'" and recent performance of companies that do IPO is underwhelming. Costs are going up. "Pricing dynamics are problematic."

A traditional alternative to an IPO is a reverse merger, he says. But it has stigma, and there are now new listing restrictions that sort of codify that stigma.

Cross 2840AM Pacific / 1140AM Eastern
Meredith Cross now talking about rulemaking impacting private capital formation that will follow the JOBS Act rulemaking. "The definition of accredited investor is pretty darn stale." That rulemaking process will be difficult, Cross says, because some get understandably concerned that it may hurt private capital formation, and others think it is a poor proxy for sophistication.

836AM Pacific / 1136AM Eastern
Marty Dunn, Partner at O’Melveny & Myers LLP in Washington, D.C., is moderating the new panel. Talking about his experience doing a Reg A offering. Thinks Reg A could be something viable, in spite of popular opinion to the contrary. Advocates for coordination of regulatory review. Not pre-emption of state regulation, but some way for a jurisdicition to say, the fact that this other regulator looked at it is good enough.

830AM Pacific / 1130AM Eastern
The Forum has re-convened after a short break. A panel will speak on small business capital formation issues NOT addressed by the JOBS Act.

813AM Pacific / 1113AM Eastern
Cross again will not give an answer as to when the rule to lift the ban on general solicitation will be finalized. She says there are many comments forthe staff to work through. "We are working as quickly as we can. I do not have a date which you can plan based on."

Bill Beatty 2812AM Pacific / 1112AM Eastern
Beatty talking now about crowdfunding. He thinks having FINRA as the SRO is great. Advocates a question-and-answer disclosure form, modeled on the SCOR form, and it could be interactive, maybe like tax return software. States have lots of experience helping people with the SCOR form.

A couple months ago in San Diego, on a panel, Beatty asked Yokum Taku, what do you do if someone walks into your office and says, Yokum, I want to raise venture capital and I have crowdfunded the past. Beaty says Yokum's answer was, "I cry. Or, more specifically, my paralegal cries."

Beatty Rule 506 slide805AM Pacific / 1105AM Eastern 
Beatty corrects the misperception suffered by most of the people in the SEC auditorium in DC: he is from the actual Washington, he says, and is pleased to be visiting "the other Washington" today. Spot on.

Well, Beatty reflects a view common among state securities administrators, that general solicitation is going to be a concern. Here is a slide listing things state regulators would like to see.

Most states would support establishment of some non-exclusive safe harbors, on accredited investor verification, he says. Otherwise, we will spend time in courts, or, even worse, he says, in front of administrative law judges who don't understand the area.

NO self-verification, Beatty says. Some kind of documented verification should be required. Having a third party do it would be fine, he says.

8AM Pacific / 11AM Eastern 
William Beatty, Director of Securities at Washington State Department of Financial Institutions, now up. This should be good.

745AM Pacific / 1045AM Eastern 
Michael Lempres, Assistant General Counsel and Practice Head at Silicon Valley Bank in Palo Alto, is speaking now. His theme, at least initially, is that CEOs of growth companies see access to captial as a their biggest challenge. The exception are life sciences companies, which see regulation as the biggest challenge.

I apologize, but I have to step away for a few minutes.

740AM Pacific / 1040AM Eastern 
Peters answers a question about companies with crowdfunding in their history, who then come to angels for further financing. They will have to be able to address any issues in their cap tables, she says.

Going back to Rule 506: the ability to have general solicitaiton, that will help entrepreneurs. Only two or three hundered thousand of eight million eligible to do angel deals, have done angel deals. So general solicitation will help access those persons and potentially bring more people into angel investing.

737AM Pacific / 1037AM Eastern 
Laporte asks a question, or relays a question: is it okay to use the term "crowdfunding" for things other than Title III crowdfunding, such as Rule 504 offerings or under other exemptions. Cross: You can use the term crowdfunding for other types of crowdfunding, e.g. a Reg A offering for a Broadway show. That's fine. You don't want to call it crowdfunding, however, if you are not actually engaging any crowd.

735AM Pacific / 1035AM Eastern
Yadley again asks Cross a timing question. She says the staff has received comments on the general solicitation proposed rules, and are working through them.

Question raised about those who are already engaged in general solicitation, in advance of the rules being finalized. "You may hear from us, and you may already have heard from us," Cross says.

Jean Peters 2727AM Pacific / 1027AM Eastern
Jean Peters, Board Member of the Angel Capital Association and Managing Director at Golden Seeds Fund LP, is now talking. She notes angels invest 20 times more early deals than VCs.

"Angel investing is a disciplined, long term process," Peters says. "We have to. Angel investing comes from our own pockets. It is not other peoples' money." Angels know the activity is highly risky and there is limited access to liquidity. Average 8 year hold.

Nearly 3/4 of angel deals today are syndicated among angel groups or with VC funds.

Peter's says the ACA is pleased that the SEC's proposed rules on lifting the ban on general solicitation in Rule 506 offerings is careful to preserve the existing paradigm, for issuers that do not engage in general solicitation.

With regard to the verification requirement, which kicks in if general solicitation is used, the ACA wants safe harbors, Peters says.

(Disclosure: I am on a volunteer advisory committee of lawyers and accountants that gives advice to the policy committee of the ACA.)

720AM Pacific / 1020AM Eastern
A FINRA question comes up. The only eligible SRO for equity crowdfunding, Hanks says, is FINRA. "Are we Kickstarter plus, or are we Merrill Lynch minus?" That's the conceptual question.

Cross715AM Pacific / 1015AM Eastern
Yadley asks Cross about timing of equity crowdfunding rulemaking. "The timing is challenging, to say the least. As Sarah said, it is a very complex provision." We need to get the bad actor rule done first, Cross says. Also indicates that finishing the general solicitation rule will have priority.

Cross expresses concern that if fraud happens out of the gate, the new crowdfunding industry will be tainted. "Even though it may seem like a lot of regulation for not a lot of money," it won't be capital formation for small business if not given a right start.

Hanks710AM Pacific / 1010AM Eastern
Hanks going through slides that list policy issues implicated by equity crowdfunding, and what SEC rulemaking is required. Those include restrictions on the scope of advertising. "What can you say on Facebook? What can you say on Twitter?" And she extends the advertising problem to the funding portals, too.

Picking up on a thought Hanks made earlier, though this is not how she expressed it, not exactly: What if you write terrific disclosure and no on reads it?

Hanks uses a metaphor: the "10,000 dentists" problem. All those investors are going to want to give advice. It would be good to get guidance on what issuers or portals are permitted to do, vis a vis managing an unwieldy investor base.

7AM Pacific / 10AM Eastern
Hanks talks about how people in the nascent crowdfunding industry have NO IDEA how heavily regulated is the industry they are entering. Securities are heavily regulated. How light can regulators go, and not get in the way of equity crowdfunding, and not get in the way of investor protection?

Slide title3656AM Pacific / 956AM Eastern
Sara Hanks, Co-Founder and CEO at CrowdCheck in Alexandria, Virginia, is talking now about the huge change to securities law represented by Title III of the JOBS Act. Here's a slide she is showing.

Hanks talks about how disclosure principles have not changed under Title III. No changes there, she says. (I know she means to be advocating for equity crowdfunding, but it still seems to me someone has to convince regulators, or policy makers, that asking a startup to write a prospectus is not the right way to go to give equity crowdfunding a fair shot.)

652AM Pacific / 952AM Eastern
Yadley says the equity crowdfunding provision in the JOBS Act would have been much worse, had Chair Schapiro not intervened with a critique of, I gather he must be saying, the McHenry bill that the House passed with overwhelming bipartisan support, and which the President supported. (Paul Spinrad has written recently about how the White House actually endorsed equity crowdfunding before the McHenry bill. I don't know if Paul has posted that yet, but if you get his newsletter, you have that.)

Yadley650AM Pacific / 950AM Eastern
Gregory C. Yadley, Partner at Shumaker, Loop & Kendrick LLP in Tampa, is introducing a panel that will discuss implementation of the JOBS Act. Yadley is talking about a committee to advise the SEC on small business that includes angel investors, to government officials who invest for states, to entrepreneurs who have started companies, to representatives of the broker-dealer community, and only three lawyers.

Lifting the ban on general solicitation was the number one recommendation of the SEC 2011 Forum on Small Business Capital Formation, and was the advisory committee's top recommendation as well.

Last year, the Forum ranked crowdfunding as priority number 14. Not that high. And the committee, Yadley says, met in February this year and did not feel they had enough information to make a recommendation.

640AM Pacific / 940AM Eastern
Commissioner Troy A. Paredes is the first commissioner to emphasize why startup activity is important to the economy. Commissioner Daniel M. Gallagher speaks briefly, too. I'm going to skip ahead to get ready for the panel of outside experts.

630AM Pacific / 930AM Eastern
Commissioner Luis A. Aguilar speaks in terms of the need for management to assess risks correctly and provide financial statements. To my mind, that framework is entirely correct when it comes to public or perhaps even established private companies, but is inapposite when it comes to a pure startup, which we know in advance is highly likely to pivot, almost without notice. There has to be another framework by which to assess startup funding.

620AM Pacific / 920AM Eastern
Commissioner Elisse B. Walter is now talking about the implementation of the lifting of the ban on general solicitation. She says a number of very helpful comments have been received. "We must be vigilant of the potential consequences," she says. It's not so much "balancing" between investor protection and facilitating access to capital, she Commissioner Walter says - that is a false frame. She mentions the recommendations from the Investor Advisory Committee, including regulations on the content of ads, a revisitation of the accredited investor definition, and other recommendations in that report.

Editorial comment here: that Committee, as a good friend of mine has pointed out, has no angel investors or venture capitalists on it. And the charter or purpose of that Committee, created by Dodd-Frank, doesn't seem to cover Reg D or private capital formation, at least not for the startup ecosystem. Here's an earlier post I wrote about the Investor Advisory Committee.

615AM Pacific / 915AM Eastern
Rulemaking teams are in place on implementing general solicitation, crowdfunding, and "Rule A+." The latter handle, "A+," is new to me. I take it Chair Schapiro is referring to the changes the JOBS Act made to Regulation A.

Schapiro610AM Pacific / 905AM Eastern
"Regulation can had a disproportionate effect" on small businesses, Chairman Schapiro says. The SEC's task is to balance protecting markets so investors have confidence, and facilitating capital formation for small businesses. She's talking now about the FAQs on the IPO on-ramp. Have had about 100 confidential submissions under the IPO on-ramp provision of the JOBS Act.

605AM Pacific / 905AM Eastern
Gerald J. Laporte, Chief of Office of Small Business Policy in SEC Division of Corporation Finance, has just introduced Meredith B. Cross, Director of SEC Division of Corporation Finance. Ms. Cross in turn is going to introduce Chairman Mary L. Schapiro.

6AM Pacific / 9AM Eastern
The SEC is holding its annual "Forum on Small Business Capital Formation" today. I am going to try to live blog through a couple of the morning panels. I'm not there in Washington DC, I'm watching the webcast. See this agenda for the forum.

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