SEC Venture Capital Ruling May Hurt Business Loan Market
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UPDATED: Nov 1, 2013
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The Securities and Exchange Commission (SEC) has proposed regulation that would allow for investors to buy stock in companies over the internet using crowdfunding exchanges.
If the SEC’s rules are implemented, this would allow for investors to buy stock in firms that are not large enough for initial public offerings, thus allowing people to get in on “the ground floor” of a budding startup.
This proposal from the SEC comes in the wake of the JOBS Act, which was passed last year.
“The JOBS Act opened up the opportunity to raise capital from purely the dominion of the large company into a chance for any company to raise money from the general public,” said Jonathan Frutkin, Principal of the Frutkin Law Firm.
“The SEC was tasked to come up with common sense regulations that facilitated investment into more than just large stock-exchange companies. Once regulations are finalized, you will see small businesses, that employ most Americans, with a new option to raise capital for expansion.”
By allowing average Americans the opportunity to invest in equity crowdfunding, they can participate in local companies and stimulate local businesses. Since the amount each individual can invest each year is capped, there is little opportunity of anyone being wiped out on a poor investment.
Impact on the Lending Scene
While the SEC’s proposal is great news for budding investors, it may not be good news for business loan lenders. After all, when businesses are able to crowdsource funds in exchange for equity, they may have little need to get into debt borrowing business loans that will cost interest payments over years or decades.
But not all experts are so pessimistic.
Paul Singh, the CEO of dashboard.io, said that the SEC’s decision won’t impact any businesses that are seeking business loans. This is because equity-based financing is very different than debt-based financing.
When investors buy equity in the form of stock, they do not receive interest payments from the corporation they are invested into. Instead, they own part of the company and may profit or lose their investment based upon a change in stock price. Business loan lenders on the other hand, only profit off of interest they earn on money that is lent out.
“In my opinion, most of this new capital will be directed towards the companies that have already raised money from ‘traditional’ VCs,” said Singh. “We won’t see new money going to new ventures until there’s a better understanding of the risk factors involved for everyone.”
Dr. Walter Schubert, Professor of Finance at La Salle University, said that the SEC’s proposed rules would allow startups to gain funds that they never would get from banks, such as business loans, or traditional venture capitalists. However, problems remain ahead.
“First, a lot of people will throw in savings that they probably should not invest,” he said. “Picking winners is not easy even for professionals, for less knowledgeable people it will likely be worse.”
He also explained that while some ventures will be funded by a new wave of investors and experience massive success, on average most people will lose money, prompting additional government involvement.
Past and Future
Bill Clark, President of MicroVentures, said that originally, the crowdfunding limit that companies could raise was capped at $5 million before it was determined that $1 million would limit the amount of risk exposed to investors.
“Personally, I think that $1 million is enough capital for a startup that is utilizing crowdfunding,” said Clark. “This should give them enough capital to prove their concept, get customers and go for a larger round with angel investors.”
Clark predicts that established businesses will end up using their sizable customer followings to good effect by expanding through crowdfunding. A second wave of companies will be young startups seeking capital.
Even though some of these young startups won’t pay off for investors, novice investors may still end up profiting, even from poor decisions.
“We will see a lot of people investing in startups for the first time and make mistakes based on hype and not investing for fundamentals,” he said. “As they start to learn from their mistakes they will grow as investors and make better choices which means they will be more selective.”