What Will Capital Raising Look Like for Small Businesses Post-Pandemic?

What Will Capital Raising Look Like for Small Businesses Post-Pandemic?

While capital formation has always been challenging for small businesses, the COVID-19 pandemic has made it even more difficult to secure funding...

While capital formation has always been challenging for small businesses, the COVID-19 pandemic has made it even more difficult to secure funding. As the economy recovers, funding opportunities are expected to increase, although it is unclear how quickly they will return to pre-pandemic levels.

SEC Actions to Support Capital Formation

The Securities and Exchange Commission (SEC) continues to prioritize efforts to improve access to capital, particularly for small businesses. In recent weeks, SEC Commissioners have provided their recommendations for helping small businesses seeking to raise money.

Commissioner Hester M. Peirce addressed capital formation in her remarks at the 40th Annual Government-Business Forum on Small Business Capital Formation. She made the following recommendations:

• Accredited Investors: Hester noted that the SEC laid the groundwork last year for allowing people to qualify as accredited investors based on sophistication proved not by wealth or income, but by education, examination, or experience. She emphasized the need to build on this foundation, stating that “people should be coming to us with suggestions of educational credentials, examinations, or professional certifications and designations that should serve as the basis for accreditation.”
• Finders: Hester noted that a regulatory framework for finders—people who periodically introduce investors to small businesses in need of capital—would establish “some much-needed parameters” for this activity.  Noting that the SEC proposed an exemption last year, Hester called for the Commission to finalize it or propose a rule for finders.
• Micro-Offering Exemption: To make it easier for small businesses to locate early money, Hester called for creating a streamlined exemption to allow small businesses to raise $250,000 to $500,000 subject to the antifraud provisions of the securities laws and a requirement to notify the SEC of reliance on the exemption.
• Crowdfunding:  Hester stated that crowdfunding seems to have been relied upon more during the pandemic in part, perhaps, because of temporary relief the SEC provided from certain crowdfunding requirements. She also highlighted that recent permanent amendments to the crowdfunding rules also are now in effect, which should further spur the use of this capital raising tool. Going forward, Hester recommended that the SEC consider whether any of the temporary relief should be made permanent and whether other changes would make crowdfunding more viable as a source of capital for small businesses.
• Modify Qualifying Venture Capital Fund Exemption under Section 3(c)(1): Hester argued that the SEC should evaluate increasing the cap from $10 million to $150 million and increasing the allowable number of investors from 250 to 600, as recommended by the SEC Small Business Capital Formation Advisory Committee.
• Expand the scope of Qualifying Investments for Venture Capital Funds: As recommended by the Small Business Capital Formation Advisory Committee, Hester stated that revisiting what constitutes a qualifying investment could make it easier for venture capital funds to support small businesses.

Access to Capital for Underrepresented Founders and Investors

In her remarks at a meeting of the Small Business Capital Formation Advisory Committee, Commissioner Allison Herren Lee addressed how to improve access to capital for underrepresented founders and investors. She emphasized that the SEC needs to evaluate how it assesses the effects of its rulemaking on underrepresented and marginalized communities. She specifically raised the following questions:

Are there likely to be disproportionate costs to certain segments of our population from our policymaking? How can we best ensure that the benefits of our rules will indeed flow through to these communities? If we do undertake specific policy initiatives, for instance, to increase access to capital for women- and minority-owned businesses, how do we analyze whether our policy choices will have the intended effect?

Lee discussed steps that the SEC should take to incorporate diversity considerations into its policymaking. “The first is incorporating our Office of Minority and Women Inclusion into our rulemaking process to help ensure that we’re leveraging all of our expertise on these topics,” she said. “The second is incorporating into our economic analysis an assessment of the costs and benefits of our rules on different segments of the population.”

Lee also called on the SEC to formally incorporate an assessment of the distributional consequences of its rulemaking into its economic analysis. “The idea that agencies should be incorporating distributional analysis into their rulemaking is not new, but it is an idea whose time has come,” she said. “When we look only at the overall costs and benefits of our regulation, we do a disservice to communities that have been overlooked and marginalized, and we miss opportunities to better calibrate our rulemaking to achieve the desired effects.”

Raising Capital in the New Normal

Capital formation will become increasingly important as we dig out from the economic slowdown caused by the COVID-19 pandemic. Entrepreneurs who finally had time to flesh out a great idea and turn it into a business plan will be looking to move forward. Additionally, small businesses that weathered the pandemic will finally be looking to grow their operations rather than reign them in.

At Scarinci Hollenbeck, our business attorneys are experienced in helping businesses of all sizes secure capital. While we will be closely monitoring the SEC’s moves around capital formation, we can also help businesses take advantage of the options that are already available.

If you have questions, please contact us

If you have questions or if you would like to discuss the matter further, please contact me, Dan Brecher, or the Scarinci Hollenbeck attorney with whom you work, at 201-896-4100.