Can crowdfunding fill stock market’s ‘black hole’ for startups and small businesses?

Jin Lee/BLOOMBERG - Investors and securities experts say the public stock exchange has become inaccessible to many promising young companies.

Once a springboard for promising young firms, experts say the stock market largely stopped working for start-ups and small companies more than a decade ago, leaving what one investor calls a “black hole” in the business growth process.

Some believe looming changes to the nation’s financing and securities laws could help entrepreneurs fill that void, but they are concerned new regulations intended to protect investors may water down the effect of the changes for capital-starved businesses.

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“Sometimes, we are so worried about what can go wrong, but these markets have to get capital to entrepreneurs,” David Weild, former vice chairman for NASDAQ, said during an entre­pre­neur­ship and investment conference timed to coincide closely with the 50th anniversary of March on Washington for Jobs and Freedom led by Martin Luther King, Jr.

“If we can’t get money into the hands of the people who create jobs, we’re not going to have a very good future,” Weild added.

One of the key changes on the horizon is the expansion of equity crowdfunding platforms, which will soon allow firms to raise capital online from non-accredited investors. Congress authorized the platforms as part of the JOBS Act last April, and after several missed deadlines, Securities and Exchange Commission officials say they plan to issue the rules to govern the process sometime this fall.

In the meantime, the agency will next month lift a ban on what is known as general solicitation, giving entrepreneurs the green light to start advertising their offerings to the public.

In large part, those and other changes in the JOBS Act were intended to help new firms raise small amounts of capital to get their ventures off the ground. However, some investors say the changes may actually have a greater economic impact by helping established companies that are ready to expand — firms they say have all but given up on the possibility of an initial public offering on Wall Street.

“The stock market has become a platform not for creating capital to help companies grow, but a platform for financial hackers, where most of the activity is just algorithmic and high-frequency trading,” Mark Cuban, a business magnate and owner of the Dallas Mavericks, said in an interview following the same event on Friday.

“In the ‘90s, you would raise $5 million or $10 million in an IPO, but those days are gone, and that has created this black hole for companies,” he said.

Speaking on a panel with Cuban, Weild noted that the “the number of small IPOs started to fall off a cliff in 1998 with the implementation of electronic stock markets.”

During that period, the number of initial offerings per year has fallen from about 500 to about 130, he said. Of those, 80 percent used to be firms raising less than $50 million; it is now down to 20 percent.

“So only about 30 small IPOs every year,” Cuban estimated, based on those figures. “That’s crazy.”

Instead, most firms reach a size in which they are too large for more private capital but too small to go public in today’s market. In many cases, he said, rather than continuing to grow, they get acquired by large corporations that could have been their competitors.

“Had they been able to go out and raise, say, $10 million in a small IPO, maybe there is another company out there pushing important medical technology or financial innovation,” Cuban said during the interview. “Not only does this cap the growth for that company, but it reduces competition, which kills the economy and kills job creation.”

Cuban says crowdfunding and general solicitation should help firms at that critical stage of growth raise more money, giving some of them the jolt they need before entering public markets and allowing others to continue growing as a private venture.

However, some of the JOBS Act regulations already issued by the SEC have him and other experts worried that the agency is straying too far from the law’s original purpose — helping entrepreneurs access capital — in an effort to protect investors.

In lifting the ban on general solicitation, for instance, regulators established a number of new steps companies must take to verify whether their investors are accredited. Currently, only accredited investors can take part in crowdfunding, and once the portals open to the masses, non-accredited investors will have limits on their participation.

Until now, investors have “self-certified” that they qualify for accedited status. However, the new SEC regulations will require some to start handing over personal financial information, like tax returns, to prove their net worth.

“No one is going to show their tax return to anybody, that’s ridiculous,” Cuban said. “Right now, people are worried about privacy concerns and the NSA, and we think investors are going to show their tax returns just to be able to invest in a business? It’s not gonna happen.”

SEC officials say the checks are necessary to make sure certain investors are qualified to risk large amounts of capital in private markets. During meetings with entrepreneurs in the past few month, officials have also asked for patience as they look for ways to protect against fraud, especially as crowdfunding opens to non-accredited investors.

Cuban acknowledged that steps should be taken to protect both accredited and non-accredited investors, but he warned that too many regulatory hoops have the potential to blunt the impact of crowdfunding.

“I think there are too many lawyers and not enough business people involved in the process at the moment,” he said after the event.

Some say the regulations may make the investment process even more difficult than before, undermining the purpose of the JOBS Act.

“It’s fully destroying the process,” Alon Goren, president of crowdfunding platform Invested.in, said during the same panel, referring to the new rules issued by the SEC.

“The reason we are bringing this online is because you can reach bigger audiences and do really exciting stuff,” he added. “But if we throw in all these roadblocks, it’s actually going to be harder than meeting in person and shaking hands.”

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