According to the Security and Exchange Commission’s Advocate for Small Business Capital Formations’ 2022 annual report covering economic and regulatory data gathered from July 1, 2021 to June 30, 2022, small and emerging business owners, particularly women, minority, LGBTQ-led and rural based firms, continued to struggle with access to equity capital in the last year. The number of Regulation D offerings dropped slightly in the first two quarters of 2022 compared to 2021 while the number of IPOs for that time-period dropped significantly.
Access to capital remains a considerable concern for all small and emerging business entrepreneurs with 75% reporting challenges in obtaining capital, in spite of historically high level of available private equity and venture capital. These problems are more acute for women, minority, and LGBTQ-led companies as well as companies based in rural areas. For example, through June 2022, only 2% of venture capital funding went to companies with women-only founders. Only 3.8% of seed and early stage funding in 2021 went to founders who identified as Hispanic, Latino, African American, Black, Native American, Hawaiian or Pacific Islander. All-women teams with minority members held 57% more meetings with venture capital investors in 2021 compared to 2020, but they still raised less money than any other demographic.
While 85% of small businesses reported financial challenges in 2021, of those seeking external financing, only 6% sought equity financing. Instead, investors chose loans or lines of credit (76%), credit cards (29%), trade credit (9%), merchant cash advances (8%) and factoring (4%) to help with capital needs. As interest rates continue to rise, the cost of debt financing will become increasingly prohibitive, especially for early stage companies that have less access to traditional commercial banks. Accordingly, access to equity investment will likely become increasingly important in 2023.
One of the biggest challenges for new entrepreneurs in pursuing equity investment is understanding the complex legal framework governing sales of securities. All sales of securities in the United States must either be registered with the SEC and applicable states or exempt from registration. Corporate stock, limited liability company membership interests and partnership interests are all examples of securities subject to these registration requirements. Exempt private offerings pursuant to Regulation D remain the most popular offering structure for raising capital, accounting for over $3 trillion in total offerings, including 1,057 offerings in Colorado, 516 in Arizona and 341 in Nevada for the period from July 1, 2021, through June 30, 2022. By comparison, registered offerings (including IPOs) during the same period accounted for $1.2 trillion in total proceeds, including 31 registered offerings in Colorado, 28 in Arizona, and 25 in Nevada. Other registration exempts including Regulation A, Regulation S, Rule 144A and Regulation Crowdfunding accounted for significantly smaller percentages of the capital raised.
This breakdown makes sense as Regulation D offerings, particularly those pursuant to Rule 506(b), are the most flexible and easiest to conduct. Rule 506(b) offerings to exclusively accredited investors can raise an unlimited amount of funds from an unlimited number of investors. Audited financial statements are not required and the Form D filing requirement is significantly less burdensome than a registration statement.
Registered offerings can result in more equity capital raised than exempt offerings because registered securities may be eligible for listing on stock exchanges, have coverage by stock analysts and provide more liquidity than unregistered securities (unregistered offerings typically have transfer restrictions). However, registered offerings are also more expensive and time consuming than exempt offerings because they require a detailed registration statement, audited financial statements, ongoing disclosure obligations and compliance with governance rules. Conducting a registered offering typically only makes sense for larger companies seeking significant amounts of capital and are capable of managing the ongoing costs of registration.
