By Habib Jamal J.D.
Analyst, Crowdfund Capital Advisors
While Americans have made significant advancements with the passage of the JOBS Act, there are still more changes that can be made to our securities laws that will increase the robustness of our economy.
One such area in which we have room for improvement is our lack of Venture Exchanges, public exchanges where smaller entrepreneurial firm (often called Small and medium-sized enterprises or SMEs) can have their shares bought, sold, and traded in a manner similar to firms that have undergone an Initial Public Offering (IPO) to a major exchange.
Why Are SME’s Important?
Small businesses are the core of the US Economy. 99.7% of US employer firms are small businesses1. The largest firms in this class employ up to 500 people and produce millions or billions of dollars in revenue. Small firms accounted for 64 percent of the net new jobs created between 1993 and 2011 (or 11.8 million of the 18.5 million net new jobs). Since the latest recession, from mid-2009 to 2011, small firms, led by the larger ones in the category (20-499 employees), accounted for 67 percent of the net new jobs2.
What is Wrong With the Status Quo?
Small Businesses are being starved of much needed capital by antiquated laws that unfairly favor large, well connected, publicly traded companies.
The attractiveness of an investment is heavily influenced by whether the investment can be easily sold at a reasonable price. Without liquid markets to provide an exit opportunity to investors, only those with the ability, capital, and wherewithal to invest for the long term can benefit from growth in these small private firms. Without the presence of the greater market these investments are artificially depressed in value compared to equally situated public companies. The result is fewer people are interested in investing in these Main Street companies when they know they can buy into a Wall Street offering today, and sell tomorrow or in three or six months depending on how the market is performing. Without the ability to sell your shares and exit, Main Street’s businesses will always lack cash because their investors are missing exit opportunities, along with other market benefits.
What other Market Benefits Could be Provided by Venture Exchanges?
The proposed venture exchanges will be able to provide greater transparency, research coverage, and market making when compared to the current way small business investment is conducted.
Having companies audited financials and investment offerings available to the world will provide a kind of day-light to what has always been the wild west of investing. Knowing that the numbers you are looking at are the same number that have been evaluated by neutral third parties like accounting firms or the SEC will provide greater transparency in transactions.This transparency will help place an objective market value on the company’s business.
How do you know you are making a good investment? Most methodologies of answering that question involve looking at similarly situated firms, analyst recommendations, in addition to the released company data.. Currently, how and where one acquires this information for SME’s can make a large difference in how they evaluate an offering. With Venture Exchanges, you will have a greater field of analysts and investment media providing information on your target and similarly situated firms. This can greatly level the playing field for small investors, without huge teams of researchers, in determining the value of a potential investment.
In addition to transparency and research overage, Venture Exchanges will provide greater liquidity to investors. By either acting as a market maker themselves, or simply matching buyers and sellers, Venture Exchanges will provide the necessary low cost entries and exits into investments in SME’s that larger stock exchanges have provided to publicly traded companies.
Asside from these obvious positives, there are additional benefits to the listing company and its consumers. A company may experience increased value in the exposure and coverage they receive by being listed on a Venture Exchange. This could increase both the inherent and perceived value of the company to investors and customers. Another less obvious benefit would be that a company listed on an exchange would be better situated to make acquisitions bankrolled by their quoted shares.
Have These Types of Exchanges Worked Elsewhere?
While the US is a center for financial innovation, several other countries have already created similar venture exchanges with successful outcomes. In our neighbor to the north, Canada’s TSX Venture Exchange (Formerly the Canadian Venture Exchange until its acquisition in 2001) has provided a public venture capital market for emerging companies since 1999. Since then the firm has raised more than $80 billion in capital for these small issuers.
Across the pond, the London Stock Exchange, a historic institution founded in 1801, has lent its credibility and knowhow to their own version of the Venture Exchange. Billing itself as “the world’s most successful growth market,” London’s Alternative Investment Market (AIM) has employed its trading platform for over 3,100 companies since its inception in 1995, raising over £67 billion to fund their growth3. A wide range of businesses including early stage, venture capital backed as well as more established companies join AIM seeking access to growth capital.AIM offers smaller growing companies the benefits of a world-class public market within a regulatory environment designed specifically to meet their needs4.
What Do We Need in the US?
Maybe the concerned voices of the entrepreneurial community are right, and any venture exchange in the US would be better than no exchange, however, I believe that with the forces looking to maintain the status quo, we will only have one opportunity to get this right. We need to look at the strengths and weaknesses of the various international venture exchanges in formulating how ours will work. We do not want an overly burdensome regulatory regime which could snuff out the flame of innovation, nor do we want rules so lax they would let the whole exchange burn down. It is our opinion that the most reasonable way to move forward would be to have scaled and appropriate regulation based on the size of the offering. Less regulation for smaller offerings, more regulation for larger, and hopefully a few intermediate stages in between to allow right-sized regulations when they are appropriate.
What is the Current Proposal?
There is a bill designed to amend the Securities and Exchange Act of 1934 to allow for the creation of Venture Exchanges to promote liquidity. The Main Street Growth Act, sponsored by Rep. Garrett, would add a new Exchange Act Section 6(m) to allow the trading of small company stocks on venture exchanges. These small companies will include the SME definition of small companies from earlier, but also include any non-publicly traded firm with under $2,000,000,000 in assets.
This bill’s provisions include the following structure around these exchanges5:
- They will only be able to bring together buyers and sellers and perform a match making of them.
- For some securities, they may elect to hold mid-day auctions instead of continuous trading.
- They may not extend unlisted trading privileges to any venture security.
They will be exempt from requirements under several regulatory measures including6:
- Rule NMS, 242.600 through 242.612 of title 17 of the Code of Federal Regulations
- NMS basically required exchanges to coordinate in order to ensure price uniformity across multiple exchanges. This included a requirement to provide quotes in $0.01 increment, and provided rules for dissemination of information to ensure uniform and timely pricing7.
- Rule ATS, 242.300 through 242.303 of title 17 of the Code of Federal Regulations. Rule ATS requires each Alternative Trading System (ATS) to report weekly volume information and number of securities transactions for each security to FINRA. It also require broker-dealers operating as ATS’s to each acquire and use a unique market participant identifier (MPID) when reporting information to FINRA. The rest of the rule applies to increased requirements for record keeping and record preservation standards8.
- Submit any data to a securities information processors
- Use Decimal pricing. ( the proposal specifies $0.05 cent ticks)
What Do We Do About It?
We have a great opportunity here to make a significant positive impact on the US economy. This could mean more jobs for the people, more tax revenue for the government, and new products for consumers. The SEC’s new Regulation A+ final rule implementing Title IV of the JOBS Act has proven that the people can produce dramatic re-regulations in the public interest if they aren’t afraid to ask. Venture exchanges may be the next step. These new exchanges could trade the securities issued by smaller public companies, and those issued under the JOBS Act Regulation A+ and crowdfunding provisions. This could drive more investment into crowdfunding and small businesses in general, creating a tide of new opportunities and innovations.
The SEC, the House and the Senate have all been exploring the idea of introducing venture exchanges recently. The House and Senate have even held hearings on the matter to gather information. The Financial Services Committee in the US House of Representative has introduced the The Main Street Growth Act as a bill for consideration. When it comes time for the vote, we don’t want a congress of laymen voting on a bill they might not understand having only heard misinformation from critics. Call your Congressperson. Write an Oped article on the topic. inject truth into a debate.
There are plenty of established interests that won’t benefit from a stronger small business market. Lots of firms are happy to keep small investors out of these lucrative deals. Some bureaucrats fear that by opening venture exchanges, they will lose the power to make your investment decisions for you. It is the job of those whom will benefit, ordinary citizens, to take hold of the debate and demand Venture Exchanges as part of a strategy to improve the economy for everyone.