Imagine being able to invest in Uber or Facebook BEFORE they went public or have markets for private securities similar to publicly traded securities on the NYSE or NASDAQ! Many initiatives have been launched to address this issue of democractising private investment and creating liquid markets for private securities.

This lack of easily available capital funding hurts small businesses which comprise over 99.5% of all US employers (as per Goldman Sachs). Small businesses cite lack of working capital as the primary hindrance to growth. Only two-thirds of them receive their requested funding, 20% receive some funding, and 13% receive nothing when applying for traditional financing.

Private investors that fund startups and new ventures face 5-7 years of locked capital creating a disincentive to regular capital flow and ability for new investors to join in the investment.

Several laws and fintech initiatives have been launched that aim to address this issue of encouraging private investment and providing liquid trading of private securities. Current alternatives include –

• Reg A and Reg A+ offerings – ‘exempt’ securities that trade on OTC exchanges. They promote private investment and reduce extensive disclosures typically required of publicly listed securities. Risks include counter-party risk and lack of liquidity.
• Reg Crowdfunding (CF) – enabled by platforms such as AngelList to support crowdfunding of private companies or startups, although they are limited to about $1M of funding.
• Private securities sales platforms like Sharespost or EquityZen that connect private equity sellers with investors who may be interested to buy those shares. These platforms offer a viable option for sale of startup shares but again lack liquidity of trading exchanges.
• Blockchain-based security tokens –. While Blockchain gained public mindshare due to cryptocurrencies like Bitcoin and Ethereum, it also created a novel approach to address this issue by ‘tokenizing’ any asset including equity, through the creation of Security tokens. Issuers can create and trade security tokens on blockchain trading platforms such as Securitize and tZero. However, given the evolving nature of blockchain regulatory regime (especially in the US) and somewhat negative public perception of anything blockchain related, security tokens have yet to deliver on the promise of creating a viable and meaningful avenue for trading private securities/tokens.

Although these are all efforts chipping away at the problem, there remains a significant impediment for private companies to efficiently raise capital and have a liquid trading platform similar to national securities exchanges available to large issuers.

Here is where the US Main Street Growth Act can be a game changer.

What is the Main Street Growth Act

This act is arguably one of the most forward-looking securities legislation in the last 50 years. Although it has taken a backseat given other pressing legislative needs during the current Covid-19 pandemic, it is expected to be signed into law this year since it has…cue the drum roll… support from both sides of the aisle! This legislation aims to address financing problems faced by small businesses across the nation. The Main Street Growth Act will allow the creation of Venture Exchanges with the sole purpose of helping small private firms raise capital for further expansion and create a marketplace that offers liquidity for smaller volume securities.

The Act takes into account the existing regulatory obligations a business must fulfill to raise capital through a public listing and the added burden of these legalities on small businesses. Small businesses can raise funds quickly through venture exchanges, and at the same time, provide retail investors an opportunity to invest in emerging companies.

Other countries already have established markets and similar venture exchanges for small firms, such as TSX Venture Exchange, AIM (Alternative Investment Market), London Stock Exchange, and NEEQ1 in China.

What does it propose

• Creation of Venture Exchanges to allow for publicly trading Early-Stage Growth Companies (EGCs) that are not yet public and maintain a certain level of daily float (currently $2B in public float) or trading volume.
• The Venture Exchanges will function as a Self-regulating organization (SRO) under the purview of existing SEC regulations. They will provide the disclosure requirements consistent with existing securities laws, but are expected to be less onerous than requirements for securities on national exchanges. They are expected to provide more transparency and disclosure than private securities have today.

How will the Act help small businesses

• Provide better access to capital: Small businesses often rely on private funding or costly secondary-market financing for growth and expansion. The Main Street Growth Act provides them better access to capital, thereby promoting swift growth.
• Improve liquidity for VCs, early-stage investors: VCs and early-stage investors fund startups in the hope of receiving returns at a later stage. However, they often experience a liquidity crunch because of the limited capital flow within these startups. The infusion of new capital through the Main Street Growth Act will improve liquidity for startups.
• Limit the legal steps & processing time involved in raising capital: The number of IPOs in the US has been declining consistently over the past few decades. A significant reason for this trend is the current scrutinized listing process, which is, no doubt, required to protect the investors, but it makes raising capital a difficult task for small businesses/ startups. The Main Street Growth Act does require small firms to follow all the steps but cuts the processing time considerably.
• Offer retail investors the opportunity to invest in promising firms: Retail investors never get a chance to invest in promising startups or small businesses at the early stages. The Main Street Growth Act creates a way for retail investors to access the opportunities while ensuring due research and risk associated with the investments.
• Create a thriving environment for startups and small businesses: The Main Street Growth Act promotes a favorable business environment for small businesses and startups. It addresses the primary challenge these businesses face throughout their early stage, i.e., access to capital.

However, as can be expected, no new piece of legislation is without its risks and limitations.

Potential risks include –

• Adequate liquidity to make these Venture Exchanges viable: “Build it and they will come” has seldom been a successful strategy. Even with adequate protections and incentives for small issuers, venture exchanges will need to embark on extensive marketing and create ‘on-ramps’ to get investors and build volume and liquidity on the platforms.
• Proliferation of multiple venture exchanges – exchanges work on volume. In case the market draws in several new exchanges, there is a risk of trading volume being disaggregated across multiple listings and exchanges. Hence it will be critical for the exchanges to create a unique brand by targeting specific areas of focus and “not be all things to all people”. They can differentiate themselves based on vertical, geography, type of security etc. in order to stand out and create a unique identity both for issuers and investors
• Lack of a robust partner ecosystem – it will be critical for exchanges to create on-ramps to drive volume and orders from existing exchange and trading platforms. This is where it will be critical for them to integrate with broker-dealers, and other individual trading platforms to create a simplified and seamless experience for investors.

Bottom Line

The Main Street Growth Act is the right step towards promoting small businesses and startups in the country. With better access to capital, we can expect more startups to push through their initial stages and transform into more prominent firms… and help further democratize the capital investment business.