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As Equity Crowdfunding Grows So Do Calls for Venture Exchanges

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  |  By Christopher Orr, SDIP

I’ve blogged a lot about the JOBS Act, the growth of equity crowdfunding and how regulatory changes are providing a wider swath of investors with access to private offerings that used to be made available only to rich or connected investors.

Now that the doors are opening for more investors to buy stakes in early-stage start-up companies, I’m also keeping an eye on calls in the industry for the development of secondary markets and venture exchanges that will give investors a clearer means of exiting these investments or figuring out what their investments might be worth.

Currently, investors can buy stakes in private companies through equity crowdfunding platforms, while Regulation A+ enables start-ups to raise up to $50 million in an IPO (sometimes called mini-IPOs or an IPO “lite”) from both accredited and non-accredited investors.

But investors who acquire shares in early-stage companies, either through participating in crowdfunding or a Reg A+ IPO, shouldn't expect those shares to be traded on the Nasdaq or NYSE, where daily stock quotes make the value of each share easy to ascertain. That is because a robust secondary market does not exist for easily trading these shares.

Instead, investors participating in these deals need to be prepared, if necessary, to hold their shares until another exit occurs, such as the company going public through an IPO or being acquired.

For self-directed IRA investors who are already familiar with the longer holding periods of certain investments, like private placements, participating in crowdfunding or a Reg A+ offering may align well with your retirement investments, which tend to have naturally longer time horizons. But if extenuating circumstances arise after you make an investment in an early stage start-up, having a clear means of exiting that investment is what the secondary market industry is exploring.

A recent article in Forbes discussed a draft bill from the House Financial Services Committee called the “Main Street Growth Act.” The bill calls for the creation of venture exchanges, or a secondary market where early investors in startups and small businesses could sell their shares, and new investors could buy in and trade these private stocks.

“Investors in technology startups, for example, are likely to have to hold their position in any one investment for an average of 7 years. Creating opportunities for selling private stock in a startup investment sooner through venture exchanges has the potential to reduce some of the early stage investment risks,” the article states.

According to a blog on Locavesting, the idea for venture exchanges, which could provide liquidity for securities in small businesses, is gaining traction. Canada and Australia have already launched successful small venture exchanges, and Locavesting pointed to this testimony from Stephen Luparello, Director, Division of Trading and Markets at the Securities and Exchange Commission:

 “The SEC is considering innovative approaches that appropriately balance the needs of smaller companies for efficient secondary markets and the interests of investors in smaller companies. Venture exchanges potentially could achieve such a balance by providing the investors a transparent and well-regulated environment for trading the stocks of smaller companies that offers both enhanced liquidity and strong investor protections. As such, they could strengthen capital formation and secondary market liquidity for smaller companies and expand the ability of all investors to participate through well-regulated platforms in the potential growth opportunities offered by such companies.”

While support for building a robust secondary market and venture exchanges may be growing, investors should remember that establishing such trading venues will not happen quickly. After all, the JOBS Act was passed in 2012 and three years later, we are still awaiting finalization of its rules.

In the meantime, investors who use their IRA funds to participate in equity crowdfunding deals or Reg A+ IPOs, should be sure the investment matches their risk profile no matter how the conversation evolves around venture exchanges.

PENSCO’s Blog is purely for educational purposes.  PENSCO does not provide investment, tax, or legal advice nor does it evaluate, recommend or endorse any advisory firm or investment vehicle. Individuals are encouraged to seek professional advice before making any investment decision. Investments are not FDIC insured and are subject to risk, including the loss of principal.