What are the Public Market Options to Secure Funding in the U.S.? Regulatory Challenges, and Trends Related to Companies Going Public in the United States

 

 

Secure funding for a corporation can be done through either public markets or private markets, and each has a distinct characteristic.

Public Market

Access to Capital

Public markets provide access to a large pool of capital by allowing the general public to invest in a company’s shares or debt.

Liquidity

 Shares traded on public markets are highly liquid, meaning that they can be bought and sold easily on stock exchanges.

Regulatory Requirements

 Companies must adhere to strict regulatory standards, including regular financial reporting and disclosure to the Securities and Exchange Commissions (SEC).

Market Valuation

 The value of a company is continuously determined by the market, reflecting in the share price.

Investor Base

 A public company can attract a diverse range of investors, including institutional and retail investors.

Private Market

Investor Profile

 Private markets typically involve investments from a smaller group of investors, such as venture capitalist, private equity firms or accredited investors.

Less Regulation

 Private companies are subject to fewer regulatory requirements, which can mean less administrative burden and cost.

Flexibility

 Private market investments often offer more flexible terms and conditions tailored to the needs of the company and the investors.

Limited Liquidity

 Investments in private markets are less liquid, as they are not traded on public exchanges and may have restrictions on transferability.

Control and Ownership

 Raising capital privately can allow existing owners to maintain more control over the company, as they may not have to disclose as much information or give up as much equity as they would in a public offering.

Companies often choose between these options based on their stage of growth, capital needs, and strategic goals. Let’s explore different options or forms available to raise capital in the public market.

Initial Public Offering (IPO)

A public offering is a sale of equity shares or debt securities by an organization to the public in order to raise funds for the company. It is often used to an initial public offering (IPO) when a company’s stock is made available for purchase by the public, but it can also be used in the context of a bond issue. An offering is also known as a securities offering, investment round, or funding round. Unlike other rounds (such as seed rounds or angel rounds), however an offering involves selling stocks, bonds, or other securities to investors to generate capital.

How an Offering Works

When a company initiates the IPO process, meaning that a private company becomes a publicly traded company by offering its shares to the public for the first time, a very specific set of events occurs.

1.           Selection of an Underwriter. The company chooses an investment bank to lead the IPO process. The underwriter conducts due diligence, prepares the IPO, and helps set the price for the initial shares.

2.           Filing a Registration Statement. The company must file a registration statement with the Securities and Exchange Commission (SEC), which includes a prospectus detailing the company’s business, financial statements, and the terms of the stock offering.

3.           SEC Review. The SEC reviews the submitted documents to ensure all the necessary information has been disclosed and is accurate.

4.           Pricing the IPO. The investment bank sets the initial stock price based on market conditions, the company’s valuation, and investor interest.

5.           Marketing the IPO (Roadshow). The company and investment bankers promote the upcoming IPO to potential investors to generate interest.

6.           IPO Launch. Once the SEC approves the offering, the company’s shares are made available to the public, and trading begins on a stock exchange.

7.           Post-IPO Stabilization. After the launch, the underwriter may take actions to stabilize the share price during the 25-day "quiet period” to maintain market confidence.

IPO underwriters work closely with the issuing body to ensure an offering goes well. Their goal is to ensure that all regulatory requirements are satisfied, and they are also responsible for contacting a large network of investment organizations in order to research the offering and gauge interest to set the price. The amount of interest received helps an underwriter set the offering price.  

 

    Other Forms of Primary Market Offerings

 

Direct Listing

Direct Listing, also known as a Direct Public Offering (DPO), is an alternative to an Initial Public Offering (IPO) for a company to go public. Here’s how it differs from an IPO:

No New Shares

 Unlike an IPO where new shares are created and sold to raise capital, a direct listing involves selling existing shares directly on a stock exchange.

No Underwriters

Direct listing does not require underwriters. In an IPO, investment banks act as underwriters to help set the share price, market the shares, and stabilize the stock post-listing.  In a direct listing, these roles are not necessary, which can save the company time and money.

Market-Driven Pricing

Since there are no underwriters to set the initial price, the opening price in a direct listing is determined by the supply and demand on the day of listing.

No Roadshow

Direct listing eliminates the need for a roadshow, which is a series of presentations to potential investors that typically occurs before an IPO

No Lock-Up Period.

Often in an IPO, there’s a lock-up period during which early investors and insiders cannot sell their shares. This is not usually the case with direct listings, allowing shareholders to sell their shares immediately.

Potential for Higher Volatility.

Without underwriters to stabilize the stock, direct listings can be more volatile initially as the market finds the right price for the shares.

Access to All Investors.

Direct listing can provide a more democratic process, as all investors have the same opportunity to buy shares at the same time, rather than the traditional IPO process where institutional investors often get early access.

Direct listings can be an attractive option for well- known companies that don’t need to raise additional capital and have a large, interested investor base ready to trade their shares. Companies like Spotify and Slacks have successfully used this method to go public.  It’s a way to increase liquidity for existing shareholders while avoiding some of the costs and complexities associated with traditional IPOs. 

Special Purpose Acquisition Companies (SPACs)

SPACs are an alternative to traditional IPOs for companies looking to go public. Here’s how SPACs work:

Formation.

A SPACs is a shell company with no commercial operations, formed specifically to raise capital through an IPO for the purpose of acquiring an existing private company.

Public Listing.

The SPACs itself goes public, typically on a major stock exchange, and the funds raised are placed in a trust account.

Acquisition Search.

After the IPO, the SPACs management team has a set period (usually 18-24 months) to identify and complete a merger with a target company.

Merger and Going Public.

Once a target company is selected, the SPAC merges with it, effectively taking the private company public through what is known as a “reverse merger”.

Advantages Over Traditional IPOs

·        Speed to Market. SPACs can allow a company to go public, more quickly than a traditional IPO process.

·        Price Certainty. The valuation is agreed upon in advance, providing more certainty compared to the traditional IPO pricing process.

·        Lower Costs. SPACs can be less expensive due to fewer underwriting fees and a streamlined process.

·        Expertise. SPAC sponsors often bring industry expertise and can assist with the transaction to a public company.

Considerations:

·        Market Risk. If the SPACs does not complete a merger within the designated timeframe, it may have to return the funds to investors, and the SPAC is dissolved.

·        Regulatory Scrutiny. While the SPACs face fewer regulatory demands initially, they must still meet all regulatory requirements after the merger.

·        Investor Dilution. Existing SPACs shareholder may face dilution when the merger occurs, especially if additional financing rounds are needed.

SPACs have gained popularity as they offer a more streamlined and potentially less risky path for companies to access public markets. However, they are not without their challenges and risks, and companies should carefully consider whether a SPAC is the right choice for their particular situation.

Regulation A

Regulation A is an exemption from registration requirements under the Securities Act of 1933 that applies to public offering of securities. Companies utilizing the exemption are given distinct advantages over companies that must fully register.

There are different tiers, depending on the size of the company, and companies must still file an offering statement with the SEC. The offering must also give buyers documentation with the issue, similar to the prospectus of a registered offering.  Here are the key points:

Two Offering Tiers:

-       Tier 1. For offerings of up to $20 million in a 12-month period.

-       Tier 2. For offerings of up to $75 million in a 12-month period.

-       Companies can elect to proceed under the requirements for either Tier 1 or Tier 2 for offerings up to $20 million.

-       Both tiers have basic requirements, including company eligibility, bad actor disqualification provisions and disclosure.

-       Additional requirements apply to Tier 2 offerings, such as limitations on non-accredited investor investments, audited financial statements, and ongoing reports.

-       Issuers in Tier 2 offerings are not required to register with state securities regulators.

Advantages of Regulation A

·        Streamlined financial statements without audit obligations

·        Three format choices for the offering circular

·        No requirements to provide Exchange Act reports until the company has more than 500 shareholders and $10 million in assets.

·        Companies can raise capital from the public without a full traditional IPO process.

 

Regulation Crowdfunding (Reg CF)

Regulation CF stands for Regulation Crowdfunding, which is a form of crowdfunding defined by the Securities and Exchange Commission (SEC) that grants ordinary investors access to a new asset class – by investing as part of a “crowd”.  It democratized investment opportunities and allows companies to raise capital from a broader audience.

Before 2016, this wasn’t possible – many offerings were restricted to only accredited (wealthy) investors or required issuers to comply with too many regulations and reporting requirements to make a crowd-investing offering worthwhile. But since “Title III” of the Jumpstart Our Business Startups (JOBS) Act passed, everyone plays on the same field. 

Most companies that raise capital through Reg CF are early stage start ups trying to get them seed or pre-seed rounds off the ground.

The principal rules governing Reg CF are as follow:

·        All transactions must be conducted online through an SEC-registered intermediary, either a broker-dealer or a funding portal.

·        Companies can raise a maximum aggregate amount of $5 million through crowdfunding offerings within a 12-month period.

·        There are limits on the amount individual non-accredited investors can invest across all crowdfunding offerings within a 12-month period.

·        Companies must disclose pertinent information to the Commission, investors and the intermediary managing the offering.

Additionally, investors should be aware that securities bought through a crowdfunding transaction generally cannot be resold, besides there are “bad actor” disqualification provisions in place to protect all parties involved.

    Trends in the United States for Companies Going Public

IPO

The traditional IPO market experienced a significant peak in 2021 with 1,035 companies going public, driven by a robust market and high investor confidence. However, there has been a subsequent decline in 2022 and 2023 with 181 and 154 IPO’s respectively, possibly due to market corrections and economic uncertainties. As of 2024, the trend shows 63 IPOs up to May, indicating a cautious approach by companies considering going public.

Direct Listing

In a direct listing, companies bypass the traditional IPO process and directly list their existing shares on a stock exchange.  Spotify pioneered direct listings in 2018, setting the stage for other companies to follow suit. Since then, nine other firms have gone public using direct listings due to the method’s smooth operations.

A University of Florida analysis found that the share of value of companies going public through direct listings within a study period rose 64.4% compared to 26.8% for traditional IPO companies. Notable direct-listings companies include Coinbase, Spotify, Slack, and Roblox.

Direct listings remain a specialty for small segment of companies. Without underwriting and marketing support from Wall Street banks, companies must be well-established and high-profile enough to attract investors on their own. Companies like Coinbase and Spotify exemplify this approach, levering their name recognition and industry prominence.

SPACs

SPACs saw a dramatic increase in popularity especially in 2020 and 2021. In 2019 there were 59 SPACs created, in 2020 the number rose to 248, and in 2021 alone 613 SPACs were created. This surge accounted for 63% of new publicly listed U.S. companies in 2021. However, the number of SPACs created in 2022 and in 2023 dropped to 86 and 31 respectively, and in the first quarter of 2024 only 8 SPACs have been created. This trend shows that the “SPACs boom” has officially ended, indicating a return to more traditional method of going public or exploring other alternatives.

Regulation A (Reg A)

Reg A offerings were revamped under the Jumpstart Our Business Startups Act (JOBS Act) in 2012 to increase the maximum offering size of exempt securities from $5 million to either $20 million or $75 million depending on the offering type.   However, despite this potential source of early stages financing for small businesses only 240 Reg A filings were received by the SEC in 2021, and only 229 were received in 2022, with an average total amount of funding of about $5 billion per year.[1]

Reg A was originally established by the SEC under Section 3(b) of the Securities Act in 1933 as a way for small issues to be exempt from registration. A 2018 Barron’s article “Most Mini-IPOs Fail the Market Test,” found that on average Reg A securities had underperformed the broader market by nearly 50% in the six months following their issuance.

Regulation CF

Regulation CF in the United States has shown a positive trend over the years with increasing participation from issuers and investors. When the bill was signed into law in 2012 during the Obama Administration, the Reg CF securities exemption was not actionable until mid-2016. Initially the exemption allowed to raise just $1 million, eventually increased to $1.07 million – a rather anemic amount when considering the cost to pursue a funding round online and the growth capital needs for a startup or early-stage firm.

In 2020 the SEC changed the funding cap to $5 million. Today technology integration is reshaping the equity crowdfunding landscape, with blockchain emerging as a disruptive force. This trend is propelling equity crowdfunding into new frontiers such as the development of decentralized finance (DeFi) platforms. These platforms leverage blockchain technology to create transparent and secure ecosystems for peer-to-peer transactions. In addition, artificial intelligence (AI) is becoming a transformative force in equity crowdfunding reshaping how investors approach decision-making and risk assessment. Several platforms in the industry are actively incorporating AI to provide investors with advanced tools for informed choices.

Finally, tokenization, the process of representing real-world assets as digital tokens on a blockchain stands as one of the revolutionary trends in equity crowdfunding.

The global crowdfunding market size was valued at $1.25 billion in 2022 and is projected to grow from $1.41 billion in 2023 to $3.62 billion by 2030. North America dominated the global market with a share of 41.60% in 2022.

                                                         

  

 

 

 

---

[1] David Krouse (2023) Why Aren’t Reg A Offerings More Popular Among Small Businesses? CLF Blue Sky Blog.