Democratization of private space investing
Updated: Mar 9, 2021
Asking Congress and the SEC to keep new crowdfunding rules.
- Op-ed | J. Brant Arseneau, 9Point8 Capital
Recent public market events saw retail investors exercise powers normally reserved for sophisticated Wall Street banks and hedge funds. Both traditional financial institutions and regulators are reeling from the “public short squeeze” of GameStop and several other companies in January and are wondering what, if anything, should be done about it. Similar concerns are also being raised about private markets and non-accredited investment activity. Regulators are asking the perennial question, “Does the retail investor need more protection or the opposite, democratization?”.
Many market segments are attracting interest from retail investors, but few are as exciting as the space industry. Space startups are in for what appears to be a stellar year in 2021. To achieve this, they need capital which is only forming in the nascent industry and where traditional venture capital is still scarce. Some companies are counting on raising capital under the U.S. Securities and Exchange Commission's (SEC) newly amended Jumpstart Our Business Startup (JOBS) Act, which allows private companies to raise money from the public.
Under the original rules, space companies could initially only raise $1.07 million a year, but in December 2020, the SEC voted for the limit to be increased to $5 million. At the same time, they are allowing the use of traditional special purpose vehicles (SPV) to make these capital rounds more compatible with follow-on institutional raises. These changes come at an important time and could help provide the capital fuel for a growing space economy. They also help create a market that will democratize access to private investments for the public.
With the recent change of government, some members of congress are asking for these amendments be rolled back or delayed. If this happens, it will impede capital formation, further exclude the public from capital markets and destroy progress in the democratization of the investing process. The space industry, and other sectors will suffer.
Last month, the SEC proposed amendments to the JOBS Act which are scheduled to go into effect in March, signaling major progress. The original rules laid the groundwork for companies to sell shares of new businesses to retail investors, through public internet solicited campaigns. Under the original Securities Act of 1933, the SEC prohibited companies to sell shares to the public unless they were registered with the SEC and followed strict guidelines. The SEC eventually created an exemption framework, that if a company qualified, could offer shares for sale without registering.
The common exemption used by most institutional investors, including venture capitalists and some hedge funds, is Regulation D (Reg D). Raising capital under Reg D limits the issuing company to sell shares mainly to accredited investors, which eliminates a vast majority of the public. While this may not seem fair, ironically it was one of the main intentions of the 1933 Securities Act; to protect the general public. The JOBS Act is meant to bring the public into the private company investment process in a balanced manner, and allow them to be exposed to the risks and rewards of investing in early stage companies.
Both, protecting the public from risks and providing them equal access to the rewards of investing, is a complicated matter and much debated by regulatory authorities. In the case of the JOBS Act, there are safeguards in place that protect investors. The public are permitted to invest in private companies, but are limited to the amount they can invest annually based on their income - effectively retail investment limits. This limit is adjusted relative to increases in an individual's income or net worth, until the individual is considered an accredited investor.
The space industry has helped create a massively interconnected world. A world where information is collected, synthesized and accessed by most individuals with an internet connection and the foresight to join forums where social, economic and policy topics are being discussed and debated constantly. This has given rise to a collective awareness, and power, that once was only found in large institutions, private clubs, and the back rooms of steak houses. Politics, economics and society as a whole, has been changed forever.
Last week’s public market volatility is no exception. The collective power of retail investors exercised a trading method that institutions have been implementing for decades; a strategy that requires foresight, coordination, capital and commitment. Retail investors collectively squeezed hedge funds out of their short positions in several companies by raising the stock price of these companies. These investments are now surely overvalued and most likely many retail investors will lose money on the way down.
Is the risk of potential losses by public participation a reason to apply draconian rules to “protect” retail investors and regulate them out of the market? Or do the markets perform efficiently and the retail investors adapt and behave differently in the future? Similarly, recent calls from some congress members to walkback advances in providing equal access to the private investment process achieved by the JOBS Act is equally concerning.
Democratizing access to investment opportunities is important for both creating access for the retail investors and to forming capital for startups. The nascent capital intensive space industry could benefit greatly from public capital support. It's crucial that the JOBS Act rule changes be allowed to stand so that they can help both the retail investors and small businesses thrive.