Financing Main Street: SEC Advisory Committee Discusses Alternatives for Small Businesses

Raising capital is a notable and daunting hurdle for any small business. For “Main Street” small businesses that may not pursue a venture capital-growth trajectory, or are at the pre-venture or pre-investor stage, there are a number of pathways to raising capital. On September 19, 2023, the Securities and Exchange Commission’s Small Business Capital Formation Committee (the “Committee”) hosted a discussion on Alternative Funding Options for Small Businesses.[1] The discussion included a presentation on the U.S. Department of the Treasury’s State Small Business Credit Initiative’s (“SSBCI”) Equity and Venture Capital Programs, followed by a wider Committee discussion on financing alternatives.

The Small Business Jobs Act of 2010 established the SSBCI for a period of seven years.[2] Congress reauthorized and amended under the American Rescue Plan Act of 2021.[3] SSBCI provides almost $10 billion in funding for programs that increase access to capital for small businesses in the fifty states, the District of Columbia, territories, and tribal governments.[4] The financing programs include capital access programs and other credit support programs, which provide equity and venture capital opportunities, loan participation, loan guarantees, and collateral support.[5] Since its reauthorization, SSBCI allocated $3.03 billion in funding for its venture capital programs (VCPs).[6] There are 46 jurisdictions with VCPs, and a total of 84 VCPs currently which include 48 direct investment VCPs and 36 fund investment VCPs.[7] Fund investments include SSBCI capital pooled with private capital in a venture capital fund, compared to direct investment, which only includes SSBCI capital.[8]

Following the SSBCI presentation, the Committee members engaged in dialogue on other methods by which small businesses can raise capital and what businesses should consider when assessing these options. Among the methods discussed, the Committee highlighted:

• Revenue-based financing. In a revenue-based financing model, a business exchanges a percentage of its projected future revenue for an extension of capital.[9] While popular, the Committee cautioned that estimating projections for revenue under these circumstances is a challenge for small businesses.[10] For example, participants who overestimate revenue may incur large balloon payments at the end of the financing, bankrupting the business.[11] For these reasons, applications of revenue-based financing have been predatory warned the Committee.[12]

• Crowdfunding. Crowdfunding allows for businesses to raise money from a pool of “crowdfunders.”[13] Unlike investors, crowdfunders do not receive a share of ownership and there is no expectation that they will see a return on their contribution, but rather participants expect to receive a gift or certain perks instead.[14] Regulation CF, Regulation Crowdfunding offers an exemption for this type of capital raising.[15] Regulation CF allows for a maximum of $5 million raised within a 12-month period.[16] The securities are sold in reliance on Section 4(a)(6) of the Securities Act of 1933.[17]

• SSBIC programs. As discussed above, SSBCI capital programs for credit and investment support are available to Tribal government programs to support small businesses, underserved businesses, offer incentives for allocations to jurisdictions that show robust support for underserved businesses, and “very small businesses”.[18]

• Donor-advised funds (“DAF”). DAFs are separately identified funds or accounts that are maintained and operated by a section 501(c)(3) non-profit organization.[19] The Committee highlighted that DAF money can be applied to private investments.[20] Donors in DAFs benefit from a tax deduction, which then gets invested into private businesses.[21] Any returns on the investment are routed to the DAF and can be applied to 501(c)(3) organizations or other charities.[22]

• Impact investment funds. Businesses can also partner with impact investment funds or organizations. Impact investing distribute capital to businesses that generate benefits relating to social, environmental, or other impact causes.[23]

• Community Development Financial Institutions (“CDFI”). Established by the Riegle Community Development and Regulatory Improvement Act of 1994, CDFIs provide financial assistance to investment areas or targeted populations in generally economically undeserved markets.[24] For example, businesses can partner with CDFIs to get capacity-building funds and help with administrative and overhead costs through training funds.[25]

• Community Reinvestment Act (“CRA”) resources. Under the CRA, financial institutions deploy capital help meet the credit needs of economically underserved neighborhoods.[26] A sponsor is usually required to access these funds.[27]

Of course, this is not an exhaustive list of options for financing your business. The U.S. Small Business Administration offers loans and other programs for small businesses. For enterprises looking to move onto the venture-growth curve, federal securities laws provide for a number of capital raising options, which we will explore in a different blog post.

Business owners and founders should discuss these options with their lawyers and financial advisors before proceeding.

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[1] The Small Business Capital Formation Committee “provides advice and recommendations to the Commission on rules, regulations, and policy matters relating to small businesses.” 15 U.S.C. § 78qq (2023). [2] 12 U.S.C. § 5708(c) (2023). [3] 12 U.S.C. 5702(a)(1) (2023). [4] Karl Fooks, SSBCI Equity/Venture Capital Programs 1, 4 (Sept. 2023), available at: https://www.sec.gov/files/fooks-ssbci-presentation.pdf. [5] Id. at 5. [6] Id. at 8. [7] Id. [8] Id. at 6. [9] David E. Fialkow and Peter M. Ayers, The Growing Trend of Revenue-Based Financing and Its Legal Implications, 140 Banking L. J., no. 2, 2023. [10] Meeting of the U.S. Sec. & Exch. Comm’n Small Bus. Cap. Formation Comm. (Sept. 19, 2023) [hereinafter SBCF Comm. Meeting], recording available at: https://www.youtube.com/watch?v=h68esfto4Zs. [11] Id. [12] Id. [13] Fund your business, U.S. Small Bus. Admin. (2023), available at: https://www.sba.gov/business-guide/plan-your-business/fund-your-business. [14] Id. [15] 17 C.F.R. § 227.100 (2023). [16] 17 C.F.R. § 227.100(a)(1) (2023). [17] 15 U.S.C. § 77d (2023). [18] Fooks, supra note 4, at 4. [19] Donor-Advised Funds, Internal Revenue Service (2023), available at: https://www.irs.gov/charities-non-profits/charitable-organizations/donor-advised-funds. [20] SBCF Comm. Meeting. [21] Id. [22] Id. [23] Vivek Pandit and Toshan Tamhane, A closer look at impact investing, McKinsey & Co. (2023), available at: https://www.mckinsey.com/industries/private-equity-and-principal-investors/our-insights/a-closer-look-at-impact-investing. [24] Pub. L. No. 103–325, 108 Stat. 2160 (2023). [25] SBCF Comm. Meeting. [26] 12 U.S.C. § 30 (2023). [27] SBCF Comm. Meeting.