# Report to Congress on Regulation A / Regulation D Performance > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/agency%3Asec%3A2d9fa89305eb1b2f ## Record - **Collection:** Agency decision - **Document type:** Agency decision ## Text Report to Congress on Regulation A / Regulation D Performance As Directed by the House Committee on Appropriations in H.R. Rept. No. 116-122 This is a report by the staff of the U.S. Securities and Exchange Commission (SEC). The Commission has expressed no view regarding the analysis, findings, or conclusions contained herein. August 2020 1 Executive Summary Congress directed the staff of the Securities and Exchange Commission (Commission or SEC) to report on the performance of Regulation A and Regulation D offerings. In its Joint Explanatory Statement accompanying the Financial Services and General Government Appropriations Act, 1 Congress states: The Committee is concerned about the implications of private and quasi-public market growth on public markets and investors. The Committee believes public markets offer certain valuable benefits to investors that private and quasi-public markets do not provide, including more robust transparency, better pricing efficiency, more accurate valuations, deeper levels of liquidity and lower trading costs, and stronger accountability mechanisms. The Committee directs the SEC’s Division of Economic and Risk Analysis to study the performance of Reg A+ and Reg D offerings and within 180 days issue a public report comparing the performance of Reg A+ and Reg D offerings versus all other offerings. In response to the Committee’s directive, this Report presents the SEC staff’s analysis of available data and evidence on the state and performance of exempt offerings under Regulation A and Regulation D during the time periods noted for each of these types of offerings. 2 The time span of our analysis preceded the onset of the global COVID-19 pandemic, which is expected to have a negative impact on offering activity. 3 1 See H. Committee Print of Consolidated Appropriations Act, 2020, Comm. on Approp., 116 Cong, 2d Sess. No. 38-678 (Jan. 2020), at 652, available at: https://www.govinfo.gov/content/pkg/CPRT116HPRT38678/pdf/CPRT-116HPRT38678.pdf. The Joint Explanatory Statement (Joint Explanatory Statement) accompanying Division C of the Consolidated Appropriations Act, 2020 addressed reporting directives to the SEC generally. The enactment of appropriations for the Commission on December 20, 2019, confirmed the directive to prepare this report. See Consolidated Appropriations Act, 2020, Pub. Law No. 11693, 133 Stat. 2317 (2020). 2 Staff in the Division of Economic Risk and Analysis (DERA) was primarily responsible for the data analysis in this report. 3 See, e.g., S.P. Kothari, DERA Economic and Risk Outlook, U.S. SEC. AND EXCHANGE COMM’N (Apr. 23, 2020), available at https://www.sec.gov/files/DERA_Economic-and-Risk-Outlook-Report_Apr2020.pdf. 2 Main Findings Regulation D Offerings Our analysis of Regulation D offerings is based on available data from electronic filings for 2009 through 2019, except where noted elsewhere. • As a capital-raising tool, Regulation D accounts for a large share of the offering market and provides a robust choice for issuers seeking to raise capital. • Over the past decade, there has been a steady increase in the number of offerings and amounts raised in Regulation D offerings. In 2019, over $1.5 trillion was reported raised under Regulation D. • By comparison, during the same timeframe, approximately $1.2 trillion was raised through registered offerings, and just over $1 billion was reported raised under Regulation A during the same timeframe. • Private funds raised more than $11 trillion of the $15.5 trillion sold in Regulation D markets during 2009 through 2019. However, non-fund issuers dominate in terms of number of offerings. • Private funds for which data is available exhibited strong performance, with significant variation across funds, as shown in greater detail in Section III.B.2. However, this period has also coincided with favorable market performance, resulting in high market portfolio returns. Note: The distinct risk and illiquidity profile of private funds, as well as differences in data sources and methodologies for measuring performance, make direct comparisons with mutual fund and market portfolio returns difficult. 3 • On the basis of our analysis of a small subset of public companies that conducted Regulation D offerings during the timeframe, and in line with prior studies, we find that such companies tend to be smaller, less profitable, and more financially constrained than public companies conducting registered offerings. The companies relying on Regulation D grew faster one year after the offering but had lower profitability and stock returns, compared to public companies undertaking registered offerings. Regulation A Offerings Our analysis of Regulation A offerings is based on data from the effective date of the amendments that dramatically expanded it in mid-2015 (also termed “Regulation A+”) through the end of 2019, except where noted elsewhere. • As a capital-raising tool, Regulation A met with somewhat mixed offering success during this period. While the use of Regulation A has increased over time, amounts raised (as reported) were generally below amounts sought. Note: Proceeds information is incomplete because of lags in reporting and most offerings being made on a continuous basis. • Among Regulation A offerings, we find Tier 2 accounted for most of the issuer activity, successful offerings, and growth in proceeds. (See discussion of Tier 2 in Section II.B. below). • Among issuers with some offering proceeds, close to 80% of issuers continued to file reports on the Commission’s Electronic Data Gathering, Analysis, and Retrieval system (EDGAR) one year after the offering, and just under one-half of issuers remain there three years after the offering. 4 • The typical issuer with available post-offering data experienced a considerable increase in assets and revenues, but not in profitability, following the offering. The magnitude of the jump is generally related to the small initial size and early stage of the typical issuer. • A minority of issuers that raised capital under Regulation A had a secondary trading market for their securities (on the over-the-counter (OTC) market or a stock exchange). Among those issuers, typical performance was below performance benchmarks; however, underperformance was not statistically significant. Note: Our analysis and inference are limited by small sample size, data noise, and selfselection of issuers into the Regulation A market. Summary of Conclusions Overall, our analysis confirms that Regulation D accounted for significantly more capital raising than Regulation A, with the difference on the order of magnitude of 1000x in a typical year during the examined period. Although the use of Regulation D by private funds, which are ineligible under Regulation A, plays a significant role, Regulation D use by non-fund issuers also significantly outpaced Regulation A use. Excluding funds, most of the issuers relying on either exempt offering method are small, unlisted companies, which considerably limits data availability. However, according to available data, some of the operating companies using these offering methods exhibit considerable growth potential. 5 I. Introduction Regulation A and Regulation D are two sets of rules that enable issuers to conduct an offering that is exempt from the registration requirements of the Securities Act of 1933 (the “Securities Act”). 4 Over the past decade, markets for securities that are exempt from registration have experienced significant growth. In response to the reporting directive from Congress, 5 the Commission’s staff has studied the performance of Regulation A and Regulation D offerings. In this report, we analyze the performance of these offerings. Except where specified otherwise, the analysis is based on available data from electronic filings through the most recently completed calendar year (2009 through 2019 for Regulation D and June 2015 through December 2019 for Regulation A), which coincided with a period of generally favorable macroeconomic and market performance. Subsequent to the end of the period analyzed in this report, as of August 2020, the U.S. has experienced significant macroeconomic and market dislocations related to the global effects of COVID-19 and the related response. These factors are expected to have a negative impact on offering activity, including under Regulation A and Regulation D, as well as on the likelihood of liquidity events, such as initial public offerings (IPOs), and the performance of these investments in 2020. Some of the analysis in this study incorporates the findings of the Commission staff’s lookback review of Regulation A (published March 4, 2020), as called for in the 2015 4 For a discussion of the various exemptions from registration under the Securities Act, including Regulation A and Regulation D, see Concept Release on Harmonization of Securities Offering Exemptions, Release No. 3310649 (Jun. 18, 2019) [84 FR 30460 (Jun. 26, 2019). 5 See supra footnote 1. 6 Regulation A adopting release, and the findings of the biennial offering limit review, as required by Section 3(b)(5) of the Securities Act. 6 Below is a summary of the characteristics and performance of Regulation A and Regulation D offerings. Regulation D • Over the past decade, there has been a steady increase in Regulation D offerings. As a capital-raising tool, Regulation D accounts for a large share of the offering market and provides a robust financing method for issuers seeking to raise capital. In 2017-2019, the Regulation D market surpassed the registered offering market based on the amount of reported proceeds. In 2019, Regulation D accounted for over $1.5 trillion in reported proceeds. By comparison, in 2019 registered offerings accounted for approximately $1.2 trillion in proceeds, and Regulation A accounted for just over $1 billion in reported proceeds. Much like public capital markets, capital raising through Regulation D offerings has been pro-cyclical. Private funds raised the largest amount of financing in the Regulation D market during this period. • Private funds exhibited strong returns during this period. While there is variance in mean and median returns, depending on the year and data source, the private fund asset class exhibited generally strong returns in absolute terms during this period. However, as noted above, this period also coincided with favorable market and mutual fund performance. 6 See U.S. SEC. AND EXCHANGE COMM’N, Regulation A Lookback Study and Offering Limit Review Analysis (2020), available at https://www.sec.gov/files/regulationa-2020.pdf (“Regulation A Lookback Report”). 7 As an important caveat, the distinct risk and illiquidity profile of private funds and data differences make it difficult to draw direct comparisons. • Among non-fund issuers in the Regulation D market, issuers in the Banking/Financial, Technology, and Real Estate industries accounted for the most capital raised. As more than 95% of non-fund Regulation D issuers are private companies, data on their performance are scarce. We present available evidence on the performance of investments in private companies. We then turn to the (small) subset of Regulation D issuers that are public companies and thus have performance data available. These issuers tend to be smaller, less profitable, and more financially constrained at the time of the Regulation D offering, compared to public companies conducting registered offerings. Reporting companies with Regulation D offerings grew faster but had lower profitability and stock returns one year after the offering than reporting companies undertaking registered offerings. However, selection bias is likely because these issuers tend to be smaller, less profitable, and more financially constrained at the time of the Regulation D offering, compared to public companies conducting registered offerings. As an important caveat, the public company subset of Regulation D issuers is not representative of the much larger set of private companies relying on Regulation D. Regulation A • As a capital-raising tool, Regulation A met with somewhat mixed offering success during this period. While the use of Regulation A has increased over time, amounts reported raised were generally below amounts sought, with the caveat that proceeds information is incomplete because of the nature of observed reporting, as well as the fact 8 that most offerings were made on a continuous basis, with an increase in offering activity in later years. • Among Regulation A offerings, Tier 2 accounted for most of the issuer activity, successful offerings, and growth in proceeds. Among issuers reporting some offering proceeds, close to 80% of issuers continued filing in EDGAR (including filings other than those required under Regulation A) a year after the offering, and just under one-half of issuers continued filing in EDGAR three years after the offering. Where data were available, the typical issuer experienced a considerable increase in assets and revenues, but not in profitability, following the offering. The magnitude of the jump is related to the small initial size and early stage of the typical issuer. • For the minority of Regulation A issuers that had a secondary trading market for their securities, stock returns after the offering were positively skewed, with means substantially higher than medians. Typical performance, in absolute terms and in excess of the market index return, was below the performance of other considered groups of small issuers. The underperformance was not significant, although the power of the analysis was limited by very small sample size. Finally, with the caveat about the latency of potential violations, there have been few instances of civil cases or administrative proceedings involving Regulation A during this period. The rest of the report is organized as follows: Section II presents the market and offering landscape and evidence on the offering and issuer characteristics for both Regulation A and Regulation D offerings; Section III presents available evidence on performance of Regulation A and Regulation D offerings and issuers; and Section IV provides our conclusions. In each 9 section below, we present the analysis of the Regulation D market first, given its much larger size, followed by the analysis of the Regulation A market. II. Market and Offering Landscape The existing regulatory framework and market practices permit a wide variety of methods for issuers to access external financing or realign their capital structure. Below we present an overview of the requirements of Regulation A and Regulation D, including recent rule changes, as well as the associated market practices and how they fit within the broader landscape of exempt and registered offerings. Over the past several years, but particularly since the implementation of the Jumpstart Our Business Startups Act of 2012 (“JOBS Act”), the Commission has undertaken several rulemaking actions that involved changes to the framework for exempt offerings under Regulation A and Regulation D, as seen in Table 1 below. Table 1. Recent Rulemaking Actions Involving Regulation A and Regulation D under the Securities Act Date Summary of Commission Action Jul. 2013 Adopted Rule 506(c) implementing Title II of the JOBS Act. Jul. 2013 Amended Rule 506 to disqualify certain “bad actors” under Rule 506 of Regulation D. Title Eliminating the Prohibition Against General Solicitation and General Advertising in Rule 506 and Rule 144A Offerings Disqualification of Felons, Other “Bad Actors” from Rule 506 Offerings Mar. 2015 Raised offering limits and made other changes to Regulation A to implement Title IV of the JOBS Act. Amendments for Small and Additional Issues Exemptions under the Securities Act (Regulation A) Oct. 2016 Dec. 2018 Amended Rule 504 to increase the aggregate amount of securities that can be offered and sold in a 12-month period from $1 million to $5 million, and repealed Rule 505. Amended Regulation A to extend eligibility to reporting companies, implementing the mandate of Economic Growth, Regulatory Relief, & Consumer Protection Act of 2018. Citation Release No. 33-9415 (July 10, 2013) [78 FR 44771 (July 24, 2013)] Release No. 33-9414 (July 10, 2013) [78 FR 44729 (July 24, 2013)] Release No. 33-9741 (Mar. 25, 2015) [80 FR 21806 (Apr. 20, 2015)] (“2015 Regulation A Release”) Exemptions to Facilitate Intrastate and Regional Securities Offerings Release No. 33-10238 (Oct. 26, 2016) [81 FR 83494 (Nov. 21, 2016)] Amendments to Regulation A Release No. 33-10591 (Dec. 19, 2018) [84 FR 520 (Jan. 31, 2019)] 10 Jun. 2019 Published a concept release on the harmonization of the exempt offering framework. Concept Release on Harmonization of Securities Offering Exemptions Dec. 2019 Proposed amendments to the accredited investor definition. Amending the “Accredited Investor” Definition Mar. 2020 Proposed further amendments to simplify, harmonize, and improve aspects of the exempt offering framework. Facilitating Capital Formation & Expanding Investment Opportunities by Improving Access to Capital in Private Markets Release No. 33-10649 (Jun. 18, 2019) [84 FR 30460 (Jun. 26, 2019)] (“Harmonization Concept Release”) Release No. 33-10734 (Dec. 18, 2019) [85 FR 2574 (Jan. 15, 2020)] Release No. 33-10763 (Mar. 4, 2020) [85 FR 17956 (Mar. 31, 2020)] (“Harmonization Proposing Release”). By allowing issuers to forgo the registration process, Regulation D affords issuers greater speed and flexibility of raising capital, reduced compliance costs, and a lower risk of sharing proprietary information with competitors. Raising capital under Regulation D may also enable issuers to retain a more concentrated ownership and control structure (including greater founder control over the company’s future decisions). Similar to Regulation D, Regulation A enables issuers to forgo the registration process and provide less extensive disclosures. Unlike Regulation D, as shown below, the Regulation A offering market is much smaller. A. Regulation D 1. Institutional and Regulatory Background Regulation D was adopted in 1982 7 to provide a unified scheme for exempting certain securities offerings from the registration requirements of the Securities Act. It was designed to simplify existing rules and regulations to facilitate capital formation, particularly for small businesses, consistent with the protection of investors. At its inception, the Regulation D market was comprised of offerings undertaken in reliance on three rules: Rule 504, Rule 505, and Rule 506. Today, Regulation D offerings may be conducted under Rule 504, Rule 506(b), and Rule 7 Revision of Certain Exemptions From Registration for Transactions Involving Limited Offers and Sales, Release No. 33-6389 (Mar. 8, 1982) [47 FR 11251 (Mar. 16, 1982)]. 11 506(c). Rule 505 was repealed, in conjunction with certain amendments to Rule 504, effective May 22, 2017. Rule 504 Rule 504 of Regulation D provides an exemption from registration under the Securities Act for the offer and sale of up to $5 million of securities in a 12-month period. Reporting companies, investment companies, and certain development-stage companies are ineligible to issue securities under Rule 504. In October 2016, the Commission adopted amendments to expand Rule 504 and repeal Rule 505, with the changes effective May 22, 2017. Prior to these rule changes, Rule 504 limited the aggregate amount of securities that could be offered and sold in a 12-month period to $1 million, while Rule 505 (available to both non-reporting and reporting companies) limited the aggregate offering amount in a 12-month period to $5 million, subject to certain other conditions. In general, issuers relying on Rule 504 may not use general solicitation or general advertising to market the securities, and securities are restricted. These prohibitions are generally inapplicable if the issuer complies with state registration requirements, or state exemptions from registration for sales to accredited investors. 8 8 Rule 501 contains the definition of the accredited investor. Today, natural persons may qualify as accredited investors based on the following criteria: (1) Individuals who have a net worth exceeding $1 million (excluding the value of the individual’s primary residence), either alone or with their spouses; (2) Individuals who had an income in excess of $200,000 in each of the two most recent years, or joint income with the individual’s spouse in excess of $300,000 in each of those years, and have a reasonable expectation of reaching the same income level in the current year; and (3) Directors, executive officers, and general partners of the issuer or of a general partner of the issuer. Some entities may qualify as accredited investors based on their status alone. These entities include: (1) Banks, savings and loan associations, brokers or dealers registered pursuant to Section 15 of the Exchange Act, insurance companies, small business investment companies, investment companies registered under the Investment Company Act, or business development companies as defined in Section 2(a)(48) of that Act; (2) Private business development companies as defined in Section 202(a)(22) of the Advisers Act; and (3) Entities in which all of the equity owners are accredited investors. Other entities may qualify as accredited investors based on a combination of their status and the amount of their total assets. These entities include: (1) Tax exempt charitable organizations, corporations, Massachusetts or similar business trusts, or partnerships, not formed for the specific purpose of acquiring the securities offered, with total assets in excess of $5 million; (2) Plans established and maintained by a state, its political subdivisions, or any agency or instrumentality of a state or its political subdivisions, for the benefit of its employees, if such plan has total 12 Rule 506 Rule 506 was adopted in 1982 as a non-exclusive safe harbor under Section 4(a)(2) of the Securities Act. In 2013, the Commission amended Rule 506 pursuant to Title II of the JOBS Act, which directed the Commission to permit general solicitation and general advertising in certain Rule 506 offerings. (Prior to the JOBS Act, general solicitation had not been allowed for Rule 506 offerings.) Rule 506(c), which became effective on September 23, 2013, allows general solicitation and general advertising in Rule 506 offerings, without any limitation on amounts offered, as long as all purchasers are accredited investors and issuers take reasonable steps to verify that such purchasers are accredited investors. Rule 506, as it existed before the adoption of Rule 506(c), was preserved and re-designated as Rule 506(b). Offerings under both Rule 506(b) and Rule 506(c) must satisfy the conditions of (i) Rule 501 (definitions for the terms used in Regulation D); (ii) Rule 502(a) (integration); (iii) Rule 502(d) (limitations on resale); and (iv) Rule 506(d) (“bad actor” disqualification). Offerings under Rule 506(b) must also satisfy the conditions of (i) Rule 502(b) (type of information to be furnished); and (ii) Rule 502(c) (limitations on the manner of offering). Rule 506(b) is a non-exclusive safe harbor under Section 4(a)(2) of the Securities Act. It allows an issuer to offer and sell an unlimited amount of securities, provided that: (1) offers do assets in excess of $5 million; (3) Employee benefit plans (within the meaning of the Employee Retirement Income Security Act) if a bank, savings and loan association, insurance company, or registered investment adviser makes the investment decisions, or if the plan has total assets in excess of $5 million; and (4) Trusts with total assets in excess of $5 million, not formed for the specific purpose of acquiring the securities offered, the purchases of which are directed by a person who meets the legal standard of having sufficient knowledge and experience in financial and business matters to be capable of evaluating the merits and risks of the prospective investment. 13 not involve general solicitation or general advertising; and (2) sales are made only to accredited investors, or up to 35 sophisticated non-accredited investors. 9 2. Offering and Issuer Characteristics Below we discuss amounts of Regulation D capital raising, issuer types, and the distribution of issuer industries and locations. In Table 2 below, we present data on Regulation D offering and issuer characteristics. Data Sources Our analysis and the data presented are based on electronic Form D filings from 2009 through 2019 available on EDGAR. 10 (The Commission required the form to be filed on EDGAR starting in March 2009.) To address duplication, we consolidate multiple amended filings at the offering level, using the original “accession id” available in subsequent filings; thus, the number of unique offerings is less than the total number of filings during the same period. In offerings with amendments, “total amounts sold” reported in the amended filing are compared to the “total amounts sold” reported in the original filing to calculate incremental proceeds, which are attributed to the calendar year in which the amendment is filed. For offerings initiated prior to 2009 and continuing in subsequent years, an issuer’s only electronic filings during the considered period would have been Form D amendments. If these amendments reference a post-2008 sale 9 See Rule 506(b)(2)(ii) (stating that “[e]ach purchaser who is not an accredited investor either alone or with his purchaser representative(s) has such knowledge and experience in financial and business matters that he is capable of evaluating the merits and risks of the prospective investment, or the issuer reasonably believes immediately prior to making any sale that such purchaser comes within this description.”). 10 See also Scott Bauguess, Rachita Gullapalli, & Vladimir Ivanov, Capital Raising in the U.S.: An Analysis of the Market for Unregistered Securities Offerings, 2009–2017 (U.S. Sec. and Exchange Comm’n, DERA White Paper, Aug. 2018), available at https://www.sec.gov/dera/staff-papers/whitepapers/dera_white_paper_regulation_d_082018 (“Regulation D White Paper”). 14 date, the first amendment filed electronically is treated as an original Form D filing, as Form D was not filed electronically prior to 2009. A number of pooled investment funds appear to report, in their annual amendments, net asset values (NAVs) for total amount sold under the offering. NAVs could reflect fund performance as well as new investment into, and redemptions from, the fund. In the absence of detailed information in the filed form, we treat the “total amounts sold” as amounts raised in the offering. Finally, when an issuer checks the box to claim multiple offering exemptions (Rule 504, 505, or 506), for the purposes of this analysis, we assume that any issuer that checks the box for Rule 506 is relying on Rule 506. Comparative Data Where feasible, we provide comparative data for issuers that raised capital through registered offerings during 2009 through 2019 and also for the current set of reporting companies. We obtain data for issuers conducting registered offerings from SDC Platinum’s New Issues database. We select all registered public offerings conducted in the U.S. market during 2009 through 2019, excluding IPOs 11 and government/federal agency offerings. We obtain financial information for reporting companies from S&P’s Compustat, a commercial database that compiles, aggregates, and standardizes financial data reported by public companies. For the purposes of this analysis, we use data from Compustat North America (Fundamentals Annual) for the latest fiscal year that is available for all companies, as of the time of retrieval, in 11 For this analysis, we consider follow-on equity offerings and debt offerings as more appropriate benchmarks for Regulation D offerings because the motivations for conducting an IPO may extend beyond raising capital to meet a company’s financial needs. See, e.g., Marco Pagano, Fabio Panetta, & Luigi Zingales, Why Do Companies Go Public? An Empirical Analysis, 53 J. FIN. 27 (1998) (showing that companies go public after a period of strong investment and growth to capitalize on higher valuations, to reduce leverage and cost of debt, and for change in control). 15 the database. The data presented in the tables and figures below may be incomplete for small and non-exchange-listed public companies. Capital Raising under Regulation D Table 2 below presents summary statistics for Regulation D capital raising activity and issuer characteristics. 12 Almost all of the capital raised in the Regulation D market is raised under Rule 506(b). For 2019, of the approximately $1.56 trillion raised through Regulation D, Rule 506(b) offerings accounted for $1.5 trillion, which exceeds the capital raised in 2019 through registered offerings ($1.2 trillion). Offerings under Rule 506(c) raised approximately $66 billion, and offerings under Rule 504 raised approximately $228 million. 12 See also Harmonization Concept Release; Regulation D White Paper, supra footnote 10. 16 Table 2. Summary of Regulation D Issuer and Offering Characteristics, 2009–2019 13 Number of Issuers 173,697 Number of Offerings 242,070 Amounts Reported Sold $13,576 billion Mean Amount Sold (if reported) $58 million Median Amount Sold (if reported) $1.50 million Mean Offer Size (if reported) $71 million Median Offer Size (if reported) $2.25 million Median Years Since Incorporation 2 Median Issuer Size (if reported) Private Funds (Net Asset Value) Non-Fund Issuers (Revenue) Used Intermediary $25 million - $50 million $1 million - $5 million 20% Total Investors As reported in initial Form D filings All filings, including amendments Average Investors/Offering (if reported) 13 3.4 million 5.9 million 10 The number of issuers is based on a unique Central Index Key (CIK) identifier. Number of offerings represents all new offerings initiated during the period 2009 through 2019, as represented by a Form D filing, and offerings initiated prior to 2009 but continuing into the period 2009 through 2019 (as represented by an amendment filed). Amounts Reported Sold is calculated as described above and includes amounts sold reported in initial Form D filings and incremental amounts sold reported in amendment filings. Total number of investors, as reported in Form D and Form D/A filings, is calculated similarly. Issuers are not required to file a Form D at the close of offering. Not all offerings report amounts raised sold in their initial Form D filing. 17 Table 3 14 below summarizes recent data on the state of the Regulation D market. Table 3. Offerings by Exemptions Available under Regulation D in 2019 Rule 504 Rule 506(b) Rule 506(c) Regulation D Total Number of New Offerings 476 24,636 2,269 27,381 Amount Reported Raised $0.2 billion $1,491.9 billion $66.3 billion $1,558.4 billion Reporting Company and Listing Status Table 4 below presents a classification of the reporting and trading status of Regulation D issuers during the 2009 through 2019 time period. 15 Approximately 2% of all Regulation D issuers are also reporting issuers and are listed on a stock exchange or quoted on the OTC market. Almost 90% of offerings by non-fund issuers raise capital through equity securities. 14 This table includes Regulation D offerings for all issuers, including pooled investment funds. Data are obtained from Form D filings. The amount raised is based on “Total amount sold” in new and amended Form D filings. Incremental proceeds reported in amended filings are recorded in the year of the amended filing. We believe reported data is likely an underestimate of the amount raised because (1) Rule 503 of Regulation D requires issuers to file a Form D no later than 15 days after the first sale of securities, but a failure to do so does not invalidate the exemption; so, some Regulation D issuers may fail to file a Form D (we note that, while failure to file Form D does not affect the exempt offering, it could have other consequences, including, under Rule 507, the potential loss of ability to rely upon Regulation D in the future), and (2) there is no requirement to file a Form D at completion of the offering, or to file an amendment to reflect additional amounts offered if the aggregate offering amount does not exceed the original offering size by more than ten percent (so, amounts reported may be lower than total amounts sold). 15 We obtain this information by merging the list of Regulation D issuers with Compustat North America data using CIK as the common identifier, which yields matches for 4,108 unique Regulation D issuers. This includes some companies that became reporting companies subsequent to their Regulation D offering. Trading venue for reporting company Regulation D issuers is based on Compustat data reported during calendar year 2019 or later. Trading venue for issuers conducting registered offerings is based on SDC Platinum data. The proportion of U.S. exchange-listed issuers is close to 90% for registered equity offerings. 18 Table 4. Reporting Company and Listing Status of Regulation D Issuers Regulation D Issuers 2009–2019 Reporting Companies Exchange-Listed OTC - Bulletin Board OTC - Other No Trading Market / Unknown Non-Reporting Companies Private Funds Private Non-Fund Issuers 2,184 23 1,852 51 67,582 102,007 TOTAL 173,697 As the table above shows, almost half of the 4,108 reporting companies that are also Regulation D issuers are OTC companies. This is a much larger proportion than the share of OTC companies in the current set of all reporting companies (23%), and is also larger than the proportion of OTC companies in the subset of companies that raised capital through a registered offering during 2009 through 2019 (22%). (See Figure 1 below.) 19 Figure 1. Secondary Market Trading Status of Regulation D Issuers that are Reporting Companies 16 54% 45% Regulation D issuers that are Reporting companies 1% 71% Issuers with Registered offering during 2009-2019 22% U.S. Exchange Listed OTC/ Pink Sheet 7% Foreign listed/ Private/Unknown 73% All Reporting issuers 23% 4% 0% 16 20% 40% 60% 80% Some Regulation D issuers became reporting companies subsequent to their private offering. The proportions remain similar (53% exchange-listed; 46% OTC) when we consider only those Regulation D issuers that were reporting companies during the year they conducted their Regulation D offering. 20 Industry Distribution Table 5 below presents the industry distribution of Regulation D issuers, issuers that conducted a follow-on registered equity or debt offering during the 2009 through 2019 period, and all reporting companies (based on information reported in calendar year 2019 or later). 17 The largest number (39%) of Regulation D issuers are from the pooled investment fund industry. Among non-fund Regulation D issuers, most issuers are in the technology, real estate, health care, and financial services industries. Table 5. Industry Distribution of Regulation D Issuers and Reporting Companies (2009– 2019) Regulation D Issuers Issuers with a Registered Offering All Reporting Companies Private Funds 38.9% Not applicable Not applicable Agriculture 0.8% 0.2% 0.2% Banking/Financial 7.6% 19.9% 39.0% Business Services 1.6% 6.2% 1.8% Energy 6.0% 11.3% 6.4% Health Care 10.0% 19.2% 11.2% Manufacturing 2.7% 11.1% 9.8% Other 21.4% 7.0% 12.7% Real Estate 25.5% 7.3% 4.1% Restaurants 1.8% 0.8% 0.7% Retailing 2.0% 2.3% 2.1% Technology 20.0% 12.9% 11.2% Travel 0.7% 1.7% 0.8% Industry Geographic Distribution 17 Industry information for Regulation D issuers is based on Form D data, which use a broader industry classification. See https://www.sec.gov/files/formd.pdf. Industry information for reporting companies is based on Compustat data reported in 2019 or later. Industry information for issuers with follow-on equity or registered debt offerings is obtained from SDC Platinum. For comparability, SIC-based industry definitions for reporting companies and registered offerings are converted to the Form D industry classification. 21 Most Regulation D issuers are located, in terms of principal place of business, in California or New York (see Figures 2 and 3 below), 18 even though many are incorporated in Delaware. The next largest states based on principal place of business are Texas, Florida, and Massachussetts. This is similar to reporting companies, whose top five states of headquarters locations are California, New York, Illinois, Texas, and Massachusetts. While 9% of offerings are conducted by Regulation D issuers that are headquartered outside of the United States, 20% of reporting companies (as reported in 2019) were located abroad, and 15% of registered offerings conducted in the United States during 2009 through 2019 were undertaken by companies located in a foreign country. During 2009 through 2019, approximately 10% of Regulation D offerings were initiated by foreign-incorporated companies. By comparison, 30% of reporting companies and approximately 13% of issuers conducting registered offerings 19 were incorporated outside of the United States based on information filed during 2019. 18 Figure 2 is based on Form D initial filings, excluding amendments, and includes offerings by operating companies and pooled investment funds. Figure 3 is based on amounts reported raised in Form D initial filings and amendments and includes offerings by operating companies pooled investment funds. 19 For issuers conducting registered offerings, SDC data on country of incorporation is available only for 63% of observations. 22 Figure 2. Number of Regulation D Offerings by Issuer Headquarters Location (2009–2019) Figure 3. Regulation D Amounts Sold by Issuer Headquarters Location (2009–2019) bln = billion 23 Issuer Size and Age Distribution Figure 4 below shows the distribution of issuer revenue ranges as reported in Item 5 of Form D. Most issuers conducting Regulation D offerings that report their revenues on Form D tend to be small. Although most non-fund issuers decline to disclose their revenues (65%), for those that do, most have revenues of less than $1 million. Issuers that report more than $100 million in revenues account for only about 1% of the number of all new offerings. 20 Not surprisingly, among Regulation D issuers that report size, large issuers (greater than $100 million in revenue) account for a greater share of proceeds. Large Regulation D issuers include private companies as well as exchange-listed companies and large OTC companies. By comparison, 65% of reporting companies and 83% of reporting companies that conducted a follow-on registered offering during 2009 through 2019 reported revenues exceeding $100 million. 21 20 Form D also contains information on NAV of hedge funds and other investment funds. Since 2009, more than three-quarters of issuers have declined to disclose NAV, but of those that do, a trend similar to revenue is reported—the largest number of issuers is in the smallest NAV categories. 21 Calculated based on DERA analysis of SEC reporting companies that had a class of equity security with a market price reported in Compustat at the end of fiscal year 2018 and as reported during calendar year 2019 or later. Data for fiscal year 2019 were still being filed as of the time of this analysis and will be comprehensively available in Compustat with a lag. 24 Figure 4. Size Distribution of Non-Fund Regulation D Issuers (2009–2019) Over $100,000,000 0.9% $25,000,001 - $100,000,000 1% 1.0% $5,000,001 - $25,000,000 1% 2.3% $1,000,001 - $5,000,000 1% 3.8% $1 - $1,000,000 3% Not Applicable 3% 2.2% No Revenues 4% 11% 9.8% 15.4% Decline to Disclose 64.5% 0% 20% 40% Amounts Sold 60% 77% 80% Number of Issuers The small reported size of Regulation D issuers is also consistent with their young age, as measured by years since incorporation. Seventy percent of Regulation D issuers were incorporated for less than 3 years when they initiated their offering. This includes 87% of fund issuers and 63% of non-fund issuers. (See Figure 5 below.) While data on date of incorporation is not available for reporting companies in our data source, previous research has indicated that reporting companies tend to be older than 3 years when they have their IPOs. 22 Among reporting companies with available data on the date of their IPO, more than 80% had their IPO prior to 2015. 22 Prior empirical research finds that the median age of firms conducting an IPO during 1980-2003 was relatively stable at seven years. See, e.g., Tim Loughran and Jay Ritter, Why Has IPO Underpricing Changed Over Time?, 33 FIN. MGMT. 5 (2004). 25 Figure 5. Regulation D Issuer Age, 2009–2019 100% 80% 60% 40% 20% 0% Funds 1 year or less Non-Funds 2-3 years 4-5 years greater than 5 Trends in Regulation D Offerings Almost 90% of offerings by non-fund issuers raise capital through equity securities. A substantial amount of empirical research has documented that public capital markets are procyclical and appear to be affected by business cycles, investor sentiment, and time-varying information asymmetry. 23 Figure 6 below shows Regulation D offering activity on the basis of the number of new Form D filings (excluding amendments) on EDGAR, by calendar year, plotted alongside the S&P 500 index levels, for the period 1993 through 2019. The data indicate that Regulation D offerings, similar to public capital markets, are also driven by business cycles. 23 See, e.g., Michelle Lowry, Why Does IPO Volume Fluctuate So Much?, 67 J. FIN. ECON. 3 (2003); Aydogan Alti, IPO Market Timing, 18 REV. FIN. STUD. 1105 (2005); Chris Yung, Gonul Colak, & Wei Wang, Cycles in the IPO Market, 89 J. FIN. ECON. 192 (2008). 26 30,000 3,500 25,000 3,000 2,500 20,000 2,000 15,000 1,500 10,000 1,000 5,000 0 500 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 New Regulation D offerings 0 S&P500 Index B. Regulation A 1. Institutional and Regulatory Background The Commission originally adopted Regulation A in 1936 as an exemption for small issuers under Section 3(b) of the Securities Act, the Commission’s exemptive authority for offerings of up to $5 million. 24 Title IV of the JOBS Act redesignated Section 3(b) as Section 3(b)(1) and added new Sections 3(b)(2) through 3(b)(5) to the Securities Act. 25Section 3(b)(2) directed the Commission to adopt rules adding a class of securities exempt from the registration requirements of the Securities Act for offerings of up to $50 million of securities within a 12-month period. Sections 3(b)(2) through (5) specify certain terms and 24 See Release No. 33-632 (Jan. 21, 1936). 25 See Release No. 33- 9741 (Mar. 25, 2015). 27 S&P 500 Index Number o f Offerings Figure 6. Number of Regulation D Offerings (1993-2019) conditions for such exempt offerings and authorize the Commission to adopt other terms, conditions, or requirements as necessary in the public interest and for the protection of investors. In 2015, the Commission adopted final rules to implement Section 401 of the JOBS Act by creating two tiers of Regulation A offerings: Tier 1, for offerings of up to $20 million in a 12month period; and Tier 2, for offerings of up to $50 million in a 12-month period. In adopting the two-tiered structure for Regulation A in 2015, the Commission stated that it expected the requirements for Tier 1 to result in securities offerings that would be more local in character, while Tier 2 offerings would likely be more national in character. While an issuer of $20 million or less of securities can elect to proceed under either Tier 1 or Tier 2, Tier 2 issuers are subject to additional requirements. For example, Tier 2 issuers are required to include audited financial statements in their offering circulars (Part F/S of Form 1-A) and must provide ongoing reports on an annual and semiannual basis with additional requirements for interim current event updates, therefore providing a continuous flow of information to investors and the market (Rule 257 of Regulation A). Tier 2 offerings are not subject to state securities law registration and qualification requirements, while Tier 1 offerings remain subject to those state requirements. In addition to expanding the Regulation A offering limit and establishing an ongoing reporting regime for Tier 2 issuers, the 2015 amendments sought to modernize the Regulation A filing process (including by requiring electronic filing), align practice in certain areas with prevailing practice for registered offerings, and create additional flexibility for issuers in the offering process. In 2018, the Commission amended Regulation A, making reporting companies eligible under Regulation A. 28 2. Offering and Issuer Characteristics Table 6 below summarizes information on issuer and offering characteristics in qualified Regulation A offerings during the period from the 2015 Regulation A amendments through the end of 2019 (the most recently completed calendar year). Table 6. Regulation A Issuer and Offering Characteristics 26 Metric Mean Median Total assets $32,582,700 $311,500 Employees 38.9 2.5 Age (years since incorporation) 6.6 3.0 $2,642,800 $0 Revenue % revenue >0 47% Net income -$490,100 % net income >0 -$14,000 21% Cash and cash equivalents $1,842,700 $31,200 Property, plants, and equipment $4,677,200 $0 Long-term debt $5,758,900 $0 % continuous offerings 80% % testing the waters 27% % offerings with affiliate selling security holders 6% States of solicitation 38 % equity offerings 93% 51 Although issuers are highly heterogeneous, to date, most issuers in qualified Regulation A offerings have been small (based on assets and revenues) and relatively young. Among the issuers with revenue information available, just under one-half had generated revenue. Turning 26 Statistics are based on qualified offering statements. The information is based on Part I of Form 1-A of Regulation A offering statements or latest amendment qualified between June 2015 and December 2019. See infra footnote 110. Certain security types characterized as “other” were reclassified as equity or debt based on description. Revenue information was not available for approximately 5.5% of issuers. 29 to offering characteristics, most offerings (93%) involved equity securities, were conducted on a continuous basis (80%), and did not report sales by affiliated security holders (94%). Offerings were generally conducted on a best-efforts basis. 27 Over one-quarter of qualified offerings used testing the waters (solicitation of investor interest), almost all of which were Tier 2 offerings. The median offering involved national solicitation by the issuer or intermediary, but solicitation was generally limited to a handful of states in Tier 1 offerings (median of three among qualified Tier 1 offerings). Secondary Trading Market Between June 2015 and December 2019, the majority of Regulation A issuers lacked a liquid secondary trading market for their securities. Table 7 and Figure 7 below summarize data on secondary trading markets for Regulation A issuers. Table 7. Secondary Trading Market of Regulation A Issuers 28 Market Issuers % Exchange-listed OTC No market identified Total 11 75 260 346 3.2% 21.7% 75.1% 100% 27 Information in Part I of Form 1-A across qualified offerings (or latest amendment qualified between June 2015 and December 2019) indicates that 93% of the offerings reported being best-efforts offerings. Some of the remaining offerings were associated with mergers and dividend reinvestment plans, while some others may reflect inaccuracies in tagging. We are not aware of firm commitment underwriting in this market segment. 28 Information on exchange listing was based on searches of CERT submissions and news searches and excludes issuers delisted as of December 31, 2019. Information on OTC quotation was based on data from OTC Markets as of the end of December 2019. Among OTC issuers, 14 were identified as being quoted on either OTCQX or OTCQB and 61 were identified as being quoted on OTC Pink. No issuers were identified as being quoted on the OTC Bulletin Board. For issuers with multiple classes of securities, we cannot determine whether the class issued in a Regulation A offering is quoted on the OTC market. Grey market issuers are excluded. Among securities quoted on the OTC market, liquidity can vary significantly from issuer to issuer and is on average lower than the liquidity of securities listed on major exchanges. Many filers mention a lack of a public market for their securities in their disclosures. 30 Figure 7. Secondary Trading Market of Regulation A Issuers No market identified 260 OTC Exchange listing 75 11 Relatively few reporting companies relied on Regulation A during this period. The amendments to permit reporting companies to use Regulation A became effective on January 31, 2019. Approximately 17 reporting companies sought to use Regulation A to conduct an offering in 2019, of which 11 offerings were qualified. The impact of reporting companies’ eligibility to rely on Regulation A on capital formation and investor protection remains to be seen. Industry Distribution The industry distribution reflects a heavy concentration of offerings in the finance sector (primary Standard Industrial Classification (SIC) codes between 6000 and 6999). Figure 8 below shows the industry distribution of the amounts sought in qualified Regulation A offerings. Finance, insurance, and real estate accounted for 53% of financing sought in qualified Regulation A offerings. Examining more granular SIC code data suggests that financial issuers were frequently real estate investment trusts (REITs) and other real estate companies, other holding companies, non-depository credit institutions, and commercial banks. The most common industry among nonfinancial issuers in qualified offerings was business services (which includes software), followed by chemicals. 31 Figure 8. Capital Sought in Qualified Regulation A Offerings, by Issuer Industry 29 Transport, communic., utilities 3% Agric., forestry, fishing 1% Services 18% Retail & wholesale 5% Pub. admin. & nonclass. 0% Mining & construction 2% Finance, insurance, real estate 53% Manufacturing 18% Figure 9 below shows the industry distribution of the proceeds reported in Regulation A offerings. The finance sector accounted for 79% of reported proceeds (with real estate issuers accounting for 69% of all reported proceeds). The most common industry among nonfinancial issuers was transportation equipment, followed by business services. 29 See infra footnotes 110 and 111. The industry is based on the primary SIC code as reported in Part I of Form 1-A or the latest amendment to it. 32 Figure 9. Proceeds Reported in Regulation A Offerings, by Issuer Industry 30 Retail & wholesale 3% Services 4% Transport, Agric., forestry, fishing communic., utilities 0% 2% Mining & construction 0% Manufacturing 12% Finance, insurance, real estate 79% Geographic Distribution Close to 50% of qualified offerings were by issuers incorporated in Delaware, with an additional 13% by issuers incorporated in Nevada. As with reporting companies, headquarters location often differs from the state of incorporation. Figure 10 below summarizes the geographic distribution of financing sought in qualified Regulation A offerings, by state of issuers headquarters location. Issuers headquartered in California accounted for 24% of the aggregate amounts sought, followed by Washington, D.C. (16%) and Florida (9%). Figure 11 below summarizes the geographic distribution of the proceeds reported in Regulation A offerings, by state of issuer headquarters location. Issuers headquartered in Washington, D.C., accounted for 36% of reported proceeds (due to one large 30 See infra footnote 111. The industry is based on the primary SIC code as reported in Part I of Form 1-A or the latest amendment to it. 33 REIT sponsor headquartered in Washington, D.C.), followed by California (13%) and Utah (7%). Figure 10. Capital Sought in Qualified Regulation A Offerings, by Issuer Location 31 Figure 11. Proceeds Reported in Regulation A Offerings, by Issuer Location 32 mln = million 31 See infra footnote 110. The state of location is based on the state of headquarters location as reported in Part I of Form 1-A or the latest amendment. The maps exclude Alaska, Hawaii, and U.S. territories. Those areas did not have issuers with qualified Regulation A offerings between June 2015 and December 2019. 32 See supra footnote 31 and infra footnote 111. 34 III. Evidence on the Performance of Regulation A and Regulation D offerings and issuers Below we analyze evidence on the performance of Regulation A and Regulation D offerings, based on primary data, where they are available, and the analysis of data from research studies and other external reports. We start by discussing the performance measures and data limitations (Section III.A). Next, we present the evidence on the performance of Regulation D (Section III.B) and evidence on the performance of Regulation A (Section III.C). A. Performance Measures and Data Considerations Measures At the outset, we acknowledge that “performance” can mean different things for issuers, investors, and capital markets. From the perspective of issuers relying on exemptions under Regulation A and Regulation D, offering performance can be assessed as a capital-raising tool. Issuers choosing to rely on a particular offering method to meet their external financing needs may weigh the amount of capital they can raise to fund their businesses or investment projects against the cost of raising capital using that offering method. From the perspective of investors, performance can be measured in several ways: (1) subsequent operating and financial performance of the issuer (e.g., profitability and growth); (2) for private issuers, the incidence of subsequent financing rounds, public market exits, acquisition exits, and business survival; and (3) for public issuers (and the subset of private issuers with return information, such as those private funds that provide such information), returns. A binary metric of issuer performance that can also be highly relevant for investors in a Regulation A or Regulation D offering is the incidence of fraud or another securities law violation. Finally, the breadth of additional investment opportunities that become available when issuers can utilize these exemptions, which can be used to diversify investor portfolios relative to investing only in 35 public companies, can also be used to characterize the performance of the Regulation A and Regulation D exemptions from the standpoint of investors. Data Sources We collect the data for the discussed performance measures from the following sources. We extract data on the exemptions’ performance as a capital-raising tool from EDGAR filings. We use Form D filings to obtain data for Regulation D issuers. Data on Regulation A issuers are based on Form 1-A filings and amendments to those filings, offering circular supplements, annual reports on Form 1-K, semi-annual reports on Form 1-SA, current reports on Form 1-U, exit reports on Form 1-Z for Regulation A issuers, as well as Exchange Act reports for Regulation A issuers that are, or become, Exchange Act reporting companies. We obtain data on issuer financial and operating performance from EDGAR filings and Compustat, where available. We gather market data for traded issuers from Center for Research in Security Prices (CRSP)/Compustat and OTC Markets, where specified. Information on mergers and acquisitions (M&A) and public market exits and follow-on capital raises is collected from EDGAR filings, SDC Platinum, and S&P Capital IQ. Information on private fund returns is obtained from commercial databases (Preqin for private equity (PE) funds and HFM Global (HFM) (formerly known as Hedge Fund Intelligence (HFI)), Eureka, TASS, and BarclayHedge for hedge funds). Primary data on the performance of Regulation A and Regulation D offerings are supplemented with statistics obtained from external sources, including research studies and industry reports. Data Limitations We acknowledge several limitations on our analysis related to the features of exemptions and availability of data. Because of the nature of the market, with most issuers not publicly traded on an exchange or quoted on the OTC market, as well as the scaled or very limited 36 disclosure requirements applicable to most issuers offering securities under Regulation A and Regulation D, comprehensive performance data are not available for all issuers and offerings, and some of the available data are noisy. 33 For example, trading information is available only for a subset of operating company issuers in Regulation D offerings that are either exchangelisted or quoted on the OTC market; and even where trading information is available, the traded class of securities generally does not have the same terms and characteristics as the securities offered under Regulation D. 34 Trading information is also available only for a small number of Regulation A issuers that have obtained an exchange listing after the offering, as well as for those Regulation A issuers that are quoted on the OTC market. Return information is available for a subset of private funds, including hedge funds and PE funds that rely on Regulation D. Such data may be an incomplete representation of the riskadjusted performance of the full set of private fund issuers relying on Regulation D for several reasons. Comprehensive data on returns of all pooled investment funds relying on Regulation D are not required to be disclosed. Data from commonly used databases is provided voluntarily and so may be affected by selection bias, resulting in overrepresentation of funds and fund-years with better risk-adjusted performance. Further, because of the differences in reporting entity identifiers, we are not able to match such data to individual Regulation D offerings. Thus, some offerings conducted under other exemptions from registration under the Securities Act and Investment Company Act of 1940 (“Investment Company Act”) may be represented in the 33 For instance, some of the performance data are manually collected from filings in an unstructured format or automatically collected from filings in a structured format, such as XML. Data may contain noise, particularly in cases of unaudited or restated financial statements or filings with tagging errors. 34 For example, securities issued under Regulation D are restricted securities that may only be resold in a limited set of circumstances, in particular, pursuant to an effective registration statement under the Securities Act or a valid exemption from registration for the resale, such as Section 4(a)(1) of the Securities Act, or the nonexclusive safe harbor of Rule 144. See https://www.sec.gov/fast-answers/answersrestrichtm.html. 37 statistics, and some fund offerings conducted under Regulation D may not be included in the presented statistics. Data on survivorship of issuers in Regulation A and Regulation D offerings are also affected by noise. Measuring survivorship through the presence of subsequent EDGAR filing activity significantly underestimates survivorship because many Regulation A and Regulation D issuers do not incur ongoing reporting obligations under either the Exchange Act or Regulation A. Measuring survivorship through the absence of bankruptcy filings may significantly overestimate survivorship because many smaller issuers that either do not have significant liabilities or that do not have significant assets recoverable through a bankruptcy proceeding will likely liquidate without a bankruptcy filing. Performance data available for private issuers are not directly comparable to the data for public issuers on the basis of similar metrics. For example, return data for Regulation A and Regulation D issuers quoted on the OTC market are not directly comparable to return data on exchange-listed securities, because the OTC market has significantly lower liquidity and a higher incidence of days with no trading. As another example, where return data for private securities are available (e.g., in the case of private fund returns), a direct comparison to the returns on publicly traded assets may be difficult because of a lack of comparability. Private investments are characterized by different risk exposures (e.g., nontraditional systematic risk factors in private fund portfolios), illiquidity (e.g., because of restricted status of securities, contractual provisions such as lock-up periods, and/or a lack of a secondary trading market), and high transaction costs (including trading, due diligence, and search costs). This lack of comparability is an outgrowth of individual market segments being designed to meet specific needs of different types of issuers and attract specific investor clienteles through offering transactions. 38 It is unclear whether our findings can be extrapolated beyond the specific time period under consideration. Unless specified otherwise, our data end at the end of the most recently completed full year of data (2019). For Regulation D, the analysis begins in 2009 because electronic data on Regulation D became available in the second quarter of 2009. For Regulation A, the analysis begins in mid-2015, when the amendments became effective and electronic data on issuers and offerings became available. The 2009-2019 period coincided with generally favorable market conditions. We recognize that evidence on performance obtained during boom periods may not apply to other periods. Therefore, where available, we supplement primary performance data on private investments with evidence from related academic literature spanning earlier periods and greater variation in macroeconomic cycles. Sections III.B. and III.C below present the available evidence on the performance of Regulation A and Regulation D. These exemptions have unique characteristics and associated differences in data availability, sample construction, and appropriate benchmarks. Further, the two market segments are vastly different in size, with annual Regulation D proceeds exceeding annual reported Regulation A proceeds by an order of magnitude of 1000x. Therefore, we present the analysis for the two exemptions separately. B. Regulation D Below we present evidence from primary data analysis and synthesis of existing studies on the performance of Regulation D as a capital-raising tool and on the performance of Regulation D investments. In line with prior work, we analyze performance of funds and nonfund issuers separately because of the unique institutional characteristics and aspects of performance data and metrics applicable to these two categories of issuers. 39 1. Performance of Regulation D as a Capital-Raising Tool First, we consider the performance of Regulation D as a capital-raising tool and as a source of diverse investment opportunities. As described above, Regulation D has accounted for a large amount of capital formation. Total capital raised annually in the private capital market is large both in absolute terms and when compared to the amounts raised in the public markets. (See Figure 12 below.) In 2019, registered offerings of equity and debt accounted for approximately $1.2 trillion of new capital, compared to more than $2.7 trillion reported raised through all unregistered offering channels. 35 Of this, the largest amount was raised by Regulation D offerings—approximately $1.6 trillion—which is considerably larger than the amount of public debt (straight and convertible) and public equity (common and preferred) offerings over the same time. Over the 2009 through 2019 period, $13.6 trillion was raised through Regulation D offerings compared to $14.1 trillion raised through registered offerings of debt and equity, including IPOs. As shown in Figure 12 below, in each of the years since 2017 through 2019, the amounts raised in the Regulation D market have surpassed aggregate amounts raised through registered offerings of debt and equity. 35 See Harmonization Proposing Release, at n. 12. Besides Regulation D, other unregistered offerings include offerings relying on Rule 144A, Regulation A as described above, Regulation Crowdfunding, Regulation S, and Section 4(a)(2) of the Securities Act. By its terms, Rule 144A is available solely for resale transactions. However, market participants use it to facilitate capital raising by issuers by means of a twostep process, in which the first step is a primary offering on an exempt basis to one or more financial intermediaries, and the second step is a resale to “qualified institutional buyers” in reliance on Rule 144A. 40 Figure 12. Aggregate Capital Reported Raised in 2009–2019 through Regulation D Offerings and Registered Offerings 36 ($ billion) $2,000 $1,800 $1,600 Amounts Raised ($ billion) $1,400 $1,200 $1,000 $800 $600 $400 $200 $- 2009 2010 2011 Public Equity Offerings 2012 2013 2014 2015 Public Debt Offerings 2016 2017 2018 2019 Regulation D Offerings Table 8 below estimates the size of the private and public markets in terms of number of offerings per year. As the table shows, offerings in the private market occur with a significantly higher frequency compared to public market issuances. Regulation D offerings occur with far greater frequency than any other offering method surveyed, indicating that the accumulation of capital raised through Regulation D occurs by way of much smaller offering denominations than other methods. This finding is consistent with Regulation D being the primary tool for capital raising by smaller entities. Table 8. Number of Regulation D Offerings and Registered Offerings by Year (2009–2019) Year Public Equity Offerings- IPOs Registered Follow-on Equity Offerings Registered Debt Offerings Regulation D Offerings 37 36 In this figure, amounts raised in public equity offerings include amounts raised in IPOs. 37 These represent offerings that were initiated during the year or were active during the year. Generally, offerings by pooled investment funds are continuous in nature and extend into multiple years. 41 2009 68 874 1,445 18,295 2010 200 872 1,930 25,993 2011 201 662 1,465 27,336 2012 206 748 1,473 28,184 2013 283 967 1,510 30,429 2014 347 829 1,576 33,429 2015 218 767 1,565 34,877 2016 119 702 1,636 35,793 2017 178 798 1,846 37,785 2018 269 723 1,641 40,417 2019 244 685 1,484 41,196 Relative to registered markets, where the majority of capital is raised through fixed maturity debt, approximately two-thirds of Regulation D offerings represent new equity capital. Registered offerings of new equity capital constitute less than 17% of the overall capital raised through registered offerings. Next, we characterize the available data on the composition and diversity of investment opportunities available in Regulation D offerings. The largest category of issuers in the Regulation D capital market, based on the amount sold, are pooled investment funds (predominantly private funds), which include hedge funds, venture capital (VC) funds, PE funds, and other pooled investment funds, according to the classification on Form D. 38 Since the 38 Other pooled investment funds include, for example, commodity pools and registered investment companies. Commodity pools are investment trusts, syndicates, or similar enterprises that are operated for the purpose of trading commodity futures. Registered investment companies are entities such as mutual funds that issue securities to investors, hold pools of securities and other assets, and are registered with the Commission under the Investment Company Act. Other pooled investment funds also include private funds that would be investment companies but for the exclusion provided in Sections 3(c)(1) or 3(c)(7) of the Investment Company 42 Commission first required electronic filing of Forms D in 2009, pooled investment funds have accounted for $11.7 trillion of new capital raised through Regulation D offerings and reported on Form D, compared to approximately $2 trillion raised by non-funds. Hedge funds are the largest category of fund issuers in the Regulation D market, having raised more than $4 trillion of new capital during this period. In terms of the amounts raised by fund type, PE funds raised the largest mean amount. A breakdown of the number of offerings and amount of capital raised during 2009 through 2019 by type of pooled investment fund, as reported by issuers in Item 4 of Form D, is presented in Table 9 below. Table 9. Number of Offerings and Amounts Raised by Fund Type, 2009–2019 Pooled Investment Funds Hedge Funds Private Equity Funds Venture Capital Funds Other Investment Funds Number of Offerings Aggregate Amounts Reported Sold ($ billion) Mean Amounts Reported Sold ($ million) Median Amounts Reported Sold ($ million) 65,591 $11,738.0 $179 $16 20,242 17,939 8,437 18,973 $4,022 $3,215 $308 $4,193 $199 $179 $37 $221 $26 $33 $3 $6 While funds dominate in terms of amounts sold in the Regulation D market, non-fund issuers initiated almost three-fourths of new offerings. (See Figure 13 below.) Of the non-fund offerings that identified a specific industry, most were from the Finance/Banking/Insurance, Technology, and Real Estate industries. Almost 22% of offerings check “Other” for industry, for Act. While some registered investment companies use Regulation D, based on our analysis of Form D data, the overwhelming majority (99.7%) of pooled investment fund offerings reported on Form D are excluded from the definition of “investment company” under the Investment Company Act. Very few Form D fund issuers are identified as mutual funds in Morningstar data (based on CIK identifiers, where available). Thus, for purposes of evaluating the performance of pooled investment fund Regulation D issuers, we focus on private fund returns. 43 which further information is not available. In terms of total amounts reported to be raised, the top industries were Banking & Financial, Technology, and Real Estate. (See Figure 14 below.) Similar to Regulation D, industries with the largest amounts raised in registered offerings were Banking & Financial and Technology, followed by Manufacturing and Energy. Figure 13. Number of Offerings and Amounts Raised by Fund and Non-Fund Regulation D Issuers: 2009–2019 Number of Offerings Amounts Raised Private Funds 86% Private Funds 19% Non Fund Issuers 81% Non Fund Issuers 14% 44 Figure 14. Number of Offerings and Amounts Raised by Non-Fund Industry (2009–2019) 40% 40% 30% 30% 20% 20% 10% 10% 0% 0% Number Regulation D Offerings Number of Registered Offerings Regulation D - Amount Sold Registered Offerings - Amounts Sold Consistent with the large number of non-fund offerings and the smaller proportion of capital they raised in the Regulation D market, the median offering size for non-fund issuers is substantially lower than the median offering size for funds. During 2009 through 2019, the median offer size of non-fund issuers was $1 million (see Table 10 below). This indicates a large number of small offerings by non-fund issuers, consistent with the original regulatory objective to target the capital formation needs of small businesses. As the table below shows, mean and median amounts raised in Regulation D offerings are significantly smaller than the amounts raised in registered offerings, across all industries. 45 Table 10. Mean and Median Amount Raised by Offering and Industry Type (2009–2019) Offering Type Regulation D Public Equity (nonIPO) 39 Public Debt Amounts Raised ($ million) Mean Median Mean Median Mean Median Private Funds $179 $16 n.a. n.a. n.a. n.a. Agriculture $10 $1 $86 $11 $528 $500 Banking/Financial $40 $2 $362 $75 $581 $400 Business Services $6 $1 $200 $80 $580 $399 Energy $18 $1 $288 $170 $550 $449 Health Care $9 $2 $83 $30 $753 $595 Manufacturing $12 $1 $206 $81 $582 $498 Other $10 $1 $172 $82 $438 $399 Real Estate $12 $2 $250 $146 $393 $349 Restaurants $4 $1 $252 $105 $604 $499 Retailing $8 $1 $289 $208 $866 $650 Technology $8 $1 $169 $59 $993 $750 Travel $6 $1 $417 $200 $466 $447 Intermediaries in securities offerings serve an important role in reducing information asymmetry about issuers and in lowering search costs involved in matching issuers with investors. While intermediation is widespread in registered offerings of debt and equity, it is much less common among unregistered offerings. On the basis of Form D data, we find approximately 20% of Regulation D offerings initiated during 2009 through 2019 reported using an intermediary to raise capital. The use of intermediaries is different across issuer types and 39 See supra footnote 11. 46 industries. Among Regulation D issuers, 28% of offerings by financial issuers and 21% of private fund offerings reported using an intermediary, while approximately 15% of offerings by operating companies (i.e., non-fund, non-financial companies) used an intermediary in their offerings. The biggest users of intermediaries are issuers in the real estate industry (35%) and energy industry (32%). There is also significant variation in fees paid between fund and nonfund issuers. Private funds, on average, paid approximately 2% during the 2009 through 2019 period, while non-fund issuers paid approximately 5.4% on average. A large proportion of investors in Regulation D offerings are accredited investors. While Rule 506(c) prohibits sales to non-accredited investors, up to 35 non-accredited investors can purchase securities in a Rule 506(b) offering. Based on the analysis of data from initial Form D filings, including by pooled investment funds, we estimate that approximately 3.4% to 6.9% of all offerings initiated during 2009 through 2019 had one or more non-accredited investor participating in the offering. 40 On the basis of information in initial Form D filings and amended filings, we estimate that approximately 5.9 million investors participated in Regulation D offerings initiated during 2009 through 2019. However, these counts do not adjust for any repeat participation among investors in offerings. Because the data do not identify individual investors, we cannot estimate the number of unique investors participating in Regulation D offerings. 40 This estimated range is based on DERA staff analysis of Form D data on initial Form D filing among all Rule 506(b) offerings from 2009 to 2019. In particular, the 3.4% estimate is based on offerings that report that at least one non-accredited investor already have invested in the offering as of the Form D filing and may represent a lower bound because it relies on available Form D filings, and because a final Form D upon the conclusion of an offering is not required to be filed. If we also include Rule 506(b) offerings on Form D that accept non-accredited investors but reported having zero non-accredited investors in the initial filing, the estimated percentage of offerings involving accredited investors during the 2009-2019 period is approximately 6.9%, which may be viewed as an upper bound estimate. 47 2. Performance of Private Funds As discussed in Section II.A.2 above, private funds account for the largest share of Regulation D market activity. Below we present available evidence on the performance of private funds. First, we present data on the performance of hedge funds. Next, we turn to other private funds (notably, PE and VC funds). Because of the nature of the data and the long-term cash flow structure of PE and VC funds, we consider these funds’ performance separately from hedge funds. We conclude with a summary of the evidence on the performance of mutual funds, which are registered investment companies, and returns on the market index. Hedge Funds 41 Table 11 and Figure 15 below present data on hedge fund performance. We obtain information on all funds covered in four major commercial data sources on hedge fund returns: BarclayHedge, HFM, Eureka, and TASS. Different databases vary in their coverage of hedge funds reporting their performance. Following the sample period used for Regulation D data, we present mean and median returns, as well as the 25th (P25) and 75th percentiles of the return distribution (P75) and the number of observations (Obs.) for each year during 2009 through 2019. 41 As used in this sub-section, except where defined otherwise, the reference to “hedge funds” is based on the use of the term by commercial data vendors that aggregate and check the accuracy of data self-reported by funds, which has also been used in academic research, and not on a strict application of any legal definition of a hedge fund. For example, one of the vendors whose data we use below, EurekaHedge, explains that “[h]edge funds are investment vehicles that explicitly pursue absolute returns on their underlying investments. . . the ‘Hedge Fund’ definition has come to incorporate any absolute return fund investing within the financial markets (stocks, bonds, commodities, currencies, derivatives, etc.) and/or applying non-traditional portfolio management techniques including, but not restricted to, shorting, leveraging, arbitrage, swaps, etc. Hedge funds can invest in any number of strategies and they are perhaps most readily identifiable by their structure, which is typically a limited partnership (the manager acting as the general partner and investors acting as the limited partners) with performance related fees, high minimum investment requirements and restrictions on types of investor, entry and exit periods.” See https://www.eurekahedge.com/Research/News/1829/What-is-a-Hedge-Fund. This definition may differ from that used by the other vendors whose data we use. 48 Table 11. Hedge Fund Returns (2009–2019) 42 Year Mean Median P25 P75 Obs. Barclay Hedge 2009 33.5% 23.0% 12.2% 43.7% 1,646 2010 13.8% 10.2% 5.1% 18.7% 1,902 2011 -3.7% -3.1% -9.4% 2.8% 2,193 2012 11.9% 10.0% 5.1% 16.5% 2,572 2013 13.6% 10.7% 4.1% 20.2% 3,072 2014 5.9% 4.6% 1.2% 9.3% 3,607 2015 1.7% 1.3% -2.7% 6.2% 4,059 2016 6.1% 4.1% 0.0% 9.8% 4,568 2017 10.9% 7.9% 3.4% 15.4% 5,063 2018 -4.9% -4.4% -10.1% -0.1% 5,444 2019 11.3% 8.6% 3.9% 16.7% 5,782 2009-2019 7.4% 5.2% -0.6% 12.7% HFM 2009 35.5% 24.7% 11.6% 47.3% 784 2010 16.4% 12.8% 7.4% 21.9% 872 2011 0.7% 1.2% -6.3% 7.3% 959 2012 11.5% 10.4% 3.8% 16.9% 1,047 2013 14.6% 11.8% 5.2% 21.6% 1,154 2014 7.1% 5.8% 0.7% 11.4% 1,270 2015 1.7% 1.6% -4.9% 8.1% 1,338 2016 10.9% 7.6% 1.9% 15.4% 1,438 2017 22.7% 9.0% 3.3% 15.5% 1,523 2018 -0.1% 0.5% -7.3% 6.8% 1,499 2019 11.3% 8.5% 3.5% 15.7% 1,317 2009-2019 11.2% 7.3% 0.4% 15.3% Eureka 42 Returns are annual returns for all funds reported in the respective database, including funds of funds (FOFs) and global as well as U.S. funds reporting data. For each database used here, funds report returns, which generally are expected to be reported net of fees. Twelve months of monthly return data are required for a fund-year observation to be included in the estimate. Thus, funds entering or exiting in the course of a calendar year are not included in the statistics for that calendar year. Due to differences in fund identifiers and overlaps, we are unable to consolidate data on all funds, so the data are presented for each database. Also, self-reporting may result in upward-biased estimates of average performance. 49 2009 24.6% 16.4% 3.6% 35.7% 2,650 2010 13.3% 10.2% 3.4% 19.0% 2,785 2011 -1.8% -1.4% -8.4% 5.1% 2,848 2012 7.4% 6.8% 0.5% 13.9% 2,817 2013 11.4% 9.6% 0.5% 19.1% 2,822 2014 5.3% 4.1% -1.6% 9.7% 2,724 2015 0.0% -0.1% -6.2% 6.1% 2,631 2016 6.0% 4.6% -1.0% 10.7% 2,541 2017 14.9% 6.6% 1.5% 12.9% 2,411 2018 -4.1% -3.1% -9.9% 2.5% 2,161 2019 9.9% 7.9% 2.8% 15.6% 1,827 2009-2019 8.0% 5.1% -2.1% 13.3% TASS 2009 18.8% 12.1% 5.5% 23.5% 8,023 2010 8.4% 7.0% 2.8% 11.4% 8,118 2011 -2.5% -2.9% -8.3% 6.0% 7,823 2012 7.7% 6.9% 2.0% 12.0% 7,146 2013 11.0% 8.0% 3.4% 13.8% 6,343 2014 4.7% 4.1% -0.2% 8.9% 5,887 2015 3.0% 2.3% -2.2% 9.5% 5,330 2016 4.9% 3.0% -2.5% 12.0% 5,084 2017 12.0% 7.1% 2.5% 12.6% 4,742 2018 -0.1% -2.0% -8.3% 4.4% 4,344 2019 11.5% 7.0% 2.8% 12.5% 3,880 2009-2019 7.4% 5.6% -0.8% 11.7% On the basis of the data presented above, we note considerable variance in return statistics over time, which were also somewhat sensitive to sample coverage in different sources. However, the hedge fund asset class as a whole reported generally strong returns in absolute terms during this period. As an important caveat, this period has coincided with favorable market performance. Thus, Figure 15 below plots mean annual hedge fund returns from the four databases alongside annual market portfolio returns from CRSP. 50 Figure 15. Average Hedge Fund Returns versus Market Returns (2009–2019) 2009 70% 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 70% 60% 60% 50% 50% 40% 40% 30% 30% 20% 20% 10% 10% 0% -10% 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 0% -10% -20% -20% Barclay Hedge Eureka HFM TASS CRSP value-weighted CRSP equal-weighted For most years of the sample period, the market portfolio realized higher returns than the return reported in the hedge fund data. However, as hedge funds may invest in a variety of nonequity assets and have a distinct risk and illiquidity profile, comparisons with stock market returns should be treated with caution. Evidence on Hedge Fund Returns from External Studies A number of studies have considered hedge fund returns. For example, a recent academic study has found mean (median) annual net hedge fund returns to be approximately 9% (8%). 43 Extensive research has analyzed risks of hedge fund investments and found that systematic risk exposures of hedge funds often differ from those of public market investments. 44 43 See Vikas Agarwal, T. Clifton Green, & Honglin Ren, Alpha or Beta in the Eye of the Beholder: What Drives Hedge Fund Flows?, 127 J. FIN. ECON. 417 (2018) (“Agarwal et al. (2018)”) at Table 1 (examining 71,117 observations from Eurekahedge, HFR, Lipper TASS, and Morningstar for 16,185 hedge funds and FOFs from 1994 through 2012. Average (median) CAPM alpha was 4.9% (3.4%); average (median) multi-factor alphas were 2.7-5.1% (1.4-3.4%), depending on the risk adjustment model). 44 See, e.g., William Fung & David A. Hsieh, Hedge Fund Benchmarks: A Risk-Based Approach, FIN. ANALYSTS J., Sept./Oct. 2004, at 65; William Fung & David A. Hsieh, Measurement Biases in Hedge Fund 51 A small number of recent studies examine the subset of larger private funds subject to Form PF reporting requirements. 45 For example, a recent study examining quarterly Form PF data on returns of larger hedge funds from 2012Q4 through 2016Q4 reports average (median) quarterly gross returns of 2.5% (2.2%) with a 25th-75th percentile range of -0.5% to 5.1% and average (median) quarterly net returns of 1.8% (1.7%), with a 25th-75th percentile range of -0.7% to 4.2%, respectively. 46 Another recent report, examining all Form PF filers’ private fund returns from 2012 through 2016, finds median annual gross returns of 12.1%, with the median fee of 1.9%, Performance Data: An Update, FIN. ANALYSTS J., May/June 2009, at 36; Manuel Ammann, Otto R. Huber, & Markus Schmid, Benchmarking Hedge Funds: The Choice of the Factor Model (Working Paper, 2011); Zheng Sun, Ashley W. Wang, & Lu Zheng, Only Winners in Tough Times Repeat: Hedge Fund Performance Persistence over Different Market Conditions, 53 J. FIN. AND QUANTITATIVE ANALYSIS 2199 (2018); Charles Cao et al., What Is the Nature of Hedge Fund Manager Skills? Evidence from the RiskArbitrage Strategy, 51 J. FIN. AND QUANTITATIVE ANALYSIS 929 (2016); Agarwal et al. (2018), supra footnote 43; Jakub W. Jurek & Erik Stafford, The Cost of Capital for Alternative Investments, 70 J. FIN. 2185 (2015); Turan G. Bali, Stephen J. Brown, & Mustafa O. Caglayan, Systematic Risk and the Cross Section of Hedge Fund Returns, 106 J. FIN. ECON. 114 (2012); Turan G. Bali, Stephen J. Brown, & Mustafa O. Caglayan, Macroeconomic Risk and Hedge Fund Returns, 114 J. FIN. ECON. 1 (2014); Andrea Buraschi, Robert Kosowski, & Fabio Trojani, When There Is No Place to Hide: Correlation Risk and the Cross-Section of Hedge Fund Returns, 27 REV. FIN. STUD. 581 (2014); Ravi Jagannathan, Alexey Malakhov, & Dmitry Novikov, Do Hot Hands Exist Among Hedge Fund Managers? An Empirical Evaluation, 65 J. FIN. 217 (2010); Andrea Buraschi, Robert Kosowski, & Worrawat Sritrakul, Incentives and Endogenous Risk Taking: A Structural View on Hedge Fund Alphas, 69 J. FIN. 2819 (2014); Ronnie Sadka, Liquidity Risk and the Cross-Section of Hedge-Fund Returns, 98 J. FIN. ECON. 54 (2010); and Ilia D. Dichev & Gwen Yu, Higher Risk, Lower Returns: What Hedge Fund Investors Really Earn, 100 J. FIN. ECON. 248 (2011). 45 Form PF must be filed by any adviser (a) that is registered or required to register with the SEC as an investment adviser, (b) that manages one or more private funds and (c) together with its related persons, collectively, had at least $150 million in private fund assets under management as of the last day of the most recently completed fiscal year. See https://www.sec.gov/about/forms/formpf.pdf. 46 The study focused on the subset of Form PF filers that are qualifying hedge funds (i.e., with a NAV of at least US$500 million as of the last day in any month in the fiscal quarter immediately preceding the adviser’s most recently completed fiscal quarter). See Mathias S. Kruttli, Phillip J. Monin, & Sumudu W. Watugala, Investor Concentration, Flows, and Cash Holdings: Evidence from Hedge Funds (Fed. Reserve Board, Fin. & Econ. Discussion Series No. 2017-121, 2017), at Table 1. See also Mark D. Flood & Phillip Monin, Form PF and Hedge Funds: Risk-Measurement Precision for Option Portfolios (Office of Fin. Research, Working Paper No. 16-02, 2016). 52 significant dispersion across funds, and near-zero net returns for the bottom 25% of reporting funds. 47 Other Private Funds Below we discuss the performance of other private funds, including PE and VC funds. For purposes of the analysis below, we follow Preqin, our data source, in presenting data on buyout, VC, and certain other private fund strategies (such as private debt investing, infrastructure, natural resources, real estate PE, etc.) as part of the broader “PE” category, applying that term in a broader sense not limited to buyout funds. 48 All of these strategies share certain commonalities, such as the nature of fundraising from limited partners (LPs), a lack of liquidity, long-term focus, and irregular cash flows that must be considered in evaluating performance. We also present breakdowns showing performance of these types of private fund strategies. According to a Preqin analysis, in 2019 global PE fund assets under management (AUM) accounted for approximately $4 trillion, 49 and fundraising was estimated at $595 billion across 47 See David Johnson & Francis Martinez, Form PF Insights on Private Equity Funds and Their Portfolio Companies (Office of Fin. Research, Brief Series No. 18-01, 2018), at 4 and Figure 8. 48 Preqin notes that it “collects performance data from a variety of sources to ensure a high degree of accuracy and confidence.” Sources of data include institutional investors that are limited partners, fund managers (with over 2,200 firms choosing to submit performance data to date), listed firm financial reports, public filings, and annual reports. See https://docs.preqin.com/pro/Private-Capital-Performance-Guide.pdf and https://docs.preqin.com/pro/Preqin-Glossary.pdf. This approach to sample construction not limited to buyout and VC funds has also been used, for example, in Arthur Korteweg & Morten Sorensen, Skill and Luck in Private Equity Performance, 124 J. FIN. ECON. 535 (2017) (“Korteweg & Sorensen (2017)”). See also J. Martin and R.-D. Manac Varieties of Funds and Performance: The Case of Private Equity, WORKING PAPER, University of Amsterdam (2018); Nathalie Gresch and Rico von Wyss, Private Equity Funds of Funds vs. Funds: A Performance Comparison, 14 J. PRIVATE EQUITY 43 (2011); Daniel Hobohm, Investors in Private Equity Funds: Large-Scale Performance Analysis and the Question if Location Matters, WORKING PAPER, Ludwig Maximilian University of Munich (2008). 49 See Elisângela Mendonça, Global Private Equity Crosses the $4tn Assets Mark - Report, PRIVATE EQUITY NEWS, Feb. 5, 2020, https://www.penews.com/articles/global-private-equity-crosses-the-4tn-assets-mark-report20200205. 53 1,316 funds. 50 According to a different recent report, in 2019 the U.S. VC industry had $444 billion in AUM across 5,733 funds by 2,371 VC firms. 51 The same study estimated that in 2019 new VC fundraising reached $50.5 billion across 272 funds, while VC funds invested $133.4 billion across 11,360 deals with 10,430 portfolio companies. PE and VC fund performance is frequently measured using annualized internal rates of return (IRR) on the basis of fund contributions and distributions (which include the value of any unrealized investments). 52 Thus, in our analysis below, we use IRR as a measure of performance. 53 Table 12 below presents the analysis of performance of PE and VC funds covered in Preqin data, as described above, grouped by fund size, where fund size is measured by capital committed to the funds. 54 From the results, it appears that the top quartile of PE and 50 See Chris Cumming, Private-Equity Fundraising Dips in 2019 for First Time Since 2010, WALL ST. J., Feb. 2, 2020, https://www.wsj.com/articles/private-equity-fundraising-dips-in-2019for-first-time-since-201011580651367. 51 See NVCA Yearbook 2020, Public Data Pack, https://nvca.org/recommends/nvca-2020-yearbook_publicdata-pack-2/ (“NVCA (2020)”). The median fund was relatively small ($80 million), reflecting right skewness. 52 IRR is a time-weighted return that uses the present value of cash contributed, distributions, and the value of unrealized investments as of measurement date, and excludes performance fees. One alternative measure is a multiple of invested capital (also referred to as total value to paid in capital), defined as the sum of all fund distributions and value of unrealized investments divided by the value of all fund contributions by LPs. See, e.g., Korteweg & Sorensen (2017) (performing the main analysis using IRRs and obtaining similar results in robustness tests using multiples). 53 Data are obtained from Preqin Ltd. The data are as of 2018, with an update in 2019 covering 19 PE strategies, including buyout, and VC strategies and 9 regional focuses around the globe, including the United States and North America. Due to a low number of funds in certain strategies, some strategies were combined into a broader strategy. Real Estate strategy includes Real Estate Co-Investment, Real Estate Secondaries, Real Estate Fund of Funds and Real Estate. Infrastructure strategy includes Infrastructure Secondaries, Infrastructure Fund of Funds, and Infrastructure. Early Stage includes Early Stage (Seed), Early Stage (Start-Up) and Early Stage. Venture strategy includes Venture Debt and Venture (General). Net IRR is calculated using capital calls, management fees, distributions, and the fair value of unrealized investments and is expressed as an annualized rate of return. For definitions of these and other strategies used in this data, see https://docs.preqin.com/pro/Preqin-Glossary.pdf. 54 Some literature has found diseconomies of scale in fund performance. See, e.g., Mark Humphery-Jenner, Private Equity Fund Size, Investment Size, and Value Creation, 16 REV. FIN. 799 (2012); Florencio Lopez-deSilanes, Ludovic Phalippou and Oliver Gottschalg, Giants at the Gate: Investment Returns and Diseconomies of Scale in Private Equity 50 J. Fin. Quant. Anal. 377 (2015); Korteweg & Sorensen (2017), supra note 52; Douglas Cumming and Na Dai, Fund Size, Limited Attention and Valuation of Venture Capital Backed Firms, 54 VC funds has generated substantial returns for its investors. Overall, PE and VC funds exhibited strong performance. The median IRR across all PE and VC funds is approximately 14%, which is close to the 10% historical average annual return on the S&P 500 index. This result is generally consistent with what academic studies on the performance of PE funds document. 55 However, PE and VC fund investments are less liquid and generally have a greater risk exposure than an investment in the S&P 500 index. 18 J. EMPIR. FIN. 2 (2011) (finding diseconomies of scale in the VC industry). But see Harris et al. (2014), supra note 55 (finding no significant relation between performance and fund size for buyout funds and finding that VC funds in the bottom quartile of size underperform while top size quartile VC funds have the best performance although they do not differ significantly from funds in the second and third size quartiles). 55 See, e.g., Robert S. Harris, Tim Jenkinson, & Steven N. Kaplan, Private Equity Performance: What Do We Know?, 69 J. FIN. 1851 (2014) (“Harris et al. (2014)”). 55 Table 12. Net Internal Rate of Return (%) by Fund Size (2009–2019) Size ($ million) Mean Median P25 P75 Obs. < 100 19.4 15.7 9.5 24.9 736 100 - 250 15.1 13.5 8.2 20.0 804 250 -1000 15.7 13.7 8.8 20.2 1194 1000 - 5000 13.9 13.2 8.1 18.7 486 > 5000 17.3 16.1 13.4 21.2 68 All funds 16.2 14.0 8.7 20.9 3,288 Tables 13 through 15 below provide additional breakdowns of fund performance data by vintage year, fund strategy, and region. On the basis of average IRRs, it appears that early-stage VC and secondaries have performed the best over the time period under consideration. 56 In terms of regional focus, PE funds with primary regional focus on deals in North America, Asia, and Middle East have generated the highest average IRRs. 56 Secondaries funds are funds that purchase stakes in privately held companies directly from the holder of the securities. Early-stage VC funds invest in companies at an early stage of their lifecycle (seed or startup). For definitions of these and other strategies used in this data, see https://docs.preqin.com/pro/Preqin-Glossary.pdf. 56 Table 13. Net Internal Rate of Return (%) by Vintage Year Vintage Year Mean Median 25% 75% Obs. 2009 16.8 13.0 8.6 20.2 238 2010 14.3 13.2 8.9 19.0 361 2011 15.9 14.5 9.8 20.4 438 2012 16.5 14.0 10.0 20.1 404 2013 14.5 13.2 8.5 18.4 488 2014 16.6 14.0 9.0 21.0 523 2015 15.4 14.4 8.4 22.0 505 2016 19.2 15.0 8.4 24.2 289 2017 17.4 12.5 3.0 27.1 220 57 Table 14. Net Internal Rate of Return (%) by Fund Strategy (2009–2019) Main Focus Mean Median P25 P75 Obs. Balanced 18.9 13.4 8 21.3 31 Buyout 16.5 15.7 8.7 23 685 Co-investment 19.4 17.7 10.8 23.4 142 Direct Lending 9.2 9.4 6.6 11.9 92 Direct Secondaries 20.8 17.1 10.4 22.3 26 Distressed Debt 13.4 11 7.4 15.1 88 Early Stage 21.9 17.4 8.6 29.2 251 Expansion / Late Stage 17.5 13.2 9.3 20.2 66 Fund of Funds 13.2 13.3 9.3 17.4 486 Growth 16.2 12.8 7.9 21.5 253 Infrastructure 15.6 9.7 6.8 14.5 96 Mezzanine 10.9 9.9 8.1 13.9 80 Natural Resources 9.2 8.2 -0.7 21.3 75 Real Estate 15.4 14 10 19.6 654 Secondaries 22.5 17.5 13.9 23.8 135 Special Situations 10.6 10.5 5.5 14.5 39 Timber 4.6 4.4 2.9 7.7 18 Turnaround 16 20.2 7.8 30.3 19 Venture 18.7 15 7 27.7 230 All Funds 16.1 13.9 8.7 20.6 3,466 58 Table 15. Net Internal Rate of Return (%) by Regional Focus (2009–2019) Main Region Mean Median P25 P75 Obs. Africa 11.0 10.2 7.6 13.6 18 Middle East & Israel 21.1 17.9 9.5 27.0 32 Australasia 17.9 15.6 11.6 24.6 47 Diversified Multi-Regional 10.2 9.5 4.1 14.4 73 Americas 10.8 10.0 3.3 16.6 76 Asia 17.9 14.4 9.2 22.5 320 Europe 16.1 13.2 8.5 19.4 693 US 13.8 12.5 8.1 18.1 914 North America 17.7 15.8 9.9 23.0 1,293 All Funds 16.1 13.9 8.7 20.6 3,466 Evidence on PE and VC Fund Returns from External Studies Various academic studies have examined PE and VC returns during earlier time periods, providing somewhat mixed evidence about the performance of those funds. 57 Several studies find strong outperformance of PE and VC fund investments compared to public equity markets. 58 For example, one study finds that buyout and VC funds outperform the S&P 500 on average by 20% to 27% over the life of a fund. 59 Other studies find that PE funds on average either do not 57 See, e.g., the survey of the literature in Andrew Metrick & Ayako Yasuda, Venture Capital and Other Private Equity: A Survey, 17 EUR. FIN. MGMT. 619 (2011). 58 See, e.g., John H. Cochrane, The Risk and Return of Venture Capital, 75 J. FIN. ECON. 3 (2005) (“Cochrane (2005)”); Arthur Korteweg & Morten Sorensen, Risk and Return Characteristics of Venture Capital-Backed Entrepreneurial Companies, 23 REV. FIN. STUD. 3738 (2010) (“Korteweg & Sorensen (2010)”); Harris et al. (2014), supra footnote 55. 59 See Harris et al. (2014), supra footnote 55. 59 outperform public equity markets, or perform only marginally better, on a risk-adjusted basis. 60 Another important feature of PE fund performance documented by the academic literature is long-term performance persistence. PE funds that are high performers tend to continue to do well, while underperformers tend to continue to underperform. 61 One recent study finds, however, that as the PE industry has matured, the persistence in performance has substantially declined. 62 A number of studies have focused on VC performance. 63 A few studies have focused on the performance of FOFs that invest in buyout and VC funds. For instance, one recent study finds that, net of fees, FOFs “provide returns equal to or above public market indices for both buyout and venture capital. While FOFs focusing on buyouts outperform public markets, they underperform direct fund investment strategies in buyout. In contrast, the average performance of FOFs in venture capital is on a par with results from direct venture fund investing.” 64 The study reports data, as of December 2012, for FOFs with vintage years 1997 through 2007 on the 60 See, e.g., Steven N. Kaplan & Antoinette Schoar, Private Equity Performance: Returns, Persistence, and Capital Flows, 60 J. FIN. 1791 (2005) (“Kaplan & Schoar (2005)”); Francesco Frazoni, Eric Nowak, & Ludovic Phalippou, Private Equity Performance and Liquidity Risk, 67 J. FIN. 2341 (2012); Narasimhan Jegadeesh, Roman Kräussl, & Joshua M. Pollet, Risk and Expected Returns of Private Equity Investments: Evidence Based on Market Prices, 28 REV. FIN. STUD. 3269 (2015); Ludovic Phalippou & Oliver Gottschalg, The Performance of Private Equity Funds, 22 REV. FIN. STUD. 1747 (2009); Joost Driessen, Tse-Chun Lin, & Ludovic Phalippou, A New Method to Estimate Risk and Return of Nontraded Assets from Cash Flows: The Case of Private Equity Funds, 47 J. FIN. & QUANTITATIVE ANALYSIS 511 (2012) (finding annual underperformance of -12% for VC funds and no underperformance for Leveraged Buyout (LBO) funds). 61 See Kaplan & Schoar (2005), supra footnote 60; Korteweg & Sorensen (2017), supra footnote 52 (finding that the spread in expected net-of-fee future returns between top and bottom quartile PE firms is 7–8 percentage points annually.) 62 See Reiner Braun, Tim Jenkinson, & Ingo Stoff, How Persistent Is Private Equity Performance? Evidence from Deal-Level Data, 123 J. FIN. ECON. 273 (2017). 63 See, e.g., Cochrane (2005), supra footnote 58; Arthur Korteweg & Stefan Nagel, Risk-Adjusting the Returns to Venture Capital, 71 J. FIN. 1437 (2016) (“Korteweg & Nagel (2016)”); Axel Buchner, Abdulkadir Mohamed, & Armin Schwienbacher, Does Risk Explain Persistence in Private Equity Performance?, 39 J. CORP. FIN. 18 (2016). 64 See Robert S. Harris et al., Financial Intermediation in Private Equity: How Well Do Funds of Funds Perform?, 129 J. FIN. ECON. 287 (2018) (“Harris et al. (2018)”). 60 basis of information from Burgiss and Preqin databases, respectively, finding average (median) annualized IRRs of 8.1% (7.2%) and 7.9% (6.7%), respectively. 65 Across vintage years 1997 through 2007, average public market equivalent (PME) 66 performance of all FOFs in the study relative to S&P 500 was 1.16 and median was 1.15; average and median PME relative to Russell 2000, which captures small cap stocks, was 1.03 (1.00), respectively. 67 According to a recent industry study, as of mid-2018, net IRRs for buyout funds in the United States averaged 15% for five years ending June 2018 (just over 10% for 10- and 20-year investment horizons), outperforming S&P 500 modified PME performance. 68 The presented data on private fund performance uses common performance measures without adjusting for risk. 69 In extrapolating from the presented data, it is important to note that 65 See id. at Table 1. 66 A PME measure compares an investment in a PE fund to an equivalently timed investment in the relevant public market index. For more detail on PME, see also Kaplan & Schoar (2005), supra footnote 60. PME takes into account irregular cash flows associated with the PE asset class. The measure does not account for risk differentials between PE and public market investments. See also, e.g., Harris et al. (2018), supra footnote 64. 67 See Harris et al. (2018), supra footnote 64, at Table 2. 68 See Global Private Equity Report 2019, BAIN & COMPANY, available at https://www.bain.com/contentassets/875a49e26e9c4775942ec5b86084df0a/bain_report_private_equity_rep ort_2019.pdf, at Figure 1.27. 69 Some studies have sought to adjust private funds’ returns for risk. See, e.g., Korteweg & Nagel (2016), supra footnote 63. The study examines VC fund cash flows between 1979 and 2012, obtained from Preqin, yielding a sample of 545 funds, raised by 278 firms, with vintage years between 1979 and 2008. Mean (median) IRR is 8.84% (4.37%), respectively, while mean (median) investment multiple is 1.57 (1.16), respectively. See id. at Table 1. The study finds average PME (normalized by deducting 1) is 0.048 (not statistically significantly different from 0). See id. at Table 2. For nearly liquidated funds, the average PME is 0.276. The study finds that the PME understates the PME premium because VC funds have betas in excess of 1 and thus overstate the abnormal returns of VC funds relative to public market investments during periods of favorable market conditions. See also Arthur Korteweg, Risk Adjustment in Private Equity Returns, 11 ANN. REV. FIN. EC. 131 (2019). The study indicates that “risk-adjusted return estimates vary substantially by method, time period, and data source” and further notes that “[t] he weight of evidence suggests that, relative to a similarly risky investment in the stock market, the average venture capital (VC) fund earned positive risk-adjusted returns before the turn of the millennium, but net-of-fee returns have been zero or even negative since. Average leveraged buyout (BO) investments have generally earned positive risk-adjusted returns both before and after fees, compared with a levered stock portfolio.” 61 PE valuations, and associated returns, tend to be affected by aggregate conditions. 70 Time-toliquidity for PE funds is also likely to be affected by market conditions. For example, according to one report, on the basis of data from 2011 through 2019, the average time-to-liquidity for active buyout funds was around 3.2 years (2.7 in 2019). 71 The report also suggests that, when faced with adverse market conditions, active buyout funds are likely to delay exits, leading to increasing average time-to-liquidity. Mutual Fund Returns and Market Portfolio Returns For comparison with the performance of hedge funds and other private funds, in this section we provide summary statistics for the performance of U.S. mutual funds (net of fees), 72 as well as market portfolio returns. Table 16 below presents return statistics of U.S. mutual funds from 2009 through 2019 as a function of fund size. The statistics in the P25 and P75 columns represent the 25th and 75th percentiles of the return distribution, respectively. Tables 17 and 18 below present mutual fund returns by year and by fund category, respectively. 70 See, e.g., Private Equity Valuations During Downturns, EFRONT, Apr. 30, 2020, available at https://www.efront.com/research-papers/private-equity-valuations-during-downturns/. 71 See Returns, Risks, and Liquidity of LBO Funds in Q4 2019, EFRONT, May 11, 2020, at 8, available at https://www.efront.com/research-papers/returns-risks-and-liquidity-of-lbo-funds-in-q4-2019/. 72 The analysis of U.S. mutual fund performance is based on CRSP Survivor-Bias-Free Mutual Fund database. We exclude all ETFs, money market funds, and variable annuities. We report summary statistics of returns net of fees at the fund level. We aggregate share classes to the fund level using weights based on total net assets in the prior month. Annual returns are subsequently calculated by compounding the fund’s monthly returns. If a monthly return is missing, then no return would be calculated for that year. We group funds into different broad investment categories using CRSP objective codes. 62 Table 16. U.S. Mutual Funds Returns by Fund Size (2009–2019) Size ($ million) Mean Median P25 P75 Obs. <100 9.41 7.44 -0.30 18.04 33,791 100-250 9.46 6.93 0.34 17.13 12,562 250-1000 9.40 7.01 0.28 17.16 18,466 1000-5000 8.97 6.89 0.03 16.93 13,102 >5000 8.84 6.95 -0.13 16.95 4,603 All 9.31 7.11 0.06 17.43 73,978 Table 17. Historical Returns of U.S. Mutual Funds (2009–2019) Year Mean Median P25 P75 Obs. 2009 28.13 26.86 16.92 35.88 6,021 2010 13.30 12.87 7.29 18.26 6,088 2011 -1.82 -0.74 -6.14 3.85 6,143 2012 12.17 12.81 7.64 16.53 6,390 2013 16.65 17.58 0.44 31.57 6,598 2014 4.77 4.92 1.01 9.15 6,906 2015 -2.23 -1.18 -4.30 1.08 7,211 2016 7.38 6.31 1.80 11.26 7,321 2017 14.88 13.90 5.87 21.72 7,180 2018 -6.76 -5.78 -11.08 -1.30 7,145 2019 18.95 19.93 9.73 26.59 6,975 63 Table 18. U.S. Mutual Fund Returns by Fund Category (2009–2019) Fund Category Mean Median P25 P75 Obs. Alternative Strategy 2.69 2.20 -3.87 8.42 4,065 Foreign Bonds 4.64 4.30 -1.85 10.21 1,677 Foreign Equity 9.87 9.25 -4.67 22.66 12,426 General Bonds 5.37 3.84 0.69 7.91 6,951 Mixed Strategy 7.98 7.72 0.25 14.26 8,086 Mortgage-Backed Securities 4.64 3.95 1.09 6.72 1,041 US Corporate Bonds 6.33 5.97 0.58 9.67 910 US Equity 12.98 12.87 0.98 23.84 30,773 US Government Bonds 2.71 1.81 0.27 4.84 1,752 US Municipal Bonds 4.83 3.64 0.79 8.02 6,297 64 We also report annual value- and equal-weighted market portfolio returns from the CRSP database in Table 19 below. Table 19. Market Portfolio Returns (2009–2019) 73 Market Return Market Return (Value-Weighted) (Equal-Weighted) 2009 31.3% 64.3% 2010 17.7% 25.2% 2011 -1.1% -9.0% 2012 15.8% 16.8% 2013 30.5% 30.9% 2014 10.5% 2.9% 2015 -1.7% -6.9% 2016 12.7% 16.0% 2017 20.7% 15.8% 2018 -6.3% -13.1% 2019 29.3% 21.7% Year Because of differences in the measures of performance and sources of data applicable to different categories of private funds versus mutual funds and the market index portfolio, as well as, importantly, substantial differences in risk exposures, underlying investment portfolios, liquidity, timing of cash flows, nature of data reporting, and extent of regulatory oversight 73 Annual returns are calculated by compounding monthly returns, including distributions, of an equalweighted or value-weighted market portfolio, as indicated, obtained from CRSP. These returns are gross of trading costs. 65 applicable to private funds versus registered investment companies, it is difficult to draw a meaningful comparison of performance between these very different asset classes. 3. Performance of Non-Fund Regulation D Issuers Various studies have compared the behavior of private and public companies, arriving at mixed conclusions. 74 Small private companies often face significant financing constraints, which can both limit growth during booms and increase downside risk during contractions. In particular, small businesses typically have limited access to securities markets and commonly rely on personal savings, business profits, outside debt, and friends and family as initial sources of capital. 75 According to one survey, approximately 64% of small businesses relied on personal or family savings, compared to 0.6% receiving VC capital. The survey also finds that about one- 74 As a general caveat, there may be differences in methodology and data definitions in the performance estimates reported in various sources cited in this section. See, e.g., Huasheng Gao, Po-Hsuan Hsu, & Kai Li, Innovation Strategy of Private Firms, 53 J. FIN. QUANTITATIVE ANALYSIS 1 (2018) (finding that public companies’ patents rely more on existing knowledge, while private companies’ patents are broader in scope and more exploratory); Viral Acharya & Zhaoxia Xu, Financial Dependence and Innovation: The Case of Public Versus Private Firms, 124 J. FIN. ECON. 223 (2017) (showing that public companies in externalfinance-dependent industries spend more on R&D and generate a better patent portfolio than their private counterparts); John Asker, Joan Farre-Mensa, & Alexander Ljungqvist, Corporate Investment and Stock Market Listing: A Puzzle?, 28 REV. FIN. STUD. 342 (2015) (finding that listed companies invest less and are less responsive to changes in investment opportunities compared to observably similar, matched private companies); Naomi Feldman et al., The Long and the Short of It: Do Public and Private Firms Invest Differently? (Fed. Reserve Board, Fin. & Econ. Discussion Series No. 2018-068, 2018) (finding that public companies invest more in long-term assets—particularly innovation—than private companies); Vojislav Maksimovic, Gordon M. Phillips, & Liu Yang, Do Public Firms Respond to Investment Opportunities More than Private Firms? The Impact of Initial Firm Quality, (Nat’l Bureau of Econ. Research, Working Paper No. 24104, 2017) (finding that public companies respond more to demand shocks after their IPO and are more productive than their matched private counterparts, particularly in industries that are capital intensive and dependent on external financing); Menachem Abudy, Simon Benning, & Efrat Shust, The Cost of Equity for Private Firms, 37 J. CORP. FIN. 431 (2016) (finding that private companies are associated with a higher cost of equity); Ilan Cooper & Richard Priestley, The Expected Returns and Valuations of Private and Public Firms, 120 J. FIN. ECON. 41 (2016) (finding that the cost of capital and valuations are similar across private and public companies). 75 See U.S. DEP’T OF TREASURY, A Financial System that Creates Economic Opportunities: Banks and Credit Unions (June 2017), available at https://www.treasury.gov/press-center/pressreleases/Documents/A%20Financial%20System.pdf. See also Alicia M. Robb & David T. Robinson, The Capital Structure Decisions of New Firms, 27 REV. FIN. STUD. 153 (2014), at Table 4 (showing that while entrepreneurial companies frequently rely on outside loans, outside equity use is uncommon). 66 third of businesses used banks and other financial institutions as a source of capital for financing business operations in 2014. The survey further finds that a significant share of businesses that established new funding relationships continued to have unmet credit needs. Further, according to the survey, small businesses owned by underrepresented minorities faced significantly higher hurdles in obtaining external financing. Below, we present available evidence and research on the performance of non-fund issuers in the Regulation D market. Comprehensive data on returns of private placements by non-fund issuers, including securities issued under Regulation D, are not available because many issuers in unregistered offerings do not experience liquidity events (and data on returns in those cases are limited) and most securities purchased in unregistered offerings do not trade in a secondary market. 76 Thus, with few exceptions, academic studies have focused on private fund returns, discussed in Section III.B.2 above. Evidence on Returns A 2016 study has analyzed U.S. angel investment returns for a sample of 245 companies that received investment from an angel investor group and that either reported a successful exit or shut down. 77 The study found an average 2.5x investment multiple and 22% IRR (gross of 76 Most private securities are restricted. A limited secondary market for private securities exists, which includes the market for limited partnership (LP) interests in private funds and the direct market for the stock of private companies. See Robert Loveland, Eric Fricke, & Sinan Goktan, Do Private Firms Benefit from Trading in the Private Securities Market?, J. ENTREPRENEURIAL FIN., Fall 2017 (“Loveland et al. (2017)”). See also Darian M. Ibrahim, The New Exit in Venture Capital, 65 VAND. L. REV. 1 (2012); William A. Birdthistle & M. Todd Henderson, One Hat Too Many? Investment Desegregation in Private Equity, 76 U. CHI. L. REV. 45 (2009); David F. Larcker, Brian Tayan, & Edward Watts, Cashing It In: Private-Company Exchanges and Employee Stock Sales Prior to IPO (Stanford Closer Look Series, Sept. 12, 2018). We lack trading data from such marketplaces in order to construct return, risk, or liquidity measures. 77 See Robert E. Wiltbank & Wade T. Brooks, Tracking Angel Returns: 2016 Report with 2017 Update, ANGEL RES. INST. (2017), available at https://angelresourceinstitute.org/reports/tracking-angel-returns2017-update.pdf. 67 legal and other investment costs), with an average 4.5-year holding period. The study found that returns were skewed, with 10% of all exits generating 85% of all cash, while 70% of investments generated negative returns. According to the study, a 2017 update identified 20 additional outcomes (exits or closures), yielding an average 2.3x investment multiple and a 19.3% average IRR for the full sample. Another industry study considering 684 AngelList investments with nonnegative returns finds a mean (median) IRR of 35% (21%), and a mean (median) investment multiple of 1.7x ( 2.7x), net of fees and carried interest. 78 Certain additional data are made available by individual intermediaries. For example, one intermediary reports a 41% unrealized net IRR and a 3.3x investment multiple (based on unrealized value divided by amount invested) for Regulation D investments in companies funded through its website from 2013 through 2016, based on 119 startup investments. 79 This intermediary also reported, as of December 2018, that 81% (96 of 119) startups were still active, 40% raised a subsequent Series A round in excess of $3 million, and 9% (11 out of 119) were valued over $100 million. Some studies have examined financial returns to individuals or households from the choice to become an entrepreneur. 80 For instance, a 2002 study finds that that, although entrepreneurial investment is extremely concentrated, the returns to PE are no higher than the 78 See Abraham Othman, Startup Growth and Venture Returns, ANGELLIST (Dec. 2019), available at https://angel.co/pdf/growth.pdf. AngelList is a platform that allows accredited investors to make VC-like investments in startups. Data on all investments are not available in the cited source. But see also, e.g., Olga Itenberg & Erin E. Smith, Syndicated Equity Crowdfunding: The Trade-Off Between Deal Access and Conflicts of Interest (Simon Bus. Sch., Working Paper No. FR 17-06, Mar. 2017). 79 See https://wefunder.com/funds (retrieved March 23, 2020). 80 For a review of the evidence on earnings from entrepreneurship, see, e.g., Thomas Astebro, The Returns to Entrepreneurship, in OXFORD HANDBOOK OF ENTREPRENEURIAL FINANCE (Douglas Cumming ed. 2012). 68 returns to public equity. 81 The study attributes the willingness of households to invest substantial amounts in a single privately held firm with a seemingly far worse risk-return tradeoff to large nonpecuniary benefits, a preference for skewness, or overestimated probability of survival. In turn, a 2011 study finds that owners of private companies require compensation for a lack of diversification in the form of higher returns. 82 Evidence on Exits In instances where a private non-fund issuer has a subsequent registered offering or an M&A exit, returns on a private company investment can be examined on the basis of the “exit” valuation. Prior work has thus considered IPO and M&A exits, with some of those studies providing information on returns attained through such exits, for a subset of the companies. 83 As an important caveat, where IPO and M&A exits are observed, data on the terms of such exits compared to the terms of pre-exit private investments are scarce and valuations are difficult to compare because of variation in legal and contractual terms of securities and limited disclosure available about pre-exit private placement rounds. Terms of private company exits involving a private financial or corporate acquirer are not required to be disclosed and acquirers may have competitive or other commercial reasons to prefer non-disclosure. 81 See Tobias J. Moskowitz & Annette Vissing-Jørgensen, The Returns to Entrepreneurial Investment: A Private Equity Premium Puzzle?, 92 AM. ECON. REV. 745 (2002) 82 See Elisabeth Müller, Returns to Private Equity – Idiosyncratic Risk Does Matter!, 15 REV. FIN. 545 (2011). 83 See, e.g., Umit Ozmel, David T. Robinson, & Toby E. Stuart, Strategic Alliances, Venture Capital, and Exit Decisions in Early Stage High-Tech Firms, 107 J. FIN. ECON. 655 (2013); Susan Chaplinsky & Swasti Gupta-Mukherjee, The Decline in Venture-Backed IPOs: Implications for Capital Recovery, in HANDBOOK OF RESEARCH ON IPOS (Mario Levis & Silvio Vismara eds. 2013), at 35; Eric Ball, Hsin Hui Chiu, & Richard Smith, Can VCs Time the Market? An Analysis of Exit Choice for Venture-Backed Firms, 24 REV. FIN. STUD. 3105 (2011); Richard Smith, Robert Pedace, & Vijay Sathe, VC Fund Financial Performance: The Relative Importance of IPO and M&A Exits and Exercise of Abandonment Options, 40 FIN. MGMT. 1029 (2011). 69 For instance, a 2016 study 84 examined Thomson Reuters’ Venture Economics data, supplemented with Thomson Reuters’ SDC Platinum New Issues and Mergers and Acquisitions data, EDGAR filings, and hand collection of data, for “al [Text truncated at 120,000 characters. The full text is on the page linked above.] --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/agency%3Asec%3A2d9fa89305eb1b2f. Public record. Not legal advice.