The SEC Just Voted To Lift The Ban On General Solicitation
wefunder.com
wefunder.com
If you look at the way YC demo day works, its a pretty reasonable way for potential investors to find startups which are compatible with their investment goals. I think this addresses the challenge of the general solicitation rule (finding the startups) without the negative of creating a bunch of unvetted startups advertising for dollars. Basically, I believe lifting this ban increases the noise significantly without much boost to the signal.
The analog I thought about when I saw the SEC was thinking about going this way was the lift on advertising prescription drugs. That really hasn't been a 'win' for me, while I'm sure some folks have discovered there are drugs available their doctor didn't know about (signal), a whole lot more people are asking their doctors to give them drugs which aren't really appropriate to their symptoms (noise). It has made the national news shows practically infomercials for a variety of meds for 'old people problems'.
So in the YC process, folks compete to be selected and then they work to make sure they are ready on demo day. Investors know that Paul and his partners have spent many weeks with these people helping them achieve the maximum potential possible. That is a form of validating their authenticity or 'vetting'.
However, with the general ban lifted, startups will now appear "out of the blue" because they used some funding to 'reach out' to "you" a person they bought from a list (typically the HNWI list [1]). That is the noise part. If you're currently getting postal mail (or spam email) from folks who are congratulating you on your success and offering to help (personal wealth management, car dealers for high end cars, high end credit cards) then you are on that list (whether or not you think you should be :-)
Because of that, in my 'bad' scenario of how this could be a not good thing, I expect that we'll see lots of "next big thing" pitches showing up on the nightly news (it scores well in the HNWI demographic) and tucked in with those platinum card offers. What is worse, we'll see the rise of companies that prey on individuals who think they have a great idea but just can't get it off the ground. They will offer to "get them funded" by putting them in touch with hundreds of "angels." And they will just be high pressure sales guys who sell lots to unbuilt housing developments in Utah or time share condos in vacation spots. So the real opportunities get lost in all the noise.
However, I recognize I'm somewhat cynical here and this could be a really good thing. I'd like it to be a good thing because there are ideas that don't get funded today that should (or would do well if they were). But watching Shark Tank now and then you are reminded there are a lot of people who want to change the world and don't have the benefit of an incubator's advice or tutoring. Those folks are going to be victimized here.
[1] The High Net Worth Individuals or HNWI list is sold in various forms by meta-data collection agencies which identify such individuals through public records (vehicle registrations), web purchasing tracking, and other social "cues".
The best solution for what? What's the point of this regulation and how is it measured?
> That really hasn't been a 'win' for me
If I understand this correctly, the SEC should prevent entrepreneurs from soliciting investments so you don't have to watch informercials? I can't argue with that!
I do believe different investors look for different signals, sometimes their ability to pick the signal is so finely tuned that they simply need more inputs, rather than relying on regulated "noise" reduction which might squelch into their signal processing band.
My hope is that the noise most people hear will be like my experience with Kickstarter: I only hear about the projects that are up-and-coming and have merit.
Sure it is.
However, if you are someone who isn't an arbitrager(investor isn't the right term) in their daily job, the pressure to join the tulip buyers is a lot heavier than the available knowledge. The root of this problem is lies, because the tulip sellers are always going to give false data to encourage people to buy, and the amount of money changing hands will always attract a lot of unethical people. The libertarian mantra is that things will balance out via crowd sourcing (is it a market investing in a company that doesn't sell products yet? I argue not), yet you hear stories about the Maddoff's of the world running 30 year schemes which very much hit 'sophisticated' investors.
At the very least, regulations designed to protect the financially unsophisticated from themselves are massively hypocritical.
You can't do that with business investments -- there's no way to mandate a particular minimum return to investors, and no way to recover lost funds if the business fails to perform as promised. If I promise you safe 15% returns, and then I run the business in a high risk way and it goes under, there isn't any way for the state to really regulate that level of risk and return except in very highly regulated industries like insurance where money is being invested in rated securities (and even then, it's not great.)
The biggest problem with private investments is that there generally isn't any liquid market to provide a "real" price. It's just whatever the company can convince an investor to pay. Nobody can short or sell you their shares easily, and if you buy in it can be impossible to sell out.
I don't see the lottery as analogous to putting money into companies. Whether the lottery is good or not is a separate issue.
Vegas seduces with glamour rather than prospectuses filled with seductive, irrelevant statistics and passionate, sincere bullshit about how the team of MIT-educated croupiers, striking design and ambient temperature make the ball more likely to land on 27 than at any other venue.
I think only one of the below needs to be true to suggest investment restrictions might be advisable even in the presence of legal gambling.
(i) "unsophisticated" investors are significantly more likely to put their life savings into RandomStartupX than they are to put them on a roulette wheel (ii) RandomStartupX is more likely to return zero than a roulette wheel (even if market returns are positive there's a power law distribution and it's probability of returning zero that's more important to those without a well-constructed portfolio) (iii) Retail investors' realistic early stage "investment" options' expected value may well actually be lower than that of a spin of a roulette wheel assuming the top startups prefer the experience of top-tier investors, which doesn't seem unreasonable even when comparing between different tiers of VC funds
But are they _really_ designed to protect the financially unsophisticated from themselves? These regulations were enacted in response to the great depression. The motivation was to protect SOCIETY from systemic problems rooted in the actions of unsophisticated investors, not to protect the investors from themselves.
I agree that rules designed to protect the stupid from their own stupidity are to be avoided at all costs, but I don't agree that this is an example of such a policy. And I certainly don't buy the idea that people should be able to do whatever the fuck they want, to hell with everyone else, so long as they are not directly causing physical harm or property loss to another person.
Proving that the scam artists will find a way no matter what the regulations say.
It's not only presumptuous to say "if someone's not rich, they must not be smart enough to invest", it's a self-fulfilling kind of thing, isn't it?
Nothing prevents people from gambling in Vegas. So clearly these laws are not about protecting fools from their own foolishness. No, the laws are about only one thing: making sure that the people who are in charge of the economic system, stay in charge. And it's not just these SEC laws, there are a wide variety of laws that secure the elite from competition by the peasants.
Whenever someone claims they're keeping you from doing something for your own good, who pretends to be your parent, they really are your master.
If you want to drive your vehicle without a seatbelt, who am I to force you to? Your seatbelt choices have no impact on anyone else except you, right?!
Although the seat-belt thing does have some legitimacy, in that it keeps the drive in front of the wheel during an accident, allowing him to potentially keep some control over the car.
keeps the drive in front of the wheel during an accident
So you think passengers should not wear them?
Also: It's not 'negative impact' as a binary check, but looking at the massive cost of medical bills. And seatbelts are enforced on public roads, not private land. Investment is fundamentally a private action, which should only be restricted in very serious circumstances.
It's not?
> If you 'invest away' all your money, you can uninvest it the next day.
Not if it's gone.
What crazy definition of investing are you using where you have any reasonable* chance of losing all your money in less than a day?
Compare that to the near-100% chance of losing your money if you spend a single hour betting all of it at casino games.
*let's say 1% or greater
Your argument would hold some weight if you could provide some source or documentation for your assertions (that investment has no feedback loop and is therefore not addictive, or that the speed at which you lose your money on an investment is something that matters for the sake of this conversation).
Compare to buying and selling stocks repeatedly for an hour. Except for transaction fees you're probably not going to move more than a couple percent.
What do you want documentation for? Buying a stock for three months is about a million times slower of a feedback loop than a casino game, and that's an unarguable fact. When I search for anything about addiction to investing, all I find is articles talking about addiction to speculating, which is not the same thing.
And of course the speed matters, because the core of my argument was that you can't do something like blow your paycheck on investments. Bad investment might lessen your savings over the long term, but they're not going to turn a working adult into someone that costs society money the way a terrible car crash or gambling addiction can.
You can make the case that the regulations may or may not be the best for what society wants, but to say that they're somehow a moral obscenity seems silly to me.
I think it's strange to say that you're prevented from investing in a corporate structure because of legal limitations when the same legal limitations are what enable you to invest in the corporate structure in the first place. It's why I don't subscribe to this viewpoint on investing.
I agree with you on the gambling bit, to an extent. Government-backed lottery really preys on a certain class of people and I don't care for it so much. Private casino-style gambling is viewed by many as an entertainment outlet. Like drinking, for example. It's generally understood that you go to the casino to have a good time....and lose your money. Winning is understood to be an aberration. That doesn't stop people from blowing everything, though.
The only reason that people gamble in Vegas is because every other place created laws to protect fools from their own foolishness. Vegas, a city built by organized crime figures who normally had to operate illicitly, didn't.
Vegas is not the only location of legal casino gambling. It is by far the largest but there is significant gambling activity elswhere in the US.
Wikipedia mentions these markets:
1. Las Vegas Strip $5.550 billion
2. Atlantic City $3.943 billion
3. Chicago region $2.092 billion
4. Connecticut $1.448 billion
5. Detroit $1.36 billion
6. St. Louis $1.050 billion
7. Tunica Resorts, Mississippi $997.02 million
8. Biloxi, Miss. $833.50 million
9. Shreveport, La. $779.65 million
10. Boulder Strip (Las Vegas) $774.33 million
11. Reno, Nevada $715.23 million
12. New Orleans, La. $653.05 million
13. Downtown Las Vegas $523.82 million
14. Laughlin, Nevada $492.51 million
There are also numerous casinos on Indian reservations across the country.
I agree with you that the rules are not really about protecting ordinary people. At this point in history, it's about protecting one set of elites from another, with the side effect of (perhaps) protecting the entire economy from certain disasters.
I think you are correct but only if you consider everything in aggregate.
There will be channels set up that will significantly boost the signal to noise ratio that could not exist under current rules. Channels like crowdfunding sites that /will/ collect information that the SEC might not require but will be useful for potential investors.
I, for one, will be seeking out these channels and vetting them for myself and will recommend the same to anyone who asks.
There is going to be turbulence while people find the balance but I still think this will be an overall win.
We've gotten accustomed to freedom of speech when it comes to political matters, but we tolerate all sorts of restrictions in commerce. The SEC has basically said in the past that if you are raising money and want to talk about it, you're only allowed to talk to certain people at certain times and not others. Same with direct to consumer advertising of drugs. The FDA was essentially saying that pharmaceutical companies could only talk to doctors about what they have on offer, not patients.
More recently (and less of a hot-button issue) the FDA got smacked down by an appeals court for their restrictions on what pharma sales people could tell doctors about off-label use of drugs (that is, drugs used in a manner not approved by the FDA). The FDA has said in the past that it's illegal for sales reps to promote off-label uses of drugs to doctors. This is true even in cases where these off-label uses are written up in the medical literature. Note that it has never been against FDA regulations for anyone else to tell the doctors about off-label use of drugs (e.g. other doctors, the janitor, Hollywood celebrities, etc...). The courts have basically said that this is a first amendment violation because it places limits on specific individuals when society as a whole benefits from the free, unrestricted flow of truthful medical information.[1]
[1]http://www.reuters.com/article/2012/12/04/us-offlabel-convic...
But 2013 isn't 1933. The average sophisticated investor is more versed in finance, more wary of solicitation if they are not, or closer to one of the former.
What this is, is a boost to non-conventional assets and managers. The ones too young or crazy to have made it through the traditional vetting process. There's already plenty of noise if some idiot broker put you on a mailing list...
"This time, it's different."
There are a ton of tools that people can use to gather information on a potential investment and the people involved.
1. Due to cognitive biases.
I'm not sure what this means. Are you saying that the average investor is now more sophisticated, or that the average sophisticated investor now is more sophisticated than the average sophisticated investor then?
If the former, if the average invested amount drops to $1-2K and the number of investors booms, wouldn't that have an effect on the average sophistication?
IMO the average investor is only investing in the house that they live in, and judging by the last 10 years doesn't seem to have the math skills to defend against a charming salesman.
edit: just noticed that this doesn't open up investment to unaccredited investors, it's just about solicitation. "Average sophisticated" makes sense now:)
Consider this, the 10-year early stage VC performance was 3.9% [1], with late stage and expansion focused funds at 9.3%. Average VC returns were 6.1%. By comparison, the DJIA returned 8.6%, the NASDAQ returned 10.3%, and the S&P 500 returned 8%. Private, non-qualified investors are going to get slaughtered. VCs are professional investors and their overall industry returns are awful. In addition, private investors have no connections. Those returns include VC's that now routinely liquidate failing companies to other portfolio companies and their LP's as "talent acquisitions", where they recover their investment through their liquidation preference; Joe six-pack won't be able to do that, he will just lose all his money.
The average mutual fund generates below market returns in the long run. If the average fund manager, a professional that spends 100% of their time trying to find strong opportunities for investment can't consistently generate excess returns, does anybody actually believe that the public will be able to? This is only compounded by the extreme risk and volatility of startup investing. Maybe you hand-wave this off, and say the average fund manager is stupid, and maybe they are, but I'd bet they are nowhere near as stupid as the average member of the general public, just go read some YouTube comments.
My bet is that late-stage and expansion deals still go to the VC crowd because they can bring mountains of cash, fast, with connections. The early-stage funding, with the 3.9% long-term returns will go to the public, with even lower than historic returns. As soon as the public figures out that they are hundreds of times more likely to get wiped out than become billionaires, this whole mess will get legislated away again.
[1]: http://www.avc.com/a_vc/2013/02/venture-capital-returns.html
My fear is that opening up startup investing to a wider pool will not only fund a lot of startups that should not have been funded (just like the dot.com boom rewarded companies that should not have been rewarded) it will result in a catastrophic correction down the road where a lot of people will have lost everything and will be asking the government to use taxpayer money to make them whole again.
Not really. We, here on HN, tend to frame things around tech startups, but there's a larger world out there that incubators don't (and often can't) address. Consider this (real life) example:
Recently a local pub came up for sale. The asking price was $200,000. The purchase would include all current equipment and supplies, existing vendor contracts (subject to state transferability rules on the alcohol contracts), and local liquor license (the state license isn't transferable). It also included the building which housed 3 occupied (at the time) apartments.
The question, of course, is how to raise the $200K. Standard business loans were out (not an established business). There's SBA, but the loan amount we were looking for was a bit high for SBA. Friends and family, of course, but we wouldn't even come close.
In the end, we had to pass (though funding was only a part of the decision to pass). Here's kicker: If we could have spread the net wider, we may have had a chance to raise the money (with less effort), and been able to go ahead with the purchase.
While this is one story, I see these kinds of things al the time. A few years back, a founder looking to start a paintball facility got nailed by this (he was advertising the investment opportunity). It ended up shutting down the project.
The point is, outside of the technology world, getting investment funding for small businesses is very hard. This rule change makes it much easier.
That isn't necessarily true. Just because small businesses can freely solicit investment doesn't mean that actually raising it will be easier.
People seem to be making the assumption that there's this huge untapped market of rich people (read: accredited investors) who are not actively investing in businesses today simply because they haven't seen an ad or received an email inviting them to get in on the ground floor of a great opportunity.
I don't see much evidence that this is the case, and based on my experience, the reality, for better or worse, is that you're either tapped into funding channels (or can work your way into them) or you're not. This doesn't mean that no money will be raised in the fashion you describe, but the notion that there's going to be a flood of wealthy individuals writing checks to people and companies they just met is absurd.
As far as the specific situation you described, $200,000 is a modest amount. If you had a wealthy individual, or group of individuals, truly interested in owning a bar, it's far more likely that they'd purchase it themselves and hire an experienced person to run it. What incentive would they have to give any equity ownership and control to a group that couldn't "even come close" to putting up $200,000 themselves? "Accredited investor" doesn't necessarily mean "intelligent investor" but a lot of the comments around this general solicitation change assume that there's an abundance of accredited investors who are, for lack of a better description, utter fools.
This discussion around the lifting of the ban on general solicitation also seems to assume that this will most greatly affect startups/Silicon Valley and small business, when in fact this will almost certainly most greatly benefit Wall Street and the financial establishment.
I remember reading when the Jobs Act was first floated that non-accredited investors could invest as well but were capped at how much they could invest in a given year based on their income.
That is an entirely different can of worms, but there too, I think there is a general overestimation of how easy it will be for the average small business or startup to raise capital.
As for my bar, let me re-phrase, just for accuracy: We couldn't come close on our own without liquidating existing investments. It didn't make mathematical sense to do so (returns were higher on existing than expected returns on the bar). From our perspective, it was an expensive hobby, not a money making investment (for us).
On the other hand, if we could raise, let's say $50K from investment, $50K converted from other investments (our own money), and $25K from family, then cover the remaining $75K through bank loan collateralized by the building (the building is valued at $125k)... Yup, that would have been easier.
My missed opportunity to take a huge equity stake in Facebook for $20,000 aside, what you're referring to is the quality of deal flow of an existing investment firm. There is no shortage of investors already actively involved in funding startups who wish they could have invested in a particular company.
That's not what we're talking about though. Your prior comment suggested that the lifting of the ban on general solicitation will make it easier for small businesses that cannot realistically raise capital today to do so.
There's a huge difference between a startup that is already working the angel and VC networks and a group of guys who want to buy a bar as a hobby and, perhaps not surprisingly, have no contacts eager to pony up even $50,000 so that the founders can keep most of their money in investments that are producing better returns than the bar would.
In other words, you're confirming one of my original observations: a lot of folks seem to believe that general solicitation will enable startups and small businesses that are less-than-compelling investments to raise money from stupid rich people.
Although I wouldn't be surprised if somebody somewhere has a list of accredited investors over the age of 80 who are likely to have Alzheimer's, that is not going to happen in significantly larger numbers as a result of this change.
Had they know about it. Yes, that's exactly what we're talking about. Sure there's a difference between a startup that is already working the angel and VC networks and a group of guys who want to buy a bar as a hobby, but there isn't much difference between the bar and a bakery who want to expand, or an established bar who wants to open a new location, or the two guys who want to turn recycled junk into interesting furniture. None of these are looking for large investments, and none have access to VC and angel networks. Though the risk is high, there may be investor who are willing to take the gamble.
Lifting the ban provides a channel, where one doesn't currently exist, for these organizations to reach potential investors. Likewise, it provides a channel for interested investors to find out about opportunities they would otherwise not know about.
I didn't imply that lifting the ban would make funding automatic. Nor, do I expect, does anyone actually believe that it would (though you seem to think that's what people are saying). What it does do is allow the two ends to connect when there's mutual interest.
What this does is open a channel of communication. It's a way for small businesses to reach investors. That doesn't imply that the small business is going to get funding (or even a conversation with an investor) any more that getting on Shark Tank implies that Mark Cuban is going to invest in your fancy new shoelace company. On the other hand, there may be an investor out there, somewhere, who just happens to have an aglet company in his portfolio that would make your shoelaces a billion dollar company.
You don't put together a Reg D offering without competent legal counsel, and competent legal counsel costs money. So before you and your buddies can even test the fundraising waters through general solicitation, you'll have to make an investment of your own and that could easily run into the five figures.
There is an entire industry dedicated to this based out of New York. It gets hungry guys in early 20s to wake at 8am and begin cold calling high net-worth individuals offering them "investment opportunities". This industry flourished before the Internet and is depicted in movies like Boiler Room. The internet ate up a lot of their business because people no longer needed to be on walstreet to get data from walstreet. However, I can see these guys jump on this opportunity and begin shilling startups to the relatively high net-worth but naive retirees wanting to invest in the next facebook.
I can't judge whether your analogy to startup funding is correct, but I agree that direct advertising of prescription drugs to the general public is a total disaster.
Sure, YC demo day addresses this problem, but there are many startups out there who will never attend YC. And because these startups still need validation and a network, this has fueled an accelerator bubble as more and more accelerators throw open their doors.
I don't believe having all these accelerators is a good thing. Many are run by folks who have very little experience, and in some cases they offer little value other than a demo day stage.
So although I'm also unsure whether this rule change is good public policy, I do hope it helps pop the accelerator bubble and forces the remaining accelerators to focus more on building value and less on playing matchmaker.
I'm not one to beat the drum of deregulation, but I think the accredited investor requirements are stupid and wrong. The beauty of the securities laws is that they democratized investing by addressing some of the information asymmetries in the public markets. Regimes that reduce disclosure requirements at the expense of creating accredited investor requirements throw the baby out with the bathwater. Essentially, you cut off many promising investments to the masses, and also artificially prop up the returns to a certain class of investors by lowering the supply of capital. It's a solution that's worse than the problem.
Plus, is there any consequence to saying "yes I am an accredited investor" even if you aren't? I would assume you lose all the "protections" and ability to say "I was duped" but otherwise does anyone care?
However, there are some situations in state and federal law where being a "sophisticated investor" with knowledge of the markets and the industry allows you to invest.
P.S. I am not a lawyer and this is only my understanding of the situation.
One thing that struck me: the wefunder guys clearly believe this is going to be a big deal for small-time investors. How will firms accept those "$1000" checks? As far as I know, privately held securities can be issued to only a very small number of investors.
Will Facebook/Goldman style investment vehicles become a common mode of skirting the law? Is the SEC going to loosen that 500 investor limit?
We can offer that vehicle to companies as a fundraising option. We also have a standard convertible note specifically for a large number of small investors that we've been using ourselves which addresses "large number of investor" concerns in a different way.
The JOBS act has already increased the accredited investor limit to 2000, and once the unaccredited investor legislation takes effect, those unaccredited investors won't count against that total.
I think this approach is pretty cool, but there are these drawbacks. Are there going to be limits, protections, or restraints? Is the solicitation still only limited to qualified investors or how does this work?
EDIT: I see I missed that the article says "qualified investors", but I'm still not sure if that's the legal term or a more loose term.
The last remaining piece of the JOBS act is Title III, the part that allows non-accredited investors to invest. There are protections for this class of investors, including income-based limits (you can't invest more than 5%-10% of your income a year) and it requires investments to be made through a crowd on a crowdinvesting platform. The SEC is still working on the exact rules and regulations for this.
- Companies need to file with the SEC 15 days prior to generally soliciting.
- Companies need to provide additional information about the offering.For one thing, I expect it to continue the trend of shifting the balance of power from investors to founders. Basically, this will be a huge amount of new competition for angel investors. And crowdinvestors don't have voting rights or a board seat. In order to continue to get into deals they want, angels and VCs will have to bring more value to the table and accept less favorable terms. So I would guess, anyway.
On the other hand, it isn't necessarily going to be a river of cash for anyone who wants it. Along with the art of pitching to individual investors, one will also have to learn the art of pitching to the crowd -- and will be competing against everyone else doing the same thing. I expect to see a small industry of companies assisting founders in this new kind of marketing.
It is unlikely to do any such thing. To argue this, you must believe that there exists a substantial number of accredited investors who are not actively investing in private companies because they haven't received random solicitations to do so.
The reality is that accredited investors come in all shapes and sizes. The vast majority of the ones who are interested in putting their capital to work through investments in young private companies are already the people we call angel investors. In other words, lifting the ban on private solicitation is not likely to produce enough new angel investors to have a meaningful impact on competition for deals.
> I expect to see a small industry of companies assisting founders in this new kind of marketing.
There is already a well-established cottage industry of firms that help private companies raise money from accredited investors.
Obviously, the firms that do this don't do so for free, and some of them demand finder's fees that no savvy founder would ever pay, but there's absolutely no reason to believe that companies unable to raise money on their own will pay less trying to market themselves to investors directly than paying a finder's fee.
Basically the stock market no longer bears any relation to the simple business of providing capital to companies to grow.
The trade in secondary markets is so huge that the stock market can happily ignore smaller growing companies - and it is it seems if VCs and similar are to be believed.
Plus we know it is - reaching IPO should be when a company really starts to deliver, takes the capital and expands. Not when the founders leave, and the growth halts.
So yes, a new stock market, not bound to the financial gaming house, is needed to supply capital to growing companies.
It wont be kickstarter. But it will be something. And I doubt it will be American. It will be a federation of small markets across India and Brazil and China.
And it wont be tech-led. We can barely use the capital.
[1] http://www.reuters.com/article/2013/07/10/us-sec-advertising...
If they had been, by my calculations, the net worth requirement would be $2.41m instead of $1m and the income requirement $482k instead of $200k. Definitely easier to get accredited these days...