Startup firms reaching “unicorn” status—private companies such as Uber, Dropbox, and Spotify valued at more than $1 billion—and the general fervor about high-tech startups are now fodder for movies, novels, and television shows. Yet as popular as these unicorn stories are, average investors cannot invest in these types of firms before they go public on NASDAQ or other stock markets. At least not yet. A provision of the Jumpstart Our Business Startups Act, passed by Congress three years ago, is working its way through the U.S. Securities and Exchange Commission. The provision would allow a less wealthy class of individual investors to buy equity stakes in private companies. But exactly how useful would this ability be for individuals, private companies, and the economy overall?
Currently, if you want to invest in a private startup company you have to be certified as an “accredited investor” who either earns a certain amount of money ($200,000 as an individual, $300,000 if married) or has a net worth of more than $1 million (not including your home). These investment criteria obviously restrict the pool of potential investors to the very wealthy, which means a company such as, say, Gimlet Media, a startup podcasting firm that announced an opening round of private funding last year, cannot offer the vast majority of its listeners a chance to invest in the new company.
The JOBS Act, specifically Title III of the act, allows for increased access to these firms for average investors by reducing the qualifications for an accredited investor through equity crowdfunding. Basically, it’s Kickstarter for stocks. If the regulation were already in place last year, then more of Gimlet Media’s listeners might have bought a stake in the startup. The proposed rules now under consideration would allow everyday investors to invest in startup equity, but with some still-to-be-determined restrictions on the percentage of their income and net worth that they could invest.
But there are questions about just how useful private stock crowdfunding would be.
First, it’s not clear that companies would jump at the chance to increase the amount of crowdfunding. Many already tap currently accredited investors, as Jeremy Quittner writes at Inc. Private companies might simply stick with investors who are already “accredited” as they tend to have far more money. And the new regulations will probably result in increased filing costs for companies that get funds from unaccredited investors because the private firms will have to increase disclosure and public filings of their financial information.
This last requirement could get very expensive. The SEC estimates the cost attracting unaccredited investors would be quite high, reports Jim Saska at Slate: $39,000 in fees to raise $100,000 or more than $150,000 to raise $1 million. Why would more companies jump into this endeavor for small investments with high costs?
On the investor side, the gains are questionable as well. Accredited individual investors today are analogous to “angel” investors, those wealthy individuals who often provide seed funding for startup firms. The number of angel investors has increased in recent years and new startup firms have had the strange problem of too many angels chasing opportunities to invest in firms. But, as Mike Isaac at The New York Times reports, the current investment process isn’t as clear cut, with one investment firm stepping in to educate these investors about process and give them tips.
If these wealthy individuals need advice on investing in individual young firms, then what can we expect among a much larger pool of newly minted, inexperienced investors? An effort to democratize returns might instead spread the experience of investing in a busted enterprise. After all, according to one estimate 75 percent of venture capital-backed firms end up failing. Given the sobering trends in retirement savings in the United States, perhaps opening up more avenues to lose savings isn’t a good idea.
The broader economic benefits of increased private investing in startups seem small as well. If anything the U.S. economy is awash in capital. The very fact that startups can reach valuations in excess of $1 billion without going public is testament to the ease with which private companies can access capital. The startup rate in the U.S. economy is on the decline, but it’s not clear that a lack of financing has anything to do with this long-term trend. The crowdfunding idea for stock investments in private companies may have been conceived with good intentions, but we all know where a road paved with them can lead.