The key thing to understand is that the higher return potential that an investment in a private startup company can potentially bring also has a very large risk factor that only investors with adequate capital reserves should be allowed to make. The accredited investor rule was put in place to protect unsophisticated investors from being taken to the cleaners with bad investments. Public companies have the SEC to mandate disclosure of risks so that a public investor has enough data (in theory but not always in practice) to make an educated investment decision about investing in a company's stock. No such requirement are in place for private companies so to be fair to small private firms and not require them to engage in costly public disclosure practices, the SEC flipped it and put the onus on the investor but requires them to be "accredited" which I define as someone who should be intimately aware of the existence of risk. The thought process is that "un-accredited" investors won't have that level of sophistication and risk being taken by schemes or just lose their investment due to a company's inability to succeed...something that happens more often than not.
I will concede that the SEC has failed the public many times in allowing bad people to pull the wool over investor eyes recently. But that is a factor of failed implementation of the rules and not the rules themselves. And there are no rules stating that small companies may not take investment from "un-accredited" investors; it just limits that company's ability to affect an IPO or be acquired by a public company.
It is also for the protection of the small companies that these rules exist. How many lawsuits would we see in this litigious society that we have if anyone could invest in anything without some level of required investing acumen? I feel that it is in any startups best interest to take capital from accredited investors only because it mitigates significant risk. Any market for investing in startups similar to the public markets would require such a regulatory overhaul that I doubt it would work, let alone ever happen.
cordor91
· 8 months ago
Without question, this should be a buyer beware market. Investing in a startup or private company entails great risk and if one is a beginner, statistically, that person will not come out as successful as he/she would have envisioned.
If a private company wanted to raise 100k, would the company be legally allowed to raise money from the local community (assuming people in the local community are not 'accredited investors')? If the answer is yes, would raising from an unaccredited investor hurt the company? The small business community is hurting and needs capital.
Changing slight subjects, do you see a problem with founders illiquid assets?
nwcnwc
· 7 months ago
Our present financial crisis has shown that not only do non-accredited investors (i.e. normal people) not understand risk, but neither do most so-called "sophisticated" investors. And I'm not even talking about the people who were fooled by Bernie Madoff (most of those people, though, probably inherited their money -- people who've actually toiled and sweated to make large sums of money by definition aren't that stupid with it). I'm talking about the extremely high-paid and for the most part well-educated money managers at various banks and funds who got caught up in the extending-ridiculous-credit-to-poor-people-who-live-in-overpriced-houses madness. If they were making "rational" decisions in their own heads, it can only be that there was something wrong with their heads. They didn't understand the risk of the "securities" they were buying.
But these people are our smartest and brightest -- they MUST have understood the risk. For whatever reason, they thought it was worth it. Worth it for themselves, that is. And it probably was. So their compensation arrangements must have been backwards.
But I digress. My point is that nobody properly understands risk, and even if we mortals were capable of understanding it, in aggregate we will always end up taking too much risk because the downside risk is limited (a bank account at zero, or bankruptcy), while the upside risk is perceived to be unlimited (in reality, I doubt there's much difference between 1 trillion and 2 trillion).
But I still digress. The original issue is Cory's dissatisfaction with the accredited investor rule. First off, this rule certainly doesn't restrict start-ups from taking money from friends and family. Second off, the government rightly controls lotteries and gambling. Investing in start-ups you know nothing about is a little like gambling in a lottery. Third off, there is no shortage of bad people out there who would gladly swindle money from our 80-year-old grandmothers. Not all of these bad people are in jail, and the SEC is never going to find all of them.
So to wisely invest in a company requires both that you have good reason to trust the people running the it and that you have and take the time to understand and feel confident about the business model. If you are missing one or both of these, then your investment is likely adding to a bubble that's going to explode in society's collective face and require wounded society not only to heal itself, but bail you out too. That's what we're living through right now.
The accredited investor rule supposedly keeps this from happening in certain areas of commerce, and now supposedly we've got to find another rule to keep this from happening in the way it just did. Personally, I think government is no better at making rules than bankers are at making loans. So government will look busy until the dust settles, then society will collectively start building its next bubble, with or without accredited investors.
fredwilson
· 7 months ago
the only way i see this working is if this is an unregulated market and the only way that is going to happen is if it is limited to "qualified investors" - that means super rich people and institutions
cordor91
· 7 months ago
Thanks for your comment, Fred!
Do you foresee this happening? Also, in our current economic environment, have you noticed capital raising restrictions which are harming small businesses? If yes, what sorts of restrictions are on your mind?
Chris Yeh
· 7 months ago
While I agree that people should feel free to invest as they see fit, it is also the case that political pressures would inevitably kill any private market that allowed unsophisticated retail investors to participate, regardless of the caveats and warnings employed.
It doesn't take a genius to figure out that if you have no income, you probably shouldn't buy a house, yet in the wake of the subprime fiasco, the answer has been to tighten standards, not educate people on why borrowing $250K when you panhandle for a living is a bad idea.
All Comments
I will concede that the SEC has failed the public many times in allowing bad people to pull the wool over investor eyes recently. But that is a factor of failed implementation of the rules and not the rules themselves. And there are no rules stating that small companies may not take investment from "un-accredited" investors; it just limits that company's ability to affect an IPO or be acquired by a public company.
It is also for the protection of the small companies that these rules exist. How many lawsuits would we see in this litigious society that we have if anyone could invest in anything without some level of required investing acumen? I feel that it is in any startups best interest to take capital from accredited investors only because it mitigates significant risk. Any market for investing in startups similar to the public markets would require such a regulatory overhaul that I doubt it would work, let alone ever happen.
If a private company wanted to raise 100k, would the company be legally allowed to raise money from the local community (assuming people in the local community are not 'accredited investors')? If the answer is yes, would raising from an unaccredited investor hurt the company? The small business community is hurting and needs capital.
Changing slight subjects, do you see a problem with founders illiquid assets?
But these people are our smartest and brightest -- they MUST have understood the risk. For whatever reason, they thought it was worth it. Worth it for themselves, that is. And it probably was. So their compensation arrangements must have been backwards.
But I digress. My point is that nobody properly understands risk, and even if we mortals were capable of understanding it, in aggregate we will always end up taking too much risk because the downside risk is limited (a bank account at zero, or bankruptcy), while the upside risk is perceived to be unlimited (in reality, I doubt there's much difference between 1 trillion and 2 trillion).
But I still digress. The original issue is Cory's dissatisfaction with the accredited investor rule. First off, this rule certainly doesn't restrict start-ups from taking money from friends and family. Second off, the government rightly controls lotteries and gambling. Investing in start-ups you know nothing about is a little like gambling in a lottery. Third off, there is no shortage of bad people out there who would gladly swindle money from our 80-year-old grandmothers. Not all of these bad people are in jail, and the SEC is never going to find all of them.
So to wisely invest in a company requires both that you have good reason to trust the people running the it and that you have and take the time to understand and feel confident about the business model. If you are missing one or both of these, then your investment is likely adding to a bubble that's going to explode in society's collective face and require wounded society not only to heal itself, but bail you out too. That's what we're living through right now.
The accredited investor rule supposedly keeps this from happening in certain areas of commerce, and now supposedly we've got to find another rule to keep this from happening in the way it just did. Personally, I think government is no better at making rules than bankers are at making loans. So government will look busy until the dust settles, then society will collectively start building its next bubble, with or without accredited investors.
Do you foresee this happening? Also, in our current economic environment, have you noticed capital raising restrictions which are harming small businesses? If yes, what sorts of restrictions are on your mind?
It doesn't take a genius to figure out that if you have no income, you probably shouldn't buy a house, yet in the wake of the subprime fiasco, the answer has been to tighten standards, not educate people on why borrowing $250K when you panhandle for a living is a bad idea.