Jonathan Steiman
  • Blog
  • Resources
  • Photos
  • My Dad's Photos
  • About Me
  • Contact

Revamping Reg D: Protecting Widows and Promoting Innovation

4/30/2011

0 Comments

 
According to recent reports, the SEC is reviewing the regulations surrounding investments in privately held companies. The agency is believed to be reviewing the rule that caps the number of investors in a private company at 499. This arbitrary number, say its critics, is outdated in the in the age of crowd-sourcing. Another area that I believe is in desperate need of review is Regulation D Rule 501, which states that an individual can only invest in a privately held company if they have:
  • A net worth (excluding primary residence) of $1 million or
  • An annual of income for two years in a row of $200,000 for singles or $300,000 for married couples.*
On the one hand, I fully appreciate this regulation. The rule is intended to determine who is a sophisticated investor. The government cannot easily determine this, so they assume that if you are making money or have money than you can withstand the risk of investing in an early-stage company. The rule, in short, protects widows and orphans from being placed into unsuitably high-risk ventures.

Unfortunately, I know this story all too well. A few years ago, a family member of mine invested $50,000 into a privately-held company. The family member was a single mother that had major health issues and was therefore unable to keep steady work. When she passed away, leaving behind a 12-year-old daughter, we discovered that she did a lease-back on her property and was advised by someone close to her to invest the money with his employer, an India-based outsourcing start-up.

The accredited investor rule can help prevent this from happening. Unfortunately, it also hurts economic growth by hindering entrepreneurship and limiting investment opportunities for individuals with a relatively low net worth. From the entrepreneur’s standpoint, the accredited investor rule lowers the probability of raising capital and getting an early stage venture off the ground.**

The accredited investor rules are also regressive, meaning that those with money get the opportunity to participate in high-risk, high-return ventures, while the general population is unable to participate in the funding the next Microsoft, Google or Facebook. Obviously, these type of ventures are not suitable for every investor; a single mother with a low paying job and health problems, for example. But it makes little sense that a young person with a healthy salary and the technology savvy to understand future markets should be relegated to the sidelines. Furthermore, even if this person loses their investment, which is the most likely outcome, they will have learned a tremendous amount.

No regulation is perfect. However, I would like to see these rules updated to capture the realities of today. Some headway is being made, given that the SEC is at least reviewing the rules. Perhaps, unaccredited investors should be allowed to invest up to $10,000 or $20,000. Or, they could be permitted to participate only after maxing out a Roth IRA and / or contributing at least 8% to their 401k / 403b accounts.
________________________________________________

Please note that I am not a lawyer; so please follow the links in this blog to the SEC rules and, if need be, consult an attorney. In the past, I have reached out to Ryan Roberts who writes the startuplawyer blog and Bart Greenberg who is at Haynes and Boone and also active on Quora. They have both been responsive and helpful.

*There are ways around this; for example, Reg 506 allows for companies to raise money from 35 non-accredited investors. However, this rule can be undone by state laws; New York and California are among the strictest. Please note that I’m not a lawyer; for more information follow the links. Also, there are discussions about excluding primary 

**Also, less available capital shifts the pricing power to investors and thus increases the cost of capital. I have not seen any empirical evidence to support this point, but I have a hunch that a change in regulations that doubled the number of people able to invest $10,000 would increase valuations, at least in the short-term. It is still up to the founder to create value regardless of the accredited investor rules.
0 Comments
    Picture
    JONATHAN STEIMAN
    Follow @jonsteiman
    I'm the Founder and CEO of Peak Support. This blog is my take on early-stage companies and innovation. Every so often, there may be a post about culture, networking, family -- you name it. After all, what is a blog if it isn't a tad bit unstructured.

    Enter your email address:

    Delivered by FeedBurner

    Archives

    December 2016
    August 2016
    December 2015
    August 2015
    May 2015
    September 2014
    July 2014
    April 2014
    March 2014
    December 2013
    August 2013
    June 2013
    May 2013
    April 2013
    March 2013
    October 2012
    September 2012
    August 2012
    July 2012
    June 2012
    May 2012
    April 2012
    March 2012
    February 2012
    January 2012
    December 2011
    November 2011
    October 2011
    September 2011
    August 2011
    July 2011
    June 2011
    May 2011
    April 2011
    March 2011
    February 2011

    Categories

    All
    2011
    Accredited Investors
    Airbnb
    App
    Apple
    Bankrupt
    Bankruptcy
    Benjamin Graham
    Best New Business Blog
    Beta
    Blog
    Bob Dylan
    Capital Asset Pricing Model
    Capital Requirements
    Capm
    Coaching
    Codecademy
    Codelesson
    Competitive Strategy
    Continuous Improvement
    Convertible Preferred
    Creative Destruction
    Crowd Sourcing
    Crowd-sourcing
    Customer Insights
    Database
    Data Repository
    Dcf
    Debt
    Design
    Development
    Discounted Cash Flow
    Disruptive Technology
    Ed Tech
    Education
    Education Technology
    Elizabeth Warren
    Entrepreneur
    Entrepreneurship
    Ephemeral Era
    Equity
    Facebook
    Facebook Marketing
    Facebook Mobile Advertising
    Finance
    Finance-ability
    Fortunate
    Function
    Functionality
    Fusion Tables
    Google
    Google Chrome
    Google Docs
    Google Fusion Tables
    Google Spreadsheet
    Google Table
    Hiking
    Innovation
    Instagram
    Institutions
    Intensity Map
    Internet Access
    Internet Platforms
    John Rawls
    Joseph Schumpeter
    Leadership
    Location
    Location-based Data
    Management
    Marketing
    Mba
    Microsoft
    Microsoft Access
    Mobile
    Model
    Nda
    Networking
    Novartis
    Operations
    Participating Preferred
    Pay-off Diagram
    Performance
    Personal Improvement
    Peter Drucker
    Polaroid
    Portfolio Management
    Postagram
    Private Equity
    Product Development
    Risk Free Rate
    Risk Management
    Scale
    Schedule
    Sec Regulations
    Sincerely
    Social Media
    Standards
    Start Up
    Start-up
    Steve Blank
    Table
    Talkto
    Taxation
    Ted Fortsmann
    Treehouse
    Twitter
    User Interface
    Valuation
    Value Chain
    Venture Capital
    Venture Finance
    Warren Buffett
    Water Safety
    Web 3.0
    Working Capital
    Y Combinator

  • Blog
  • Resources
  • Photos
  • My Dad's Photos
  • About Me
  • Contact