SEC Chairman Wants to Let More Main Street Investors In on Private Deals Jay Clayton outlines overhaul plans in interview, says changes could happen ‘pretty quickly’ By Dave Michaels Updated Aug. 30, 2018 2:38 p.m. ET NASHVILLE, Tenn.—The Securities and Exchange Commission wants to make it easier for individuals to invest in private companies, including some of the world’s hottest investments, which have been out of reach for many people, the agency’s chairman said in an interview. SEC Chairman Jay Clayton, a Trump appointee wrestling with how to boost flagging interest in public markets, said the commission also wants to take steps to give more individual investors a shot at companies that have for years avoided going public. Companies including Uber Technologies Inc. and Airbnb Inc., have shunned the public markets in favor of private investors such as venture capitalists. For decades, regulators have typically walled off most private deals from smaller investors, who must meet stringent income and net worth requirements to participate because of the added risk private investing holds. Mr. Clayton said the SEC is now weighing a major overhaul of rules intended to protect mom-and-pop investors, with the goal of opening up new options for them. “The private markets are awash in capital these days,” Mr. Clayton said Wednesday in Nashville, where he spoke to groups of entrepreneurs and business-school students. “The question is, who is participating?” Private firms have grown outside of the glare faced by public companies such as Tesla Inc.,whose founder Elon Musk recently set off a firestorm by tweeting that he planned to take his company private. Mr. Musk has complained that public markets encourage short-term thinking and routinely sparred with short sellers betting against his company’s stock. His plan, which has since been abandoned, has triggered an SEC probe into whether his tweet was misleading. Mr. Clayton declined to discuss Tesla. Privately sold securities, mostly off the radar of federal regulators, are increasingly how money is raised from venture capitalists in Silicon Valley and other innovation hotbeds because they are lightly regulated and don’t require regular scrutiny from regulators and investors. Those markets also have traditionally been a major source of fraud afflicting small investors. President Trump also has pressured the SEC to consider the balance between public and private markets, using Twitter two weeks ago to call on the SEC to study letting public firms report earnings every six months, instead of quarterly. “I’m not wedded to a particular result, but I think we should look at it,” Mr. Clayton said in the interview, conducted Wednesday. He said that the commission is studying the move, and added that even if companies reported earnings less frequently they would still update investors on important trends for the business. Adjusting the rules affecting private markets also could offer Mr. Clayton, a former Wall Street deals lawyer, a way to make good on his goal to help small investors access more high-quality investments for retirement or other needs. The SEC plans to issue a lengthy paper in the coming months—known as a “concept release”—that will seek public comment on how to revamp the capital-raising process, including by expanding access to private stock sales. After that, “I think you could move pretty quickly on this kind of thing,” Mr. Clayton said. Allowing more people to easily invest in private firms would help address “the massive capital gap in the middle of the country” where there are few venture capitalists and founders have trouble getting cash, said Patrick Henshaw, a vice president at Cintrifuse, a public-private partnership in Cincinnati that connects the city’s major corporations with startups. The chance to devote part of an individual portfolio to private companies would give investors more diversification and the chance to benefit when firms go public, said Lonne Jaffe, a managing director at Insight Venture Partners, a venture-capital and private-equity firm. It also could lead to a marginally lower cost of capital for the companies, since they would be able to tap another channel of funding, he said. “I don’t think it’s going to be game-changing,” Mr. Jaffe said. “But you are now exposed to an additional equity instrument you could not have gotten until they became public.” The paper will discuss helping businesses make sense of the patchwork of fundraising methods allowed by Congress in recent years. Some of those measures made it easier for Silicon Valley stalwarts to stay private longer. Others permitted crowd-funding and “mini-IPOs,” a type of stock sale that allows businesses to tap retail investors but requires they provide them with periodic disclosures and audited financial statements. Republicans and businesses initially hailed the new public fundraising channels. But they have barely been used in comparison to private offerings, according to SEC data. Since 2015, companies have raised about $90 million using equity crowdfunding and $1 billion under the “mini-IPO” rule, known as Regulation A+. More than $1.7 trillion was raised during just 2017 through private stock and debt deals. Mr. Clayton noted the attraction of private offerings at several stops in Nashville, where he spoke to a conference of entrepreneurs at the Wildhorse Saloon, a live-music venue that typically hosts country-music bands and line-dance lessons. “There are complex offerings where you need a lawyer of the type that I was in the private sector, but you shouldn’t have to hire a high-powered Wall Street lawyer to conduct every private placement,” he told Launch Tennessee’s 36|86 Entrepreneurship Festival, named for the coordinates of Nashville. Private securities, which can include stakes in anything from an apartment complex or oil well to a biotech company, can offer investors higher returns than publicly traded stocks and bonds. But there is typically less information available about the firms, increasing risks for investors. Securities firms with a higher number of troubled brokers are more likely to sell private stakes in companies, often targeting seniors, an analysis this year by The Wall Street Journal found. Rules aim to protect individual investors from such riskier deals. Those who meet certain wealth or income standards—such as household income of $300,000—can participate. Those investors still must be given lengthy questionnaires and disclosures, steps that promising startups typically find too cumbersome given the limited dollars typically offered by a single person. Instead, startups can tap much more money at one time by targeting a few venture capitalists or corporations. The SEC hopes to streamline that process and create more “accredited” investors, such as by allowing in people who don’t meet the income or wealth thresholds but have professional licenses or advanced education, Mr. Clayton said. Mr. Clayton said his thinking evolved about giving small investors better access to the private market as he spent more time at the agency. He said the changes wouldn’t take away investor protections and would result in people getting access to higher-quality deals. “It came from doing the job and recognizing that for retail investors the opportunity set beyond the public market is pretty low and pretty costly. And pretty risky,” he said. “But people want that.”
As someone who has done the rounds with VCs and angel investors, I can't imagine trying to start a startup while at the same time soliciting a few thousand dollars here and there in dribs and drabs from random joe investors, not to mention the time sink holding their hands and dealing with them afterward. What an absolute nightmare! I sense some severe adverse selection here, the only people who will target these folks are "entrepreneurs" who are more focused on fundraising than actually launching a company because you'd be crazy to waste time here if you actually cared about launching a product. As a result, they'll all get burned and we'll end up with even more restrictive legislation down the road.
I'd imagine they would use "aggregation agents" akin to YieldStreet, that's the only way I'd see this happening efficiently. I also see the the potential for a lot of people to lose a lot of money.
Or large companies like Uber where there are thousands of shareholders who have a shortage of liquidity.
I would guess the vast majority of term sheets have a clause in them that says something like if you sell your shares pre-IPO then every shareholder of that class has to have the option to sell their shares with you on a pro-rata basis and buy the shares on a pro-rata basis, along with a bunch of other restrictions that make it basically impossible to sell any employee stock option/grant shares before a liquidity event. They sometimes make exceptions for senior people so they can move out of their studio in the East Bay to a 1 bedroom closer to the company (or other "quality of life benefits the company" type reasons) but that's the exception. I would think the VCs would basically lock this down going forward starting with all future first round term sheets because the last thing they want is insiders becoming less committed by diversifying away from the company, not to mention having to convince a bunch of random shareholders of whatever direction they want to take the company in. They're pretty pathological about wanting pigs not chickens.
This is great, the accredited investor BS needs to go. Let everyone do what they want with their money. Losing can teach people a lot
This would be fine if the financial sector which was "too big too fail" didn't buy politicians to redistribute tax dollars to bail them out once they abused the scams for all their worth.
Instead of loosening the rules to allow mom and pop investors to put their money into private companies, Mr. Clayton should instead focus on how to make it safe for mom and pop investors to invest into private companies. It's easy to just allow people to throw money at companies that want them but designing mechanisms to ensure that those companies are not going to just take the money and scram and are never heard again is what is important. If public companies like Enron that have financial statements audited by "supposedly" reputable accounting firms can defraud investors like that, it is not hard to imagine that mom and pop investors losing their life savings that they have accumulated their whole life losing it all to some schemes cooked up by those "private companies" in those "funds" or some "audited" financial statements especially when mom and pop investors neither have the training and the sophistication nor the opportunity to personally interview and visit and examine those private companies in any way. All those venture capital firms, when they invest in those private companies, they often work very closely with the private companies, being involved in every single step of the way during the development of the products/services of those companies, guiding them, marketing for them, basically knowing those companies inside out. Are those mom and pop investors going to have the same opportunity to be that personally involved with the private companies to get to know them that well before they open their wallet to them? If not, how are you going to ensure that all those private companies that need funding are legitimate companies who have a good idea/concept that just needs funding to get started? What other information or mechanism besides providing updates and audited financial statements is there to ensure the mom and pop investors are getting the information that they need for investing their funds with the right company? If fraud did happen, what are the recourses besides legal courts are there for the mom's and pop's to recover their funds? It's easy to look at the success stories like Uber and Airbnb and slobber over the amount of money those investors have made but what about the companies that failed or worst turned out to be frauds?? This scheme of basically allowing everybody to be the Dragons in the Dragon's Den without really giving them the opportunities or the means to work with or examine closely the private ventures that they put their money in has got disasters written all over it.
Very good points. I'll add that scamming is even more likely because of the very nature of startups, where even the legit ones can seem like they're operating in fantasy land both with the nature of their technology and the aggressiveness of their business plan. Much harder to detect a scam if you're not an expert in the space where that startup operates or have access to such experts.