The SEC and Private Markets

The WSJ says that the SEC is reviewing the rules under which privately held companies raise capital and are subject to securities regulation. They quote the SEC Chair Mary Schapiro as saying:

The staff is taking a fresh look at our rules to develop ideas for the Commission about ways to reduce the regulatory burdens on small business capital formation

Who knows what, if anything, will come out of this review, but I am all for taking a look at rules which were written when I was three years old. Two things I would strongly suggest the commission look at is the 500 shareholder rule and the requirements to be a qualified and/or accredited investor to invest in privately held companies.

Both of these rules directly or indirectly keep small investors, ie the general public, from investing in privately held companies. Most people do not qualify as accredited or qualified investors so their ability to invest in privately held companies is significantly restricted. And because privately held companies cannot have more than 500 shareholders without having to file disclosure statements, most companies prefer institutional investors who can invest large sums of money to small investors who cannot.

Some of the most exciting companies to emerge in the past decade have decided to stay private for longer periods of time. There are many reasons why that is the case, but one of the reasons is that founders, Boards, and senior management realize that being public and having your employee equity go up and down every day has a cultural impact that is not always good for the organization.

The best companies will most likely eventually go public and deal with the issues that being a public company presents, but the value creation that occurs pre-IPO has been and will likely to continue to be very significant. And it would be a fantastic outcome if the SEC decides to allow the general public to be a more active participant in the value creation that happens while companies are still privately held.

UPDATE: A commenter pointed out that a private company can have more than 500 shareholders, but it will be required to file disclosure statements. I fixed the post to reflect that. The same commenter, sdd, suggested that the 500 shareholder limit be amended such that it does not include shares issued to employees. I'd add former employees to that. This is a great suggestion. Most of the companies that I have been involved with that have had 500 shareholder issues have had them as a result of employee equity.

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