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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#VC & Technology

Comments (Archived):

  1. ShanaC

    Yup, we need a more logical system for trading small caps stocks, and for trading not fully public companies that are small cap growing into large cap (or medium cap)And we need to rethink the ipo process and what belongs in that process. I sort of wish there were a more organic system of IPOing – in which every milestone you complete makes you “more public” until you are “public”

    1. Gorilla44

      That’s an interesting concept.I know some “smaller” companies go public on the TSX (Toronto) or AIM (London).Can someone explain how those are different from the Nasdaq or FTSE?Thanks.

    2. JLM

      Public v private is like being pregnant — there are no intermediate milestones.You are either with child or you are not.

      1. fredwilson

        generally, i’d agree with youbut given how liquid and marketable its stock is – do you think facebook is “public”?

        1. JLM

          FB would be the poster child for how it should not be done and exactly why there has to be a bright line standard that everyone can understand and follow.FB and its still born deal w/ Goldman is also an example of how the industry itself attracts undue attention and causes its own problems.There is nobody on Wall Street who is defining and protecting the honor of the Street and it is odd given that there are a lot of very good people involved. And, some not so good people.

          1. COMRADITY

            First, I didn’t realize that FB’s Goldman deal was “still born.” And didn’t Twitter do a similar deal with JP Morgan?Second, isn’t “the industry” (I assume you mean the VC industry) intentionally attracting attention? These equities aren’t traded based on earnings. It’s fair to say that at this early growth stage earnings aren’t so impressive. The value of these equities is based on popularity (for example, active users and advertiser deals reported in the press). If popularity drives value, then attracting attention is indeed intended.I’d expect early stage companies with integrity would want to encourage some disclosure requirements, relevant to an early stage company, specifically to differentiate between those who are generating “undue” attention and those who merit it.In response to replies below:Thanks Geoffrey. But is it really “rock-n-roll” for a company with integrity to want transparent and clear transactions. As C.K. Prahalad proposes, to eliminate corruption, a marketplace needs Transaction Governance Capacity (TPC).Fred and JLM, thanks for clarifying the Facebook/Goldman and JP Morgan/Twitter. Yes, the coverage of these stories is confusing.To both JLM and Geoffrey. Totally agree that popularity should not play the role it does in the stock value of these companies. JLM, demand may not be at the same scale as in the Tulip Scandal, but the market is limited to accredited investors specifically to prevent that, isn’t it?

          2. fredwilson

            Twitter never did a deal with JP Morgan. To my knowledge Twitter has nevereven had a meeting with JP Morgan. JP Morgan is a limited partner in a fundthat owns some stock in Twitter. Don’t believe what you read in the media.It is wrong more often than it is right

          3. Guest

            Really like that last sentence; that is actually a very interesting way to think about it. If I understand you correctly, basically use the disclosures and the disclosure process to say here is the substance to some of the hype you see – now go look at the other guys. I actually kind of like that in your face rock-n-roll mentality (no surprise there). Interesting.One point, even startups value should not be traded on popularity; these are businesses or future businesses. Some form of economics has to come to bear, even at the earliest of stages. That said, the valuation process is much much harder because a DCF model is about all you can use. Valuing on users is meaningless – LONG TERM. User base has to be monetized in some manner for a viable economic concern to come into being. Every time I see users mentioned as a valuation schema I bloody freaking cringe! Users are GREAT metric for the startup dashboard. They can help founders check their instincts about MVP, customer profiles, usability, etc. etc. But in the long run users mean nothing if they don’t generate revenue or profits.

          4. JLM

            Two FB – Goldman deals, one went and the other imploded. The one that imploded was the $1.5B private placement. JP Morgan has never done a deal w/ Twitter that was publicly announced.”The value of these equities is based on popularity…”That is a fair description of the Tulip Scandal, no?That is not “investing”, that is at best a casino. America needs rational and fair markets for investment not faddish style show casinos.Investing is not a swim suit contest.

          5. JLM

            That’s like blaming rape on the victim.Accredited investors are entitled to the same treatment and protections as any others.Public markets and public market regulators are not obligated to follow a fad started by misguided “investors”.They are supposed to be regulating the markets, setting up guard rails.The bankers who have offered such investments should and do know better.

          6. COMRADITY

            Updated my comment below to reply to you, Geoffrey, and Fred.K–

          7. COMRADITY

            I do not get the analogy of blaming a rape on the victim. No one forces anyone, an accredited investor or the public to buy a stock. They choose to do it.Media company future value is driven by anticipated popularity times advertising. Popularity can be fickle. What advertisers will pay for one media over another is related to available supply and demand by brands to associate with the media (popularity). For example a TV show has a limited number of commercials, a website can rotate spots indefinitely. When the demand (popularity) for the stock exceeds available supply the price goes up. So popularity can drive these stock prices up and down in multiple ways.A reputable media company should hope that regulators and bankers recognize the importance popularity can have on the ups and downs of stock price.

          8. JLM

            Simply because one is “accredited” does not mean you can lower the standards of disclosure. Being accredited means you are more likely to understand the implications not that you are an authorized “mark”.You are using the term “popularity” in a slightly difference context than you had previously — attention.I have no quarrel with valuation techniques which apply reasonable arithmetic to industry data — revenue multiples, viewership.But I have a total aversion to hype and I think that absent meaningful disclosures companies like FB are primarily floating their valuations on hype.That is not to say that all “hype” is counterintuitive. Sometimes, it is right on the mark.But, again, that is not investing.

          9. Guest

            Nice comment JLM

          10. COMRADITY

            totally agree with your sentiments JLMand not just protect investors but also to allow businesses with integrity to rise above all the hype.especially in a market where value is both legitimately and falsely influenced by popularity.

      2. ShanaC

        Im still a holder of the belief that in the first trimester, you are in facta little bit pregnant, if only because there are so many miscarriages then.And stocks/companies are not fetuses gestating – we just set up a systemwhere it is very binary (public v private)We don’t have to.

        1. JLM

          Oh, please, cher, it was just an analogy. Don’t over think it.

          1. ShanaC

            😉 Deal

  2. DGentry

    We are rapidly creating a new and far less regulated second stock market. The most valuable new companies stay private and achieve liquidity using a different set of rules.Its probably true that the rules governing the public markets are decades out of date and need to be blown up… yet I can’t help but wonder about the ramifications of a second market, reserved to those meeting qualifications.

  3. William Mougayar

    Agreed, as long as it doesn’t lead to bubble symptoms. I think it would still have to be regulated, perhaps differently or more lightly.

  4. JimHirshfield

    Changes are in order, but regulators will be looking to protect grandmas from losing everything. Thoughts?

    1. Steve Poland

      I think they simply need to reduce the requirement of being an “accredited investor”. Someone making six figures plus a year should be able to do what they want with those funds.On the flipside, the poor go to their corner store to invest their wages in NY Lottery… honestly, that should be outlawed. “A dollar and a dream” — NYS is taking advantage of the poor dreamers of this world.

      1. Gorilla44

        Quit picking on the lottery. You gotta be in it to win it.

        1. Magnus Wikegård

          “A lottery is the perfect tax…laid only upon the willing.”George Washington

      2. CJ

        I know people who spend upwards of 40 bucks per week on the lottery. Imagine if that money were invested in a DRIP. thats a retirement right there.

        1. Reid Curley

          To paraphrase Seth Godin:People who buy lottery tickets are not paying for a chance to win millions of dollars. They are paying for the feeling that they have between the time that they buy the ticket and the time that they don’t win the lottery.I doubt that DRIPs provide the same element of suspense.

    2. Dave Pinsen

      Grandmas can lose everything now by pouring all of their savings into lotto tickets. They can also pour all their money into stocks with symbols ending in Qs, and regulators don’t prevent that, so why prevent them from investing in privately held companies?

  5. Druce

    The first thing that will happen is a massive bubble, sketchier and fraudulent companies getting in on private offerings, and then a huge collapse.True public markets bring timely and complete disclosure, public price discovery, fair access for all investors, low transaction costs, and of course a true market for control, M&A and ability to influence management.The SEC should look at why more companies choose to stay private. To the extent they are legitimate reasons, the public markets should be fixed where they can be made less burdensome.If people simply want to avoid public scrutiny, legitimate public disclosure and fair dealing, the SEC should say, ‘tough noogies’, and if you want to do that, stick to investors who knowledgeably and explicitly waive those benefits, not small individual investors.I used to think a lot of financial regulation was ill-thought-out. they got repealed and circumvented, and we saw how that went, in the financial crisis. I realized the regs weren’t as ill-thought-out as I thought LOL.

    1. fredwilson

      that’s a useful perspective druce

    2. Guest

      Nice post Druce.I just discovered Fred’s post for today. Earlier in the day I started looking for some details behind this proposal because I too have some concerns.There may be some good that come from expanding the number of shareholders but only if some transparency and disclosures are put into place. I am still unclear what proposals in this area of the new proposal are being considered. If all private company investors have access to financial information then that is OK. If the proposal is to allow more investors but allow private companies to have something less than a full disclosure I would be concerned.I have spent years in a variety of private company valuation roles. I can tell you that it is as dependent as much on art as it is science. It is not pure art and it is not pure science as some might have you believe. What is needed to make the most educated conclusion as an investor is access to good, solid information. As long as investors have access to that then this type of proposal might solve some issues facing some growth-oriented startups. If this is an attempt to gain some benefits while hiding behind something less than full disclosure to the investor class I say “PASS”

    3. Aaron Klein

      I dunno. I’ve yet to locate these sheeple who blindly throw money at speculative equity investments. 🙂

      1. Druce

        LOL – they’re like taxicabs, never around when you need them…and especially not when it’s raining and you really need’em!

  6. Brooke Aker

    SEC should flip the accreditation around to the privately held companies. Then use a neutral 3rd party to establish legit businesses from frauds. Any private company who wants to raise “average citizen” money can bear such a cost. This way Grandma will know her money is going to an innovative use and not into the pocket of some guy smoking cigars on his yacht.

    1. Austin Clements

      Having a company go through a regulation body in order to accept capital investment from the general market? That’s essentially the same process as going public. The only major difference is that the business owner gets to choose which investors they accept in private transactions. If a business owner is being that selective I doubt they will get anywhere near the 499 maximum.Any major changes to private investment regulation will likely just blur the line of what it means to be private versus public. You don’t want a company with millions of investors to not have to disclose their financials. Damn near every business on the exchanges would opt to do that instead, but it undermines the fundamental trust relationship between the company and the investor.I think its much more important to just streamline the process of going (and staying) public so more companies can accept more dollars. Some combination of minor regulatory changes and an inspired banker somewhere will come together to make the IPO a much smaller hurdle than it is today.

      1. Brooke Aker

        Was assuming the SEC could make the requirements “light” enough for most cash poor start-ups to stomach.

  7. Harry DeMott

    This conversation is rife with “the law of unintended consequences” issues.In general, I feel the government has no business telling anybody what they can or cannot invest in – and generally, if they get fleeced, or lose it all – then it is on them. People lose billions in the lottery every year without complaint from the government despite the government posting the odds of losing on most tickets.Now that said, any further liquidity in the private market is going to be great for that market. The more liquidity – the better the market. However, liquidity needs transparency to go with it. One without the other is a pure casino.I think most VC’s who are confident in their investing abilities would welcome additional liquidity – because even though it will drive the price of entry up and the returns down slightly, it will also allow for exits from tougher situations – which might counterbalance the higher upfront costs.There is a real problem in the current secondary markets with asymmetric information. Sure I can buy Facebook stock from someone – but does that someone sit on the board – or work at the company and just plain know a lot more about the business than I do? In general, the answer is yes.You might argue that the public markets are corrupt and rigged – but they are far more efficient than the private market in private company securities is.

    1. William Pietri

      The government has an interest in regulating that because the American people do.In particular, casual investors don’t have time to investigate opportunities well enough to detect frauds. Fraudsters are pros and casual investors are amateurs, so they’ll always be able to trick a sufficient number of people.Your choices are a regulated market where amateurs feel relatively safe to invest, or an unregulated one where they shouldn’t, and therefore generally won’t. That will keep a lot of potential investor capital out of the market, harming everybody. Further, people buy opaque assets based on the average quality level, so more fraud would drive down prices on good assets, reducing return on investment.One of America’s great strengths is the strength and vibrancy of our capital markets, and a big part of that is the strong legal protections for investors.

    2. JLM

      Disclosure, periodic rigorous disclosure is the antiseptic that is applied by public markets to all the skinned knees and elbows of the public markets.In public markets, nobody can trade on “material non-public information” under pain of criminal penalty.And, yet, in secondary markets it is impossible to not possess material non-public information by the very nature of the seller.What everybody wants is the “she-male” of securities taking the best from the public — liquidity, transferability — while ignoring the necessity for being public and staying private.It is not going to happen and should not happen.

      1. Harry DeMott

        That’s kind of my point.Everyone in a private company wants liquidity without transparency.Public market guys want the lack of disclosure and running the company for short term can’t have it both ways.

        1. JLM

          Not only can you NOT have it, you should NOT have it. It’s not fair.

          1. Harry DeMott

            Right.So make it all transparent – and then decide on the degree of public you want to be.Full public – Sarbanes Oxley compliant – or some lesser version which will give you less liquidity – but with a lot more transparency.Kind of like a 144A offering in the debt world.

      2. Guest

        You are on fire today. Mostly agree with you on your comments on today’s topic. If you have seen the actual proposal please post a link. I have spent a little time trying to find them (even sent a tweet to one of the SECs Twitter accounts) but have yet to find anything. I would like to read the proposed changes in detail before finalizing any opinion I have. I have just seen some comments in WSJ or from Dan Primack’s post.

    3. fredwilson

      great points Harrythe real issue is disclosure and i can tell you that increased disclosure requirements on startups will be a huge problem for the entire sector. these companies are not ready or prepared for that burden, nor should they befacebook is a different story. it’s an edge case. and a very visible one

      1. Harry DeMott

        Facebook is over the edge – prepared and pretty well locked downYou’re right on most companies though. Sarbox is a huge burden forpublic companies which they bear to access liquidity.I figure there should be 3 layers to the markets.Layer 1: private company where I want to buy stock from an employee (not a senior officer) I should know everything the employee knowsLayer 2: I want to buy stock from an officer or board member. I shouldknow everything they know including having access to board materialsetc.Later 3. Public company where I should know as much as the seller (yeah I know this is idealistic)Essentially it is the symmetry of I formation that matters intransactions. If you can achieve information parity without putting anundue burden on the company then you can achieve liquidity without thefull burden of sarbox.Sent from my iPad

        1. JLM

          I agree with your overall sense but would caution that Boards know — well, they are supposed to know — stuff that others will never know.Using the standard of ‘Board knowledge’ is not applicable to securities trading.Reg FD (fair disclosure) is a damn good guideline as it relates to knowledge, the dissemination of knowledge and trading on such.It would be good if it were followed more closely.

  8. William Pietri

    Could you say how you think they should avoid the very significant problems that led to those regulations in the first place?

    1. fredwilson

      scale the investments you can make against an investors net worth and increase information and disclosure requirements as the size of the capital bases/investments received increases

      1. Guest

        That is an interesting idea

  9. Morten Josefsen

    In my native Norway currently all limited liability firms have to publish audited accounts annually. I know the Nordics have a different view on financial transparency (anyone with an internet connection can check my personal income and tax bill), but how would something like that adress this issue in the US? Is it unthinkable?

    1. Gorilla44

      An audit costs $10,000 – $20,000+ for a small company.

      1. Morten Josefsen

        That would indeed kill many small firms. One could introduce a cut-off, eg based on turnover or total assets. I guess professional services like audit is one of the areas where normally very expensive Norway is much cheaper than the US.

      2. JLM

        A $10MM revenue company of a fairly simple business model costs about $60K to audit to SEC, SOx, 404 standards and that is if they are a going concern and clean. With an enterprise piece of software to boot.But that is not the end. Under SOx, that same company is subject to quarterly reviews in addition.The scope of work is 3 quarterly reviews and a final year end audit.The price tab is likely in the $60K range. I know as I run a small public company with $10MM of revenue.This is also only if the company provides most of the work in the PBC (provided by client) checklist.Audits are not cheap.

        1. David Smuts

          Multiply that cost several-fold JLM if such a $10MM rev company has subsidiaries overseas who most likely use International GAAP instead of US GAAP!

          1. JLM

            GAAP? HahaDoes it ever strike you that we allow the accountants to make up the rules for accounting, we allow them to change them and then they charge companies to apply them?And then we act surprised when the application is expensive?GAAP and audits are a huge scam but a very, very well done one.

        2. Guest

          By the way, kudos to running a public company wit such small revenues. “I know as I run a small public company with $10MM of revenue.”I cringe when I hear people say SOX killed the opportunity for smaller companies to go public. Does it make it more expensive? Heck yes it can. Is it a pain in the @ss? I can only imagine. But it can still be done. I

          1. JLM

            I find the disciplines of a public company to be perfectly consistent with how I think any company should be run but the costs are a pain in the butt.

          2. JLM

            Geoffrey, to state the hopefully obvious, I am doing everything I can to not run a $10MM revenue company, just for the record.I hope it shall be a $100MM company some day soon.Mighty oaks, acorns, etc.

          3. Guest

            Nice time to reply. I happen to be checking these threads right now as I just came back to the house after spending all day fixing a fence with my neighbor and a friend of his. If I cannot type it is because I smashed the base of both my thumbs when a 2×4 came crashing down form the top crossbar line that was poorly tacked ( on a temp basis ) between the two posts. But I digress ….YES! Oaks & acorns!!!

    2. David Smuts

      In the UK, limited liability companies must publish annual accounts. If their turnover is significant they will also have to have these accounts audited. As for personal taxation, we guard this very secretively here. No chance of public disclosure on personal income.

      1. Morten Josefsen

        This is what I had in mind for the US.Personal income disclosure is a Nordic preoccupation I guess. Can’t really make up my mind if it is good or not. I just accept it is there.

        1. David Smuts

          I don’t think Personal income disclosure is a good thing, however I do applaud and support another Nordic intervention. Norway requires all public company boards to have at least 40% female representation. In the US it’s a paltry 12%. Japan about 4% and Germany, not much more than Japan. We’ve made improvements in the UK (15%) but these pin stripe male CXO’s aren’t going to accept greater female board representation without legislation!

  10. ErikSchwartz

    Where this might go bad is not the narrow swath of companies that people who read AVC are interested in. It will go bad when the outright con men start to play. IMHO caveat emptor still applies, if people are foolish/greedy enough to get conned (like they are in the lottery) that’s their right.The larger problem with the public markets is they are no longer a way for companies to raise money and for people to own a piece of growing firms. They are a machine driven game that plays on the edges, not based on fundamentals, but on statistical trends.Some massive percentage of equities are held for under 10 seconds before the program sells them. This helps no one but the trader.

    1. JLM

      The AVC folks are not the problem the SEC is dealing with.

      1. fredwilson

        they will get to us eventually JLM. all this chatter is going to get to them eventually

        1. JLM

          A few years ago we got a long letter from the Ft Worth SEC office — hell, I never even knew the SEC had a Ft Worth office — in which they objected that we had used the term “EBITDA” in a pubic utterance.Their objection was that EBITDA was not a GAAP defined term. I thought that was odd. Turns out EBITDA is not a GAAP defined term though the individual constituent terms are, in fact, GAAP terms.They scolded us that we had to refrain from using the term EBITDA as it was not a GAAP defined term and that in the future, if we used the term, we had to “derive” it from GAAP terms.The world was teetering on the edge of oblivion as we thoughtlessly contributed to its imminent demise by throwing around such terms as ………………………EBITDA.We had to sign a document acknowledging our manifest wickedness and a promise to refrain from using the term EBITDA again. Unless we “derived” it.We conformed meekly to their requirements and have resisted the temptation to use the term EBITDA thereafter.But I must admit that on a full moon, with a bit of fog in air, with the wind howling and just the slightest edge of chill in the air — I am sorely tempted to recklessly use the term WITHOUT the appropriate derivation but then my minds clears and I resist.But who knows, one day, I may throw caution to the winds and …….Beware, you are warned.

          1. fredwilson

            I will do it for youEbitda, ebitda, ebitda!

          2. Guest

            That is a funny sentiment. Appreicate your efforts to stand up for your blog commenters Fred. :)That said, I do happen to think EBITDA is meaningless term variable. Mostly because adding back 100% of depreciation is pointless. Economic depreciation is real and some measure of normalized recurring Capex needs to be captured in the thinking. I don’t know if anyone else does this but I call EBITDA “poor man’s cashflow” because it is so simple but its simplicity is the source of its weakness. It has some uses in comparing Enterprise Values on a debt-free basis for some purposes but stand alone usage is meh. Just my two cents.

          3. fredwilson

            i agree about depreciationif you add in capex to EBITDA, you get EBITDA + CAPEXthat’s a good proxy for pre-tax cash flow

          4. mike gilfillan

            Great post about being scolded on EBITDA. Other than running a clean company and going through an annual audit, what else would you say makes up the Top 10 hassles/problems of having to comply with the SEC on being public?I ask because if you’ve been through the audit process before, it doesn’t seem that big a deal to comply with SOX/SEC regulations if you exceed 500 shareholders — just pay the accountants and make some timely filings.BTW, couldn’t agree more about your insight into the great GAAP scam!

          5. JLM

            The SEC (elephant hunters) and the PCAOB (pest control guys) are redundant. The PCAOB was created arguably to enforce SOx.The PCAOB (public company accounting oversight board) was created to look after the exact same things that the SEC was supposed to regulate. In fact, the PCAOB was populated w/ lots of #2s from the SEC.Both rely upon on the rules of the Exchanges and literally mimic almost all — but not all — of the Exchange rules as it relates to issuance, governance, insider trading and reporting. There is a silly circle jerk of rules which reference other bodies’ rules.The rub points have to do w/ the nature of commentary — a public company is loathe to say anything too creative as they can be held accountable for their utterances. This is a chilling force on such things as blogs just at a moment that more information is the antiseptic that is most dearly needed.This is also in spite of the implications of Reg FD (fair disclosure) and the Public Securities Litigation Reform Act of 1995 which provides a safe harbor for “forward looking statements”.The SEC cannot adequately enforce insider trading rules against the violators. The current scandal w/ “intelligence gathering and expert” companies is just the tip of the ice berg. Remember, these guys hung out a shingle, can you imagine those guys who are patently illegal?The SEC contributed to the recent financial mess by its waffling on its rules pertaining to shorting a stock — the shorting of stock itself being akin to banging your sister, repealing the uptick rule and allowing naked short selling. They provided the means, methods, opportunity and weapon to destroy companies they were to have protected. At least protect us from incest.Further affiant sayeth not. Hey, it’s Sunday!

    2. Guest


    3. raycote

      That is a separate issue that is unlikely to be addressed.And we all know why!

  11. Tom Labus

    There is also the SOX aspect of being public after Enron et al. A lot of the IPO business left the US because of this and management did not want to sign their life away with each Q release. That had a major impact on how new companies viewed being public.Figuring a way to allow individual investors access to this market would require some intelligent discussion and planning. Unfortunately, these traits are not readily available in DC.

    1. JLM

      Most of the IPO business that left the US was market driven — it cost less.The representations made by management in an offering prospectus did not materially change under SOx, what changed primarily was the requirements for companies who were already public.An offering prospectus is a pretty damn comprehensive document in which every possible horrible is drummed up and subsequently ignored. It seeks safety in disclosure rather than actually dealing with the risks.An offering prospectus is the equivalent of a drug whose main side effect is DEATH.There is absolutely no difference in the liability that a CEO or CFO has before or after SOx as it relates to fraudulent or inaccurate financial statements. SOx simply articulates what case law had already established — the CEO and CFO are responsible for what they publish. Period.You are absolutely correct that public policy is the driver of SEC regulation. The Congress makes the law and the SEC makes the implementing rules. That is the legislative process. One page of law = 50 pages of rules.

  12. JLM

    You have to remember something about the SEC — the SECURITIES and EXCHANGE Commission — it regulates both the issuance of securities and the exchanges upon which those securities are traded.While there is a huge distinction between being private and public as it relates to disclosures and safe harbors, private companies are still issuing securities and they moreso than ever before want some way to be able to exchange or trade or monetize these same securities but short of providing the disclosures routinely provided by an exchange traded security.This is the business of “I want the benefits of the safe harbors provided by properly formed and issued securities. I want these same securities to be traded freely.” v “I don’t want the burdens of initial issuance of these same securities and I want the freedom and ease of trading them on established exchanges.”Folks want the car to run but don’t want to pay for the gas.This is not going to happen. Ever. Not w/ the long list of scumbags and sorry tales the SEC deals with on a routine basis.And, it should not happen because there are simply too many scumbags out there.

    1. Tom Labus

      The finance business will always have scams. It’s human nature to believe (once and awhile anyway) that that south sea deal is great and Bernie’s a genius. I don’t know how you legislate around that.

      1. JLM

        You enforce the penalties and you make an example of certain situations. You hold Boards accountable for the management of the company. You enforce tax laws.When Tyco’s CEO Dennis Kozlowski had a $6MM party in Sicily for his wife — pneumatic blonde second wife — he should have been fired, the Board should have been sued and the company should have been disciplined fiercely.This is why I think that public beheadings on the steps of the NYSE should be seriously considered for enforcement actions.

        1. markslater

          hear hear. (to quote a phrase from the legislative floor of the greatest exporter of democracy 😉

          1. JLM

            Don’t get me wrong, if I could be the King of England I would gladly fill out the application. I love the English. For years and years I had a partnership w/ George Wimpey Co — builders not the burgers. It was great fun.We used to have Board meetings at Lower Slaughter Manor and go to Cheltenham for the races.Great fun.Dueling and beheading would regulate the markets a bit more rigorously.

    2. Guest

      I must be in a cynical mood today I guess. Your comments speak to me; don’t know what else to say.

    3. Aaron Klein

      I agree with you 99%.But I still think it’s a little off that you need a $1MM net worth or $250K income to be eligible to invest $15K in a startup.At least phase up the accreditation levels by investment amount.

      1. fredwilson

        that is what I’ve always thought they should doif you have $100k of net worth or more, you can invest $10k per dealif you have $500k or net worth or more, you can invest $50k per dealif you have $1mm of net worth or more, you can invest $100k per dealsomething like that

        1. Aaron Klein

          Perfect. Simple and effective.

        2. John - SourceDataGroup

          We are a document preparation company. We ‘package’ Reg D offerings of up to 5M for small companies. I agree with you Fred on your ‘train of thought’ as to an accredited investor net worth. Very often we have ‘good’ deals but very little active interest from the ‘upper’ end of the investor pool since the ‘pool’ is much smaller with the current rules.

        3. Steve Rosard

          Fred,Do you really think a small investor should be able to invest up to 10% of his/her net worth in a single private company, and up to all his/her net worth in 10 private companies? I’m sure this wouldn’t meet your own portfolio requirements, especially given that most pros would advise individuals to limit their aggregate exposure to alternative investment classes, which include VC/private company investments, to not more than 10-15% of their net worth.

  13. David Smuts

    Whilst it’s a good thing that the SEC is conducting a review of its regulations and their impact on small business capitalisation, let’s be mindful that it is not the SEC that legislates these rules, but rather the houses of congress, and given their acrimony over reaching a deal on a Federal budget I can hardly see partisanship put aside for the benefit of small USA INC.The daft SEC rules which restrict private investments are also coupled with even more daft Blue Sky laws, and the beast of them all: Sarbanes-Oxley.Unless all three undergo reform small USA INC will struggle to compete in an increasingly merged and international marketplace. It’s for this reason we chose incorporation outside the US.

    1. David Smuts

      Oh and I forgot to include…., a very convoluted and overly-complex company taxation regime and one of the highest rates of corporation tax in the G7 (the UK now has the lowest old system (kit and caboodle) needs fundamental reform, and not just a cursory SEC internal review which will ultimately not result in any changes to the legislation

      1. Nate Boyd

        Of course, many corporations in practice pay a much lower effective tax rate — see the NY Time’s recent expose on GE’s tax practices, which regularly pays less than 10%. The complexity you describe only benefits companies of sufficiently large/complex operations, who can also afford the requisite tax accounting team.

        1. JLM

          I thoroughly dislike Jeffrey Immelt — he of the nose firmly up Pres Obama’s nether regions.But having said that, the articles about GE are patently (pronounced with a pompous long “a” please) unfair.They had massive financial losses — accumulated tax losses — in their GE Capital financial subsidiary and they appropriately applied them and offset taxable income in their other subsidiaries in a consolidated corporate tax return.Simple tax accounting. No story there, move along, folks.

          1. Nate Boyd

            I’m supposed to take your word on that, eh? How do you explain the downward trend of effective corporate tax rates in general across the economy over the past few decades even as profits have been increasing?

          2. JLM

            I would take my word on nothing.I am not defending anything and thus am not suggesting that you take my word on anything.I read the articles and listened to the company’s explanations and they make perfect tax accounting sense.I suggest that the effective tax rates of corporations are influenced most dramatically by the tax code and its complexity which allows big corporations to lobby for focused and specific tax benefits.Understand that public companies report publicly on a GAAP basis which has almost nothing to do with their tax books.These are different accounting issues.

          3. Reid Curley

            Multinational companies operate in foreign countries as well as the US. Countries other than the US have been lowering their corporate tax rates, so that we now have potentially the highest rates in the developed world once state taxes are factored in. Assuming the mix of business among countries remains the same, the effective tax rate for corporations should be coming down because of lower non-US taxes. Of course, you have plenty of instances where the effective rate comes down faster as businesses emphasize overseas markets because of the more attractive tax environment.Sure, the absurdly complicated US tax code plays a role in enabling some companies to lower their effective US tax rate, but you can’t make that statement about a company like GE, even if they did not have the NOLs JLM refers to, without diving deep into the details and having a department of international tax pros to boot.

          4. Nate Boyd

            To be clear, I am not accusing GE of doing anything illegal, I’m accusing them of manipulating politicians to modify the tax code so that they can exploit it. The fact that I’m not able to easily verify what GE is doing without my own tax team is proof enough that the system is broken.I am skeptical that the effective tax rate for the F1000 is dropping simply as a by-product of globalization. Companies are jumping through hoops to re-allocated profits to minimize their tax exposure. But these tools are only available to large corporations, and so Main Street businesses and startups cannot compete against larger businesses that are less innovative and fundamentally offer more for the economy.Irrespective of the cause or legality, there is a problem here.

          5. JLM

            Companies like GE do not “manipulate” politicians, they simply own them or make them their bitch.Can you imagine how inexpensive it is, in the greater scheme of things, for a company like GE to buy a rural Congressman? Rent a few dozen?They probably don’t even know where the money is really coming from.

        2. David Smuts

          Exactly Nate, the burdensome corp tax/regulatory regime only benefits the large corporates who can afford to work round the rules, and stymies innovation by burdening smaller, private new entrants.What geniuses they are!What a system!

      2. JLM

        Perfectly brilliant comment. It is all tied together — capital markets, regulation, tax policy and job creation.If you want to create jobs, then someone is going to have to be able to make a buck to pay for them.This is exactly what this administration fails to understand and embrace and all because they have absolutely NO business experience.This is what happens when you hire a community organizer to run the country.

        1. David Smuts

          Well said JLM. Our problem lies with the lawmaking process itself which is factional. One side can’t accept another’s proposal to improve/adapt existing leglislation because it didn’t originate from their team! Only in times of national crisis do they seem to work co-operatively.And if this aint a National Crisis (economic and social) then I don’t know what else is!

          1. JLM

            We exist in a moment in time in which the supply of patriots — persons willing to put the country before political gain — is at an all time low.I remember Pres Obama at the first budget summit lecturing the Republicans that he had won the election and now he fails to acknowledge that the Republicans won the last election.I have never divined a “smaller” person than Pres Obama — the Nobel Peace Laureate who is currently fighting 3-4 wars simultaneously.

          2. David Smuts

            And this selfishness in governance is endemic throughout the world. UK, Japan, Israel…., all the same.And you can only imagine who we’ll replace our old friends (read despots) in the Middle East with!Maybe the hope lies in mass enlightenment via the internet!?

        2. fredwilson

          i am very proud that at this very moment, our portfolio has 557 job openings, across 24 companies in 27 cities

          1. JLM

            Multiple countries also. A very nice well done service and a real value add to your portfolio.Is it sortable by company?

          2. fredwilson


  14. JLM

    In general, the requirements of the SEC — Securities Act of 1933 and the Securities Exchange Act of 1934 — are reasonable for companies who are running a clean shop.Want some damn dry reading — go read these pubs. You will never buy another Ambien.A careful reading of the Acts will show that there are a myriad of accommodations made for “small businesses” as appropriately there should be, so don’t get on the jag that “one size fits all”. That is simply not true.Now SOx which was a knee jerk reaction to a lot of bad doings is basically a rehash of the same kind of regulation but with a bit more specificity.Do you think that there is really, really, really anything different between a company issuing its financial statements (before) and a CEO and CFO “signing and certifying” their company’s financial statements under SOx (after)?Guess what — every auditor in the history of mankind has made CEOs and CFOs sign a representation letter to the auditors that the financial statements they are auditing are true and have for years.This element is as protective as leaving a night light on in your bathroom to scare off Ken Lay. It is not likely to provide any real protections because scumbags are scumbags.The disciplines imposed upon public companies are by and large very good business disciplines. And they tie together securities, reporting, shareholder, corporate governance and exchange rules in a cohesive fabric. That unfortunately costs time and money. But they are all good disciplines.The issue of whether the thresholds should be 500 shareholders or some level of accreditation are simply moving targets which the SEC should be given some discretion to move as markets move. The underlying rules are good rules though I would certainly embrace that 500 could be 1000 today or that an individual could/should be able to waive anything they want to waive.If you want to issue securities to the public (even just large groups of employees) and trade them then you should be public and follow public company disciplines. There is some intermediate way station that would some sense under a “jobs creation” philosophy but that is a political determination and not a regulatory determination.

  15. Antonio Tedesco

    Fred, do you really think they need to redefine the accredited investor definition?”They must have a net worth of at least one million US dollars not including the value of one’s residence or have made at least $200,000 each year for the last two years ($300,000 with his or her spouse if married) and have the expectation to make the same amount this year.”If you’re NW isn’t north of $1MM, should you really be investing in early stage companies? You’d be better served paying off your credit card bill charging you 29% interest.Also, where will valuations go? You’ve complained that they are high now.

    1. fredwilson

      yes, i think there are many people who work in startups, have some capital saved up, but nowhere near $1mm of net worth outside their home who would make great angel investors

  16. celestus

    Well, there needs to be some sort of incentive for companies to go public. The information that they disclose in their financial statements is a public good in the economic sense. So you shouldn’t give private companies all the benefits of going public, which you’re very close to with “anyone can invest” and “arbitrarily many people can invest.”One middle ground is that individual investors can participate in private companies, but institutions where the real money is (e.g. mutual funds) cannot. Here a lot of people are going to lose a lot of money because they buy Facebook (for example) at any price, but I think that’s happening now on SharesPost anyway. I still think it would be necessary for the SEC to announce that they will be less aggressive in shareholder lawsuits where the company in question is private, but that would be mostly for the company’s benefit- it would likely have no effect on investor behavior. The only problem is that if the public loses too much money on private companies, even in this scenario, there will be a negative reaction that may leave private companies in a worse position than they are currently in.I can also see the accredited investor criteria being ratcheted down as long as it applies only to stocks rather than to investments in PE/VC/hedge funds.

  17. markslater

    the problem is the SEC has to legislate for the worst-case or as JLM puts it, the scumbags. which make up 90% of the people who stand to benefit from its modifications.

  18. Mike McGrath

    The built in assumption with the rule is that if you have money (accredited investor) then you have the discernment and sophistication to take the risk. This is a holdover of eugenics/Darwinist thinking and disenfranchises a large swath of Americans who have lower salaries but invest wisely and methodically.I had this same conversation with my friend the video artist a few weeks ago. This is what we came up with:

    1. JLM

      Love your video. You could easily be the next Billy Mays. You are missing a calling, my friend. Do it.

      1. maxniederhofer

        @Mike, concur with JLM. Use that silky smoothness to hawk some stuff.

        1. JLM

          I’ll take half of the deal. Let’s gt Mike on the web and tv and selling some shit. Now.

          1. Mike McGrath

            What’s my cut? I don’t want to end up like that ShamWow guy…

          2. JLM

            Well, we intend to trick fuck (technical investment term) you on some way out of the money options, get a 9 x preference on our money and generally siphon off all the money while making you commit to an onerous personal services contract in which we can remove your larynx if you should ever default on the deal.Sound good to you?On a serious note, you really are very good on camera and I loved the sound effects and the background.

    2. Guest

      VERY good point. That can be an issue. Information/Disclosures are what are important. After that is solved then it begins to matter less what your net worth is or how much money you make. I know many many many people who do not make a lot of income from their jobs but are wicked smart investors. I also know many rich folks that have made bad investment decision again and again.

      1. Mike McGrath

        Of course! There is a city full of Madoff investors and a country full of little old ladies who bought a share of IBM every week for 50 years.

      2. fredwilson

        i agree that information and disclosure are critical to insuring fair markets. however, the reason that many companies stay private is they want to limit their information disclosure requirements.

        1. Guest

          Yes I know that is a struggle for a lot of startups. I just always err on the side of more information when thinking / talking about investor class REG changes. I admit that my thinking is tempered by the fact that I have only been a passive advisor to growth companies and/or worked as an employee. But I have been an investor since college. If I had experience as a founder of a hyper-growthco I am sure my thoughts might be different.Some of my initial thoughts (and I admit I have not finished Mary’s letter, although if I had I am not sure it would change anything) are predicated on the fact that I think these secondary markets for private company stock will be (are) a given. As a result, I just think more disclosures by the underlying company might be necessary. I think there might be a way to scale up the disclosure requirements in tiers. Maybe current state for up to 500 investors; then add a layer of some disclosures for another tier of of investors (say 500 to 1000), etc. I don’t know something along those lines. I am looking at an older Offering Memorandum right now for a company that was in existence for 3 years prior to the offering date and it is appalling the information that is provided.What can be done to ensure earlier stage investors do not have a greater degree of influence than later stage investors? Earlier investors might have more influence formally via a Board seat. However, it could also be something as simple as the company founders know the earlier stage investors better because they spent more time with them. The passage of time has allowed more trust and, there, more influence – potentially. As a result, I just think more public disclosure makes sense as more investors come to the party (even though competitors might gain a little more knowledge about a private co).The sad truth of the matter is it is almost impossible to regulate, enforce, prove, define, etc. what a truly responsible and worthy accredited investor is. It is much easier to define levels of disclosures required through various stages of capital raising by companies. If there are going to be changes made (and there probably should be), it just makes sense to me that the disclosure area is logical place to start. Not saying it is fair.

  19. Nate Boyd

    How about instead focusing on regulating how much cash highly profitable corporations, private or public, can hoard without investing in jobs, innovation, or otherwise giving back to the economy and communities out of which they built their wealth? Or the overseas tax havens and other tax shenanigans of large corporations? Or the unfair sales tax exemption of online etailers like more private investment into private companies seems like a low priority to me, not to mention potentially dangerous for the reasons others have mentioned.

    1. raycote

      Again… those are other issue that are unlikely to be addressed.And we all know why!

  20. JLM

    BTW, Fred, a great post in a long, long series of great posts.You are the consummate salon host able to throw just a bit of an intellectual canape out to your articulate and intelligent audience and let the discussion begin.You are the master and it is great fun. Keep it up.The quality of this discussion and the comity of your audience is one of the high points of my day.You are a sly old dog. Thanks.

    1. Donna Brewington White

      Major agreement!You are on a bit of a roll, yourself!But, then you pretty much always are.

    2. fredwilson

      i was sick all last week. just started to feel better yesterday afternoon (at the mets home opener – must be something about baseball, beer, and peanuts)i don’t feel like i gave the blog a lot of energy this past week. i didn’t have it to give.thankfully, the AVC community can make up for thatand they do!

      1. JLM

        Mexico, the gift that keeps on giving. I cannot remember ever coming back from Mexico and not being sick the following week.

  21. kidmercury

    only way out is through new financial markets. like what charlie suggests with local exchanges, or what i suggest with non-state networks/virtual economies. you can cling to the old system if you’d like, though it will get you nowhere.

    1. JLM

      I am looking forward to the day that a company like Exxon just decides to run its own market like it runs its DRIP and direct investment program.This will cut out all of the machine driven trading, ultra complex trading strategies, short selling — things which were not contemplated when exchanges were formed and which are not in a company’s interest.There is a bit of a precedent for this in the manner that Southwest Airlines does not quote its fares on any of the discount sites but deals directly w/ the flying public.It could be done and why not?

      1. kidmercury

        exactly, for me too that day can’t come soon enough. the only reason it’s not here yet is because people are too afraid. whenever enough people decide they’ve had enough with being ripped off and poor, then we can get on business and spreading prosperity.

  22. Steve

    I am doing extensive research on startups, venture-backing, and IPOs. A major burden on small companies is the Sarbanes-Oxley Act. They need to carve out an exemption of some sort for small companies. It is proving to be a hinderance to entrepreneurism and startups.

  23. sigmaalgebra

    For a new company to be ‘more public’ faster brings some dangers:When have Michelangelo painting the ceiling, keep out the tourists. Eventually the public will see the work and give their opinions, but at least let the paint dry first.More specifically, for a new, innovative, growing company, a lot that is crucial for the value at IPO and afterward needs time, money, and effort that does not show well on a balance sheet or income statement. So let the innovation and its results be solid and broadly visible before making financial statements public.Or, as we know well, one reason a public company in area X will buy an innovative small company in area Y instead of developing something similar to Y in-house is that the innovative development would come from pre-tax earnings and, thus, affect the quite visible bottom line on the income statement while the purchase does not. So, if startups have to make their financials public too soon, then they won’t do innovative work either.Or, even if the public likes the sausage, they might not like seeing it made before being able to taste it.As in the movie ‘The Aviator’ about Howard Hughes and as at…(easy to find on Bing, tough to find on Google)”So it’s my money. What I do with that money may seem crazy to those sons of bitches in Houston. I’m sure it does, but it all makes good sense to me.”Even though this was just a movie, I saw some similar things in aviation that worked out great but where even the Board of the private company had a tough time accepting and the public would have not accepted and would have shorted the stock.An abstract view of the problem is: It is often possible to get a small, short-term, easily visible financial gain at the cost of a large, long-term, difficult to see in advance financial loss. A good private company founder can make the right decision here, but in a public company the temptation for the short-term gain is huge. So, any project for innovation that takes more than one quarter from initial conception to positive ROI is frowned on. Indeed, the flip side of this brain-dead company management is much of the opportunity for startups.I see this dilemma frequently: (A) There is no way in this solar system anyone in venture capital (there might be a chance for Chris Sacca, due to his time in a Ph.D. math program, as the only exception) could evaluate my work before they see high and rapidly rising ComScore numbers, but this work much more than “makes good sense to me”. (B) In a public company the situation would be even worse. Then (A) and (B) mean that no one funded by venture capital or in a public company will do anything like my work, and that’s a great opportunity for me.Bluntly, public financial statements can capture only a small part of the future value of current work in a company. So, let that value become solid and broadly visible before letting the work be vulnerable to public opinions.

    1. RichardF

      Disagree with you about VC’s being able to evaluate whatever it is you are working on sigma just because they don’t have a Ph.D in Math. As long as you are able to explain the compelling reason why a VC should invest then it is relatively easy for a VC to substantiate what you claim by employing an expert in the field to evaluate your work.Happens all the time in biotech VC.

      1. sigmaalgebra

        Yes, apparently biotech venture capital does commonly evaluate the ‘secret sauce’ of their projects. Maybe those venture partners want to be sure not to fund snake oil. And a good fraction of biotech venture partners have MD and/or biomedical Ph.D. degrees which let those partners do or direct such evaluations.But apparently information technology (IT) rarely sees or evaluates advanced, original applied math secret sauce. And the number IT venture partners with Ph.D. degrees is tiny.Evaluations of advanced, original research are not so easy; typically a suitable “expert” is not easy to find. Evaluating research is a big ‘industry’ based heavily on research professors publishing research and, for the peer-reviewed journals, more such professors serving as reviewers, editors, or editors in chief who have worked their way up over decades. Even then evaluations can be difficult (I omit the details of a story where some of the best of US computer science didn’t have the math prerequisites to evaluate one of my papers in computer science — the paper did get published, apparently, by some special efforts by the editor in chief of the journal). The NSF has a big Rolodex of ‘grant reviewers’. Being able to do well just directing reviews is not so easy.For about 70 years the US DoD has done quite well evaluating, just on paper, some of the best technical work ever, and my background in such work made me surprised that IT venture capital essentially just won’t do such evaluations.I started my project with derivations on paper and then wrote the corresponding software. I got some timings, developed a scalable architecture, and did some server planning arithmetic. It looks good. I did the advanced, risky stuff first. The UI/UX I left for last, and now it’s about half done. Since this is my first, serious UI/UX, and since I’m developing for quite serious production and not just a ‘prototype’, I’m not fast at it. But the rest of the UI/UX is what’s left of the software to be ready to go live.I’ll need to collect some more initial data, and then I’ll be ready to go live.If my project is good, then I’ll quickly have some good ComScore numbers.The venture partners and I agree: UI/UX and ComScore numbers are essential. In addition I have more: My ‘secret sauce’ is the key to the promise of a site with much better results for the users and, thus, a major business.If the venture partners want to look only at UI/UX and ComScore data (and team, and problems size) and ignore the secret sauce, then so be it. That they won’t evaluate my secret sauce is rapidly becoming moot for my project.That venture partners ignore advanced, original applied math secret sauce is almost inevitable: If they could even direct such evaluations, then too many people would understand how to do my work, and much of my opportunity would be gone.So, my secret sauce is just my advantage that I might as well just not talk about.Yes, one venture partner did ask, essentially, “How can you do that? Why are you smarter than all the geniuses at Microsoft, Google, Facebook, etc.?” So, then, the ‘secret sauce’ starts to be a subject again. Indeed, I’ve always assumed that a venture partner would say, “Sure, it’s a huge problem. If you could solve it, great. But so far no one’s solved it. So, how come you can solve it when no one else has?” so do mention ‘secret sauce’, but venture partners nearly never think this way. Basically the guys on the recent Forbes venture capital Midas list just didn’t make their money evaluating advanced, original, applied math secret sauce.A venture partner might argue: “When growth takes off like a rocket, then commonly entrepreneurs want, need, and will accept a Series A. When you are at that point, give us a call.”. Or maybe they figure that if my work actually makes a big splash, they they will learn about it on TechCrunch, VentureBeat, C|Net, Hacker News, etc. and then give me a call. Maybe they have found that, really, their business is based on ‘human nature’, that their checks are more enticing than any coed! But when they call I’ll probably be on a step ladder pulling 10GbE cables!Maybe they are correct, but maybe not: My planning arithmetic indicates that at any early level of usage, one month of such usage will generate enough revenue to grow capacity to double that level of usage. And via the cloud, hosting, or colocation, the growth could be still faster and/or last for more doublings. And for more, my area has lots of empty buildings with GbE Internet, and apparently in my area getting some hundreds of GbE is not too difficult.So, if my project is successful and revenue and capacity are growing quickly, quickly enough to thrill a Series A investor, then in a few months my project should throw off enough cash that I will not want to convert from an S-corporation to a C-corporation and take on a Board which does not understand my secret sauce, would not be comfortable with my developing more such secret sauce, and, really, just does not understand my business, all of which just terrifies me.Also my lawyer has explained that there can be some important timing issues involved, e.g., for taxes.Next that “few months” forms the only ‘time window’ within which both sides of the table will shake hands. But that window (A) is shorter than the usual time to raise a Series A and (B) would be in the middle of ‘crunch time’ for me and ask me to take on 30 hours of work in each 24 hours — bummer.So, to avoid such crunch time I have wanted a list of very ‘interested’ venture partners I’d also want on my Board, and, thus, have contacted some venture partners, sent them some foils, less than 10, with large fonts and only a few words, and asked if they were “Interested?”. Overwhelmingly the response has been silence.For me, the secret sauce is the main reason to be “Interested”, certainly now and even until an IPO, and the venture partners have essentially never seen any such stuff and have no way to do anything with it except f’get about it.I about have to give up on the venture partners: They can’t evaluate my project now and all along would take way too much of my time. I’ve spent a lot of time and am running out. We’re just not in the same business.The venture partners are making working with them too difficult for me: Yes, my business is in the center of Web 2.0, ‘consumer Internet’, ‘new media’, etc. and if successful would be a big thing and good for any venture fund.But to me this business is much like starting a pizza shop on Main Street: Actually starting a pizza shop could be more expensive and, at this point, more work. The main difference in my Main Street business is just Moore’s law, the Internet, and my applied math that together can yield a major business. Main Street businesses nearly never get venture capital, and I should also be able to be successful without venture capital. Venture capital could have helped this project although that time is quickly passing. It looks like, whether my project is successful or not, there won’t be any venture capital involved.

        1. RichardF

          well good luck if you can get where you want to be without VC moneyall the better.

          1. sigmaalgebra

            Well, for any of the planning, there needs to be an assumption that this is a good project. With that assumption:This project should be easier to start and bring to nice profitability than a pizza shop, and with much more profit than a pizza shop, and from there grow to a major business.There are many thousands of successful pizza shops that never got venture capital. I shouldn’t need it either.A pizza shop has to take over some bare retail space, put in suitable plumbing and HVAC including some special ventilation for the ovens, likely a lot of A/C power and natural gas, a good water supply, likely special fire protection, sinks, rest rooms, work tables, special flooring, floor drains, walk-in refrigerator, ovens, counter, various tools and supplies, furniture, phones, ads, etc., all before the first pizza.I can call up Tiger Direct, Antec, Kingston Memory, etc. again, order some parts, plug them together for a nice 4-6 core server with 16 GB of main memory and several 7200 RPM 2 TB SATA drives for no doubt less than the cost of a pizza oven or a walk-in.Microsoft’s BizSpark program will let me have the copies of Windows Server and SQL Server I will need for free for a while. HP has offered a loan of a 32 core server that can have up to 2 TB of main memory.I can get 15 Mbps upload bandwidth at my left knee for $55 a month.My Web pages are simple, dirt simple, and hopefully simple enough even for small mobile screens. So, likely, and considering my current ASP.NET pages, I can send a page for less than 100 KB, call it 1 Mb. Then, even without a ‘content distribution network’ (CDN) for caching, say, of my home page, logo PNG file, and standard JSP file, put 1 ad per page, from some ad network, and half fill 15 Mbps upload bandwidth 24 x 7 and get, let’s see, 7.5 ads per second at, say, maybe an effective $2 per thousand ads displayed and get2 * 7.5 * 3600 * 24 * 30 / 1000 = 38,880dollars a month in revenue.So, by the time I’m set up enough to get ComScore numbers enough for a Series A, I can just lean back and wait until I’m sending 7.5 pages a second and f’get about a Series A.About two months of that and I can pay Microsoft and not need the BizSpark copies and can go to the colocation site not far away and get a 100 square foot cage, put in some more servers, get as much as I want of the dual 10 GbE Internet connections they can provide me, and keep growing.Send 75 pages a second, and in a few months I will have more cash than I’d get from a Series A.My software timings indicate that my software is quite efficient, and Windows Server can have 16 TB of virtual memory: So, when my ‘base data’ grows, I’ll pull it out of some special tables in SQL Server (that software is running) and put it in just some ordinary files and then pull it into just virtual memory with good locality of reference.My guess is I can do quite well for about 150 TB of such ‘base data’, all in virtual memory.Of course, now main memories can be as large as 2 TB, and some main memory prices are down to $10 per GB.Then my planning arithmetic says that four racks of production servers can generate $4.5 billion a year in revenue. Of course will need more racks for redundancy, backup, staging, test, development, etc.I did that planning assuming dual core processors and rotating disks. With 8 core processors and fast solid state disks (SSDs), the number of racks should decline.If I outgrow a colocation site, then I should rent some industrial space and get, say, dual 100 GbE Internet connections, batteries, Diesel generators, HVAC, etc. and have a major operation.Should be less work than growing one pizza shop to a dozen, and plenty of Main Street entrepreneurs have done that, too.I can’t complain.


    I agree with many about the need to design different disclosure requirements for different stage companies before opening up these markets.…K–

  25. Nick

    501 shareholders means you have to report financials, not go public. That’s an important distinction. I’m not sure if financial reporting includes sarbox or not.

    1. bernardlunn

      Great question. Anybody know the answer? It matters a lot. If you have transparent financial disclosure I don’t care where the shares are traded

    2. fredwilson

      yes. i updated my post. i understand that but my post did not explain it correctlythanks for the comment

  26. Ted Rheingold

    My first reading was that Goldman Sachs pushed this on the SEC so as to be able to deals like they tried with Facebook. Historically the SEC only takes action based upon what their banker brethren endorse (or when rare political pressure is forcefully applied.) I look forward to hearing this is not the case, but I just can’t fathom my the SEC would move on this when it would only encourage more activity beyond their control.

  27. Ken

    agreed!! – while they are at it they should repeal SARBOX so that small companies can afford to go public!!! make it viable to be a $300M EV public company

  28. Lou Volpano

    As Winston Churchill said – “the best case against Democracy is five minute conversation with the average voter”…Now – if the average American knew THE DIFFERENCE between a debit and credit … they’d be accredited!But this is just more HUCKSTERING…. not value creation

  29. John Ball

    Fred, I fully appreciate and support the evolved requirement for private offerings. However, your suggestion to modify (lower) the standard for an accredited investor introduces new, largely untested risk from which the downside would be difficult to recover (for investors, etc.).It wasn’t that long ago that “some” in venture capital pushed “their” risk out to a willing, and largely unprepared public market in search of returns apparently unavailable elsewhere.We are facing unprecedented pressure for households to find supplemental retirement capital (income). Private offerings could find intense interest from this investor profile, where reporting, risk, and business valuations are largely unknown and evolving very quickly.I accept the traditional “buyer beware” that accompanies such offerings, but few of the investors you propose that we bring into the fold are as well equipped as John Galt. 🙂

  30. Dave W Baldwin

    Well written Fred. It was scary last year trying to figure where Congress would go with ridiculous rules, as in what you put together in November is SOL in March.We HAVE to change the rules to give a chance to the smaller income household, as I’m sure all of your comments reflect.

  31. Guest

    In case anyone else has been waiting for the actual document (source material) like I have. Here is a link I just came across.http://finance.fortune.cnn….

  32. John

    Yet another sign of a bubble amend private tech companies. At some point the music will stop and lots of people will lose money. Then we’ll all read articles ridiculing the SEC for letting it happen. I’d rather see regulators make it easier (less expensive) for companies with a value of $250M to go public.

  33. Guest

    Just posted a link to the source document that was shared but that comment is not showing up it seems. The source document was made available via Fortune/CNN web site if anyone is interested in seeing the source document as I have been.

  34. sdd

    Fred – I think you have some facts wrong here. Private companies can have more than 500 shareholders. They simply have to file their financials with the SEC once they exceed the 500 number.I believe the fundamental concept that once a company has a large number of investors it should disclose its financials to those investors makes sense. It will ensure that the buying and selling of those securities will be based on some fundamentals as opposed to hype and speculation.FInally – I think employees should be exempted from the 500 investor limit. That should provide plenty of room for provate companies to have lots of investors and still not disclose their financials.

    1. fredwilson

      great comment. i understand the rules but did not explain them well enough in the post. i will fix it.since most companies stay private in part to take advantage of the lack of disclosure, the 500 investor rule is treated like a “do not go over” numberi totally agree about exempting employees from the 500 investor limiti am going to update my post to reflect this commentreally great input/feeback

  35. Terrykelliher

    Its about time! Capital formation under current rules are much too restrictive for small business formation. Leaving business investment to Venture Capitalists and only millionaire angel investors at the early stage is not a way to build business or wealth in this climate. Investors and the public is far more educated today. Restricting the public from the market is counter productive.

  36. kidmercury

    EPJ puts the smackdown and calls it fascism, arguing lax SEC regulations will only apply to certain companies, tossing in a few disses about the big business tax breaks in san fran. http://www.economicpolicyjo…is EPJ droppin’ truth or talkin’ smack?

  37. Eric

    One of the problems with going public is that not only is the value of your company no longer in your control, but that frequently it changes for reasons that have nothing to do with what the company is doing.I have watched a number of companies announce large deals (US$2-10 million) and their stock go down because a competitor had regulator problems. So sometimes it is the industry or sector that affects stock (and thus company) value.For companies where Stock and Options are part of the incentive package these changes can be devastating when the stock drops below the share price.

  38. Joe

    Exclusivity is creating some irrational valuations, with people buying on both the company and the “once in a lifetime” opportunity. It’s time to widen the potential investor pool, in both qualifications and overall numbers.

  39. John

    Did we forget that regulation exists strictly for protection. It’s all about the worst case scenario. Argue all you would like for sane logic, but the premise of protecting against the worst case scenario must be fixed.Remember all those people who took out risky loans during the real estate boom? Do you want them investing in startups with their money? If you lower the bar for accredited investors they will. I know people who have borrowed against their house to invest in risky ventures and I’d prefer not to join a syndicate with them. Regulation isn’t about smarts – it’s about protection.The classic example is a miracle drug that has not undergone clinical trials being denied to a dying patient so that the FDA can “protect” the public.

  40. paramendra

    This is quirky: “…the requirements to be a qualified and/or accredited investor to invest in privately held companies.”

  41. Cromwell Coulson

    When discussing the public trading of private company shares, there needs to be made a distinction between shares held by 1) insiders and control persons (management, directors, employees, large shareholders) and 2) those held by non affiliate outsiders (original/ investors, angels, former employees, former spouses).Anyone who is in the first group (control persons and affiliates) that is buying or selling with non-affiliates via the public or private markets (OTC Markets, SecondMarkets, Sharepost, etc) would be in violation of U.S. securities laws unless adequate current information is made publicly available. Any insiders or control persons that have been ignoring this and selling shares to the public (or buying from non informed non-affiliates) should be expecting a call from the SEC division of enforcement. I would suspect that is why Facebook has rightly banned current employees from selling any shares through these platforms. I hope other companies are doing the same thing, but suspect there are some insiders and affiliates that will be found to have been abusing the information asymmetry. But because some people turn out to be bad, is not a reason to condemn the creation of these markets.The big issue is what to do about non-affiliate investors shares. These are investors that have received ownership in a company for capital or services. While big investors are able to force companies to disclose, register, sell – that is not the case for small investors. As long as companies are using equity to raise capital from friends and family or as an incentive to employees, we will see more and more non affiliate shareholders looking for liquidity.Having alternative marketplaces with investors willing to buy their shares is a good thing. It makes the shares that companies issue to early/angel investors and employees be worth cash in the future and thus more valuable when issued.This is not a new phenomenon. The U.S. OTC Markets developed over the last hundred years around investors wanting to buy or sell non-affiliate shares. There are many old line industrial companies and banks that are publicly traded OTC due to the fact that shares were given to family members and employees over time. If you read about Warren Buffet and the rest of the Graham/Dodd crowd’s early days as investors, they were able to find many OTC value situations in these type of companies, and provide non-affiliate investors with a willing buyer of their shares.Many investors are intelligent and react well to better information. Companies that do not publish information usually trade less and on average trade at substantially lower volumes and valuations. That said Facebook and other share trades are a unique case driven speculation of the future IPO hype.When we started segmenting the OTC Markets based on the level and quality of disclosure, we found that most investors were staying away from the companies that provide no information. The Pink No Information stocks (we put a stop sign next to their symbol) represented less than 1.5% of the total dollar volume in 2010 ($165 billion in total). The OTCQX companies that provide the best information have over 155x the dollar volume of the bottom tier. Clearly letting investors know there is no information changes their behavior.Some might still say these non affiliate shares should be permanently restricted/frozen if full disclosure is not made public by the companies or any problems are found. Others point our that without full disclosure it will be easy for frauds to take place, forgetting that almost all frauds are conducted by insiders, not non-affiliates who have held shares for over a year.I would hope that the SEC will find a pragmatic balance that lets non affiliates realize cash from these investments they have held, with proper disclosure of risks, from other investors that are well aware of those risks. As well as provides incentives for companies to make more information publicly available for investors to act with greater intelligence, rather than just speculate on that they think is happening at a company.

    1. JLM

      Damn, I actually know who you are and am the CEO of a public company which is listed on one of your exchanges.I want to quibble just a bit with your characterization of the risks attendant with the sale of securities by a “control” person.The legal issue is simply the nature of the disclosures, if any, and the presence of material non-public information possessed by the seller and the willingness of the buyer to proceed absent such typical due diligence material.If the buyer “could” be a similarly characterized investor — a control person — and waives such representations and disclosures and is willing to embrace the burden of having inadequate information or in rarer instance in which a company might cooperate with a bit of due diligence or conversation — not representations — and the appropriate indemnifications are crafted, there is nothing to prevent such a transaction from taking place.Which gives rise to the more important and troubling question — absent credible information or an auction mechanism — how is the “right” price “discovered”?It would take a fairly unique seller and buyer to be able to make such a deal happen and it would be something other than “investing” at its core.But it could be done and legally.

      1. Cromwell Coulson

        You are right that control persons are not completely frozen.There are ways to sell shares to other control person and big boys (and the big boys get lots diligence/reps in the big boy letter) The problem with big boys is they are pretty smart, ask a lot of questions and drive hard bargains.That is why insiders would prefer to sell anonymously to the public. However, unless they file a registration statement with the SEC or make adequate current information publicly available and follow the 144 limited sales safe harbor/10b5 anti fraud provisions, they should not be buying or selling in the OTC Markets, SecondMarkets, Sharespost, or otherwise. It is called a scheme to evade registration and often comes with SEC enforcement inquiry.A public price usually makes the price part of the negotiation between two control persons easier as there is a benchmark to work from.Also we operate a marketplace of competing broker-dealers, not an exchange.

        1. JLM

          Insiders selling to the general public should only be undertaken in a fully registered offering.This is exactly why the SEC exists to ensure that persons with “inside information” — material non-public information — do not trade on it.One can put any number of self-serving adjectives to describe the participants but if the buyer is the general public, then it should be undertaken in a public vehicle with all the attendant protections and disclosures.What is odd to me is that the companies feel no sense of duty — fiduciary duty really — to ensure that there stock is not traded in an inappropriate manner. I am mystified about this.It is difficult to see many shades of gray on such a subject as it is the polar opposites of information we are dealing with here.I am interested as to why you make the distinction between a “marketplace of competing broker-dealers” and an “exchange”. Is there some distinction I am missing?The Acts and FINRA seem not to recognize any distinction.

    2. JLM

      The issue of non-affiliate investor shares — and what they can and cannot do with the stock — can be dealt with, in part, by the careful “legending” of the stock certificate itself wherein appropriate notations are made on the stock certificate which would provide guard rails pertinent to the “special” situation being addressed.I personally hate giving stock for services and think it to be quite short sighted and I am an advocate of as simple as possible capital structure with, if possible, only a single class of common stock — it can be done with the right controls.

  42. Saul_Lieberman

    I tell my (investor and entrepreneur) clients that startups should not be raising money from investors that cannot afford to lose their investment. I am not sure that should be the SEC standard or how any regulation can approximate that standard. But I am not troubled per se with a result that does not allow the general public to be a “more active participant in the value creation that happens while companies are still privately held.”

  43. android developers

    Really informative blog posting for investors I agree that for any private company can have more than 500 shareholders, but it will be required to file disclosure statements. So it is not a easy way to invest money into share markets.Its very risky and purely depends on market value.So thanks for sharing very useful information .

  44. adam_caper

    My take is that both the current rules, and the proposals I’ve seen to date to reform them, are unnecessarily blunt objects.WRT to capital formation, I think a careful distinction can — and needs very much to be — drawn between the sale of shares to raise capital and the subsequent sale of those shares to provide liquidity for those early holders. I see grave problems with removing the current prudent ‘sophisticated investor’ provisions from the former, as salesmanship has a troubled history of trumping prudence when it comes to unsophisticated investors. Opening the floodgates to boiler-room types would jettison the valuable wheat-from-chaff function that professional (or at least relatively sophisticated) investors serve in the earliest stages of a start-up firm’s development. A backlash would likely ensue, with the very real potential of making capital formation worse, rather than better, in the long-term.Allowing sales of shares after a reasonable holding-period, however, seems like a reasonable middle-course. For one thing, because of the fragmentation of the sellers such a structure would be less hospitable to hard-sale middlemen. For another, since the sales would be by insiders, and those insiders identities would be known, the conditions would be favorable for accountability (that is, an insider who engaged in fraud or predatory behavior would risk backlash).Similarly, when it comes to disclosure rules I think that there’s a middle ground. For example, a somewhat-less-burdensome standard than SarbOx could be created which would instill transparency without generating onerous cost (remember that SarbOx is intended to cure the ‘plausible deniability’ buffer between senior management that led to the kinds of massive dislocations created by Enron and its ilk; smaller private firms are both less likely to create dislocations and less able to use compartmentalization as a way to game the system). Since their boards and management teams are small and deeply engaged, a system which rests on principles of material disclosure would probably do the trick for the kinds of small, closely-held firms under discussion here. With such disclosure both allowing a firm to broaden its shareholder base and promoting a secondary market which fosters liquidity for early investors seems eminently workable.Simultaneously doing away with sophistication hurdles for initial capital formation, opening the playing field to all comers completely and jettisoning any provisions towards transparency may feel like it would bring on Christmas morning, but it has all the earmarks of New Year’s eve; a massive party, to be sure, but one killer hangover once the music stops.

  45. andyidsinga

    it would be neat to find a regulatory solution that creates a new kind of ‘small investor’ where only small $ amounts could be invested though mechanisms like kickstarter. So when a funding round was put together a small investor category could be up to say 50% of round, and X$ max per small investor. in addition, maybe add a locavestor incentive…JLM / Charlie / anyone does something like that exist already ?It seems that with kickstarter you’re not getting any ownership in the funded business … is that correct?

  46. fredwilson

    great idea

  47. JLM

    Well, that’s going to cost you, pal! Haha.You have to wonder what Madoff is thinking about in his Federal prison.He should have been publicly beheaded on the steps of the NYSE in a “pay to view” Fox Business special with Maria Bartiromo handling the ax. Ratings crack!

  48. JLM


  49. kidmercury

    you may want to check out profounder dot com, founded by jessica jackley of kiva fame.

  50. andyidsinga

    thats really cool. just ckecked it out. So profounder appears to be a revenue share system (… ) …no equity …which, i guess ( talking out of my ass here ) means that vc and angels will not be interested ?