Can the SEC rule change make it rain for thirsty angels?


In July, the SEC approved changes to investment regulations, specifically Regulation D and Rule 156 regarding exemptions for smaller companies, as directed by the Jumpstart Our Business Startups Act (with the acronym JOBS in a bit of Orwellian panache) that passed Congress in 2012. The original rules were made for smaller companies and start-ups to raise funds from individual qualified investors rather than organizing a complex public offering. The changes allow “general solicitation” campaigns, meaning that for the first time it will be legal for companies to advertise calls for investment on the web or via email blast rather than the current slower method of presentations to investors and angels. The public comment period on this controversial change is still open until September 23 and the hundreds of responses are well worth a read.

Some have hinted that the measure is not intended for new start-ups, but geared towards companies who have already received angel funding but are running low on capital, and not sufficiently profitable to fund their own growth. This would certainly limit the scope of the measure’s “historical” nature, as some observers have glossed it.

With the new regulation requirements of an expensive and onerous filing process for each campaign, it is certain to favor companies that can afford to run expensive online campaigns that can quickly saturate target markets. This is counter to the way that most start-ups raise funds by continuous solicitation and benchmarking, as has been well noted in the running comments section.

When angels cry

Angel investors who have already sunk money into ventures clearly hope that these measure can help them weather the so-called series A crunch (basically: “Help, we’re running out of money!”). As it is currently construed, though, the measure is more likely to flush more cash into the coffers of already cash-flush companies rather than providing any kind of a boon to the flagging start-up scene.

However, even when Reg D changes go into effect, making it easier for angels to tap their followers, friends, and families, there is still much to ponder. Very likely, this will make it more difficult for new ideas and companies to enter the market, while keeping bad businesses alive via a cash infusion. Angel investors are eager to keep new players from entering the market while buying time to make their own ideas pay.

Cash flush

The question is whether flushing more money into a failing system is really wise. If venture capital won’t go there, is it any safer for middle-class dollars? With the failure rate of tech start-up’s reaching 90% in some estimates, we might more accurately call it not investment, but gambling — and at such terrible odds that no self-respecting card shark would ever belly up to the table. Of course, the game does have that desperate last hand feel to it, when the losers become willing to go all in, just for a chance of a showdown on the river. It is this tendency, no doubt, that the wily are so eager to exploit.

Tapping the middle-class for dollars may help a few companies stay afloat a little longer, but when these investments don’t pay, the economy as a whole will receive quite a sustained blow.

The JOBS Act was passed under the impassioned rhetoric of, “We have to keep these companies alive because they bring us economic growth and jobs.” Instead these regulatory changes mandated by the JOBS Act will merely open up more “smash and grab” tactics by enterprises. Far from encouraging capital creation the measure also moves towards co-opting and even institutionalizing crowdsourcing, making it more difficult for new models and ideas to leverage this vital tool of our new economy.

Dissenting opinions

Commissioner Luiz Aguilar, in his dissenting opinion pointed out,

“The need for the Commission to exercise its authority and protect investors is great, because general solicitation clearly has the potential to put investors at risk.  In short, without additional protections, general solicitation makes fraud easier and enforcement more difficult.”

Even Commissioner Troy Paredes, who voted in favor of the general provisions, admitted,

“Simply put, the proposal provides for a regulatory regime that would unduly burden and restrict the capital formation process.  More to the point, the proposal, if adopted, would undermine the JOBS Act goal of spurring our economy and job creation.”

Facebook is held up as a success story of the tech sector but its disappointing IPO clearly demonstrated that even the best may be overvalued. Faulty assumptions and accounting projections are based on a growth model that is beginning to fail, as pointed out by Mary Meeker in her “State of the Internet” report this year. Allowing companies to go around the market with this Internet-based end run may make a few angels better off but won’t help jobs or the general economy.

Comments are closed.