The recent collapse of newly public tech stocks such as Uber Technologies, Lyft, and Slack Technologies leads to an unavoidable conclusion: The process by which American businesses raise capital is broken. Many of today’s most innovative and fastest-growing companies spend years incubating in the private market, to the benefit of a minority of investors.
The recent collapse of newly public tech stocks such as Uber Technologies , Lyft , and Slack Technologies leads to an unavoidable conclusion: The process by which American businesses raise capital is broken. Many of today’s most innovative and fastest-growing companies spend years incubating in the private market, to the benefit of a minority of investors. Because of outdated regulations that dictate how companies can raise funds, Main Street investors are being left out in the cold.
Due to federal securities laws passed in the 1930s, only institutions and wealthy individuals can invest in many of our country’s most exciting young companies. An individual must fall under the “accredited investor” label to participate in most private-market securities offerings. This means having an annual income of at least $200,000 or a personal net worth of more than a million dollars.
The Securities and Exchange Commission, which does a tremendous job policing our capital markets, has long believed that investors must be “financially sophisticated” to participate in private offerings. While I fully agree that smaller investors should be protected from risky and opaque schemes, precluding them from investing in innovative companies at reasonable valuations perpetuates an undemocratic, two-tiered system.
If there was ever a time for policy makers to modernize and democratize the private-market landscape, it would be right now.
The number of initial public offerings in the U.S. has fallen almost every year since peaking in 1997. In part, that’s because some of the world’s most innovative companies are content to remain privately held and hold off on their public debuts. Due to the abundance of capital in institutional funds today, the “let’s stay private” mentality might grow more entrenched. Private-company executives—especially during growth periods—value avoiding the resource drain caused by annual shareholder meetings, quarterly financial reporting, and increased regulatory obligations. Instead, they get to spend their time enhancing the value of their businesses.
Investors dominating the private market are well aware that they benefit when executive teams lack public-company obligations. A recent survey of private-equity managers and institutional limited partners conducted by PitchBook revealed that the No. 1 reason the private markets attract capital is “higher potential returns than the public markets.”
Unfortunately, when young growth companies stay private for a long time, this compresses the capital appreciation opportunities for the public investor. McKinsey has found that “many tech companies that undertook initial public offerings in the past three to four years have performed poorly,” with the most high-profile example being this year’s public offering of Uber, whose valuation has fallen more than 30% from its IPO price. Perhaps if Uber had broader public participation during its private investment rounds, its IPO price would more accurately have represented public investor sentiment.
To its credit, the SEC announced this summer that it is seeking public comment regarding “the limitations on who can invest in certain exempt offerings.” Chairman Jay Clayton recently said “we must increase the type and quality of opportunities for our Main Street investors in our private markets.”
Turning Clayton’s words into reality will still require robust investor protections and safeguards. Fortunately, financial-regulation technology is significantly more advanced than in the 1930s and there is a strong foundation in place for high-tech surveillance tools that can help regulators, financial advisors, and brokers monitor private securities offerings.
When it comes to oversight of public-market investing, the general public already embraces common sense behavioral safeguards. The government relies on data and technology to monitor who pays tolls on the highway and who is driving recklessly. We gain the privilege of a driver’s license and mobility in exchange for being monitored.
Similarly, behavioral technologies could be applied to investment appropriateness. For example, if an investor were to allocate a disproportionate amount of their portfolio to private investments, their investment advisor or broker could electronically track, flag, and prevent the activity. Plus, it should be the responsibility of the advisor to provide risk-disclosure statements, as is required with far more complex securities such as derivatives.
Also, companies would need to provide a degree of visibility into their financial status and future plans. While some investors might shy away from companies that don’t publicly disseminate 10K reports, innovative solutions might arise from the ratings agencies, which could assess and rate a company’s financial position without overly exposing its private data. Some of these private companies might end up showing higher risk, but with that often comes the potential for higher returns.
It is incongruous to allow anyone with a few dollars to open a brokerage account and speculate on listed stocks but not permit these same investors to assess opportunities connected to promising young companies being nurtured by private-equity sponsors and venture capitalists. We ought to connect those who are living out the American dream as entrepreneurs with the broader American citizenry, which can nurture those dreams with their enthusiasm and capital.
I have spent my entire career trading in the public markets and helping enterprising companies go public. But equity investing can’t begin and end only at our nation’s great exchanges. The next great American company can be seeded by the man or woman on the street, not just on Wall Street.