Your Right to Invest in Startups

I started Early Investing because I believe everyone deserves the right to invest in companies they like, whether they’re public or private.

When the JOBS Act of 2012 was signed into law – which will enable everyone to invest in private companies (including high-growth startups) – I thought it might take a year or two to fully go into effect.

Yet here we are in mid-2015 and still only the top 3% of U.S. investors can buy into private companies.

That includes the fastest-growing tech companies in the world (which is my primary focus).

The worst investments in the world, however, remain available to anyone.

Today Joe Q. Investor can go to his bank, withdraw his family’s life savings, and blow it (almost) any way he wants.

He can throw dice at the craps table, speculate on penny stocks, or skewer his money – wrap it in bacon – and BBQ it.

Only one of those activities is illegal, BBQing the cash. But they’ll all have similar results in the long run.

HOWEVER, if Joe Investor wants to invest in a private company, he can’t do that.

He needs to be an “accredited investor” to do so, according to that old rule passed by Congress in 1933 and still enforced today.

In certain cases, a non-accredited investor can claim a “friends and family” exemption, and invest privately. Besides that, his non-public options are practically nil…

Arbitrary and Discriminatory

According to the SEC, an “accredited investor” is one who makes more than $200,000 per year ($300,000 for a couple) OR has a net worth of more than $1,000,000 (excluding their primary residence).

These large, round numeric limits are anything but scientific. They’re arbitrary and stink of bureaucracy. In fact, if you watch government policy long enough, you’ll see these even, round numbers everywhere – and you’ll realize they’re not based on much of anything.

How could a government agency possibly determine the level of income that qualifies a person to invest in private companies?

It can’t, and it shouldn’t try.

People will always want to invest in early-stage companies. It’s human nature to seek out opportunities with the highest potential return.

If the only option you offer these opportunity-seekers is penny stocks, the outcome is preordained. It will not end well for the vast majority of “microcap” investors.

Unintended Consequences

The stated intent of these laws is to protect individuals from unnecessary risk.

But the result is that non-accredited investors are excluded from investing in promising private enterprises.

This is especially important in today’s market, where private companies are IPOing later than ever. Take a look at this chart we adopted from a recent presentation by venture capital firm Andreessen Horowitz.

0715EI_market-return

The chart shows the effect of companies delaying their public offerings. You can see that in the past, tech firms like Microsoft, Apple and Oracle all provided excellent returns to public market investors.

Today that’s not the case. The vast majority of profits in companies like Google, LinkedIn and Salesforce went to their private investors. By the time a big tech company IPOs today, blockbuster returns aren’t attainable.

Few Bargains in Public Markets

I’m a believer in stock-picking. But there simply aren’t many cheap stocks to be found today in public markets.

Take the Russell 2000, the most widely tracked small cap index. Russell advertises a price/earnings ratio of 22 times. But if you look closely at its site, the P/E is reported “ex negative earnings.” That translates roughly to “doesn’t include all the companies with losses.”

EI_russell-1

The WSJ reports a very different P/E number: 75 times…

So as much as I’d like to say that investors should look to small caps for growth, I can’t… Small caps today aren’t cheap.

It’s hard to find very many stocks at all that can reasonably be called a bargain.

There are far better options in private markets. I’ve seen the deals, and participated in dozens of them. It’s an extremely exciting market that everyone deserves the chance to participate in.

The Future Is Bright

The future of investing is everyone being able to buy equity in private companies, both early-stage startups and later-stage growth companies.

And we’re already starting to see this happen. In a few months there will be private startup deals that anyone can invest in online, for as little as $100.

But progress is slow. So far the SEC has implemented only one of the two JOBS Act provisions that will allow investment by anyone.

These first deals that everyone will have access to will be later-stage growth opportunities – companies raising anywhere from $20 to $50 million.

This is Title IV of the JOBS Act, also known as “Regulation A+” (more on that here).

It’s a good start, but the really interesting part comes with Title III. This will enable investment in early-stage startups (companies raising up to $1 million).

Early-stage is riskier, but with this risk comes large potential reward (the highest potential of any investment I know of, certainly).

The SEC has been slow to act on implementing Title III. If you live in the U.S. and want to nudge it in the right direction, contact your Congressional representatives.

Ask them to tell the SEC to finish what it started with the JOBS Act. Tell them that it’s past time Title III went into effect.

Who knows, they might listen…

Good investing,

Adam Sharp
Founder, Early Investing