Brilliant Idea: Let’s Make It Harder For Startups to Raise Money!

According to John Maudlin, startups and new small businesses are “the job-creation engine of the US.” He is right.  In a report by the Kauffman Foundation using US Census Data, start-ups and businesses less than five years old created all of the net new jobs over the last 25 years.

It is incredibly easy to start a business and find funding in the United States compared to the rest of the world.  You can start an LLC in Wisconsin in less than 10 minutes, compared to up to over year in some developing countries.  The US has the deepest and most well developed network of Venture Capitalists and Angel Investors anywhere in the world and if new businesses are looking for angel investment, they can obtain it with minimal paperwork.   According the the Kauffman Foundation, over the last 25 years, “angel investors were responsible for up to 90 percent of the funding these businesses received.”  This angel funding allowed these startups to create jobs and bring innovative ideas to the marketplace. In 2008, angels invested $19.2 billion in over 55,000 companies.

The US innovation and “job creation engine” is the envy of the rest of the world.  So what’s the best way to destroy this engine?  It sounds ridiculous, but it seems like the politicians who drafted the Restoring American Financial Stability Act of 2010 asked themselves this question when they were writing the bill.

Hidden inside the 1300 page bill are a few paragraphs that have the potential to kill job creation and innovation in the USA.  Currently, new businesses can raise money from Angel Investors fairly easily if the investors meet a few criteria.  Investors must have at least $1m in net worth or make $250k in income per year.  If your investors meet the criteria, they are considered Accredited Investors and startups can accept their money with a simple 5 page informational filing that goes to the SEC.  Startups can potentially raise hundreds of thousands of dollars in weeks if they have an amazing idea and find the right investors.

If this bill passes, it will raise the accredited investor net worth criteria to $2.3m in net worth or $450k in annual income, eliminating close to 60% of the potential angels in the USA.  I’ve raised close to 500k in angel investment between both of my businesses and we wouldn’t have been able to accept ANY of it if these rules were in place. If anything, the rules should be changed so that the net worth requirement is lower.  We allow anyone to invest in stocks, bonds, options, futures and other exotic investments, but not in new businesses.  Says John Maudlin:

Why should 95% (or maybe soon to be 99%!) of Americans, simply because they have less than $1,000,000 (or $2,500,000?), be precluded from the same choices available to the rich? Why do we assume those with less than $1,000,000 to be sophisticated enough to understand the risks in stocks (which have lost trillions of investor dollars), stock options (the vast majority of which expire worthless), futures (where 95% of retail investors lose money), mutual funds (80% of which underperform the market), and a whole host of very high-risk investments, yet deem them to be incapable of understanding the risks…”

The other change in the bill is even more damaging.  The bill requires that all startups register with the SEC and implements a 120 day waiting period so that the SEC can approve new businesses.  Startups move in minutes and hours, not weeks and months.  Entrustet has been live for just over 1 month now and we’ve gotten real users and made real money.  A 120 day waiting period would kill companies before they even get off the ground. But the waiting period isn’t even the worst part.  Registering with the SEC would cost up to $100k in legal, accounting and other fees, not to mention lost productivity when startup founders could be working on their idea instead of battling the government for access to capital.

And what if a small project like Facebook started to grow rapidly?  It could take weeks to draft all of the legal paperwork, plus another 4 months of waiting around on the SEC.  And this is assuming the SEC doesn’t get backed up like the US Patent Office.  I also don’t want some government bureaucrat processing SEC applications while I am hurting for investment.  Facebook could have very easily died in Zuckerberg’s Harvard door room if he had to wait 120 days for SEC approval before getting his first round of funding. I have no doubt that if this bill passes, the waiting period will be over 200 days within 2 years.  After all, it takes an average of 34 months for the patent office to review new patents.

The last change in the bill devolves some of the power to regulate angel investors to the states.  This change means that instead of one filing, every state will be different.  For Entrustet, we have investors in multiple states.  We would have had to file new paperwork in each state if the rules change.

So why is Congress attempting to change the one part of the US economy that is creating jobs?  The US currently regulates angel investors as if they were investing in hedge funds.  We do need more regulation on hedge funds, but the problem is that angel investors are getting caught in the net.  This is a huge mistake.

There is a fundamental difference between hedge funds and startups.  While both are risky, hedge funds generally shuffle money around to make money and don’t create much, if any, value, whereas startups spark innovation, create jobs and improve society as a whole.  Startups use the money to create new jobs and innovate.  Think betting that the South African Rand will fall in value vs. funding the next Google.  Here’s Maudlin’s solution, which I agree with 100%:

Here’s what needs to happen. Get rid of the disastrous rule requiring filing with the SEC. It makes no sense and will cost hundreds of thousand of jobs and divert the SEC from their main tasks. Angel investing has not been a problem to date, and there is no need to fix something that is not broken.

Second, if you really think we need to raise the accredited investor limits, then carve out an exemption for venture capital.

And keep the clause that gives startups federal exemption.

And, if you really want to create jobs, then cut capital-gains taxes on new ventures and angel investing to 10% or less. Let’s create some incentive to get America moving!

If passed without any amendments, these rule changes will be a huge detriment to the US economy.  They are short sighted and attempt to protect us from ourselves.  By lumping angels with hedge funds, the government is painting with a broad brush and there will be all sorts of unintended consequences.  This issue is not a republican vs. democrat issue either.  Everyone should want to make it easier for startups to create new businesses and new jobs, especially in this economy.  This bill does the exact opposite and would be terrible if it passes.  I hope that there is enough negative publicity so that this part of the bill never makes it into law.

Do you think this bill will pass as is?  Do you think hedge funds and angel investors should be treated the same way?  What do you think will happen in your own startup?

HT: Forrest Woolworth and the PerBlue Blog

17 Comments

  • So what is the strategy for trying to stop the bill? Are there any legislators that would understand the issue and/or care? Is your best hope just that commentators will give it some publicity?

  • So what is the strategy for trying to stop the bill? Are there any legislators that would understand the issue and/or care? Is your best hope just that commentators will give it some publicity?

  • This is just one more, in a long line of attempts to protect the ultra rich (socialist elite) in the US, while killing any chance at opportunity for the smaller, but ambitious company to be successful.

    Along with the “Hire” act, which is designed to stealthly keep tax money from flowing out of the US, and has very little to do with creating jobs, like the name would indicate.

    All this new legislation is being snuck in without small / medium size business people being given the chance to understand how it is about control. Not about helping job growth. And certainly not about helping small to medium sized companies be successful.

    And, unfortunately for the US, is why the US is going to continue to see a “Brain Drain” of entepreneurs moving abroad and starting their companies “offshore” where regulations and taxes are much more in their favor.

    Of course this bill is going to be horrible for the US economy. Its obvious. So why else would the US Govt be pushing so hard to pass it. If not for control, and to help their ultra rich cronies?

    To summarize “Why should 95% (or maybe soon to be 99%!) of Americans, simply because they have less than $1,000,000 (or $2,500,000?), be precluded from the same choices available to the rich? ”

    Because its more profitable (for the super elite) that way.

  • This is just one more, in a long line of attempts to protect the ultra rich (socialist elite) in the US, while killing any chance at opportunity for the smaller, but ambitious company to be successful.

    Along with the “Hire” act, which is designed to stealthly keep tax money from flowing out of the US, and has very little to do with creating jobs, like the name would indicate.

    All this new legislation is being snuck in without small / medium size business people being given the chance to understand how it is about control. Not about helping job growth. And certainly not about helping small to medium sized companies be successful.

    And, unfortunately for the US, is why the US is going to continue to see a “Brain Drain” of entepreneurs moving abroad and starting their companies “offshore” where regulations and taxes are much more in their favor.

    Of course this bill is going to be horrible for the US economy. Its obvious. So why else would the US Govt be pushing so hard to pass it. If not for control, and to help their ultra rich cronies?

    To summarize “Why should 95% (or maybe soon to be 99%!) of Americans, simply because they have less than $1,000,000 (or $2,500,000?), be precluded from the same choices available to the rich? ”

    Because its more profitable (for the super elite) that way.

  • @Corky – Not really sure how much impact anyone can have, but I emailed both Sens. Feingold and Kohl, but I’m not really holding my breath. Other (more) influential entrepreneurs have been writing about this issue as well, so hopefully if enough people write about it, it will get the publicity needed to make the needed changes.

    @Freedom – I don’t think there is anything that sinister afoot, but I agree with many of your points. I think it’s in the bill because most in congress don’t understand economics or starting businesses. Many also believe that the government’s job is to protect people from ALL of the evils in the world (like investing in risky investments). I disagree, but that’s the way our government is going.

  • @Corky – Not really sure how much impact anyone can have, but I emailed both Sens. Feingold and Kohl, but I’m not really holding my breath. Other (more) influential entrepreneurs have been writing about this issue as well, so hopefully if enough people write about it, it will get the publicity needed to make the needed changes.

    @Freedom – I don’t think there is anything that sinister afoot, but I agree with many of your points. I think it’s in the bill because most in congress don’t understand economics or starting businesses. Many also believe that the government’s job is to protect people from ALL of the evils in the world (like investing in risky investments). I disagree, but that’s the way our government is going.

  • @Nathan. I hope for the U.S.’s sake you are right and that there is “Nothing Sinister Afoot”, but I don’t know if I share your optimism :-). Maybe I am just cynical :-).

    I agree, that many, maybe even most in congress are completely ingorant about business. At least small business. These career politicians and harvard professors, don’t have a clue about the “real” world we live in.

    You would think that some understand though and they still seem to let this stuff slip in.

    Anyway we both agree it is very bad for the U.S. whatever the reasoning behind it.

  • @Nathan. I hope for the U.S.’s sake you are right and that there is “Nothing Sinister Afoot”, but I don’t know if I share your optimism :-). Maybe I am just cynical :-).

    I agree, that many, maybe even most in congress are completely ingorant about business. At least small business. These career politicians and harvard professors, don’t have a clue about the “real” world we live in.

    You would think that some understand though and they still seem to let this stuff slip in.

    Anyway we both agree it is very bad for the U.S. whatever the reasoning behind it.

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