May 12, 2011
I watched with interest the May 10 proceedings of the House Committee on Oversight and Government reform before which the SEC Chairman appeared.
As a serial CFO, currently of a small ($2.2MM) Arizona technology company that sells worldwide, I noted the disconnect between the need to enhance the ability of American companies to raise capital and the overriding concern with the concern over investor protection that appears to drive the SEC.
It is perfectly clear that financial fraud, insider trading, insufficient transparency and similar issues are a major concern and if anything the SEC is less aggressive than it ought to be in prosecuting the most egregious offenders.
But enforcement is not the issue we most need to address..
That issue is the current disastrous state of capital formation, particularly for small companies in the US who are at a severe competitive disadvantage relative to their international competitors.. And we are not speaking of IPO's - which are few and far between.
Throughout the United States hundreds of thousands of small businesses continue to experience unbelievably hostile conditions when attempting to raise capital. Banks, once the intermediaries between depositors and borrowers, have walked away from their responsibility in favor of market manipulation for their own account. Equity funding by Venture Capital is rarely available in deals of under $25MM and in any case the volume of VC funding to small business is miniscule. In this climate companies resort to factoring receivables at usurious interest rates as one of their best options. Instead of being able to grow in size and value, these companies are often forced into premature acquisitions under adverse circumstances, often turning promising enterprises into value-destroying breakups.
What is necessary?
First of all, private companies of under $100MM revenue raising up to $10MM should be more fully exempted from Securities Act requirements in regard to Accredited Investors, number of shareholders, registration requirements. The concept of an "accredited investor" makes no sense in relation to small companies and should be eliminated by amendment to the ill-conceived Dodd-Frank legislation.
At the same time, these private companies, if they accept investment, should be required to file standardized financial statements on a publicly-accessible website, even if the financials are internally-prepared as is the case with many small companies. Investors need information much more than they need "protection".
The absence of secondary markets for private companies is also a concern.
Without one, founders and investors are locked in until a liquidity event which is generally an acquisition, often under unfavorable conditions.
Local and regional online exchanges would be inexpensive to establish and would provide an alternative.
For the smallest startups, today's technology makes possible approaches like crowdfunding, and these vehicles should be encouraged, not obstructed.
Why are these things not taking place today? Instead of promoting the development of innovative tools to increase capital formation, the entrepreneur and investor are faced with a formidable defense of the status quo. In 2009 we paid legal charges of over $50K in connection with an exempt offering that raised less than $400K in that year. For that expenditure we received boilerplate documentation, so poorly drafted that I routinely have to walk investors through the thicket of redundant legal verbiage. What is wrong with plain-English disclosure?
David Loynd, CPA