October 24, 2013
TO: US Securities and Exchange Commission
FROM: Catherine V Mott, CEO BlueTree Capital Group and BlueTree Allied Angels
DATE: Oct 23, 2013
RE: 506c, General Solicitation
PLEASE NOTE: I am not a securities attorney. Therefore, my story approach is an attempt to highlight the impact of the new regulations from an operational perspective. My focus is to attend to this question: How can the confusion in the startup market place be made clearer by the SEC so we can operate as an efficient healthy marketplace?
To whom it may concern:
The health and wealth of our US economy has for years, relied on the Main Street approach to funding startup companies. This differs greatly from a Wall Street approach to funding. The Main Street approach consists of fellow business folks and regional business professionals providing capital for early stage business formation. They have the means to lend a financial hand and often times, serve as mentors for these early stage businesses. Typically this is a process of regional investors (angel investors) investing in their community. And, it quietly goes about the business of growing the local economy, and substantially impacts local job creation. (Historical examples: Alcoa was funded by 2 local business men, and Home Depot was funded by a dozen). These Main Street investors enjoy watching the cars in the parking lot of a company increase as their investment proves to be successful. The psychic reward is a feeling of "doing good in the neighborhood". The average investment by a single investor per deal, according to a study by the Kauffmann Foundation, is $25,000. Yes, a small investment, compounded with other small investments, has a large impact on regional job creation.
On the other hand, the Wall Street approach to investments relies heavily on deal houses and brokers who are contacting potential investors to perform a transaction. The brokers make a living selling a transaction. The transactions they are selling have little to do with investing in your regional community. Location and mentoring for success are of no value to these brokers and their investor prospects. The motives for brokers are different from the Main Street (regional angel investors) who value more than the investment itself.
The Wall Street process is typically reserved for big investment players because that means a bigger commission. There is nothing wrong with this system because the needs of the investment opportunity match the financial investment vehicle. Therefore, Wall Street typically does not get involved until that early stage company is a growth company which means there is a financial incentive to do so, like helping the company go public. At this point, the larger commissions are needed because it is a much more complicated transaction. At this point, the company has the revenue to pay the commissions.
I am telling this story because I believe that a "one size fits all" is not an appropriate strategy for SEC to deploy. Main Street investments have to be differentiated from Wall Street investments. There are different motives and different circumstances involved. Consequently, that means rule making for Main Street investment activity needs to be differentiated.
Until recently, Main Street has been quietly going about the business of funding startup companies and has not attracted the attention of the SEC until the Jobs Act mandated it. Main Street has been quietly funding companies to the tune of $23 – 26 Billion annually (UNH Center for Venture Research), and creating about 66,000 – 70,000 new jobs annually in the United States. According the SBA, Business Dynamics Statistics report, since 1980 all net new jobs in the US have been created by companies 5 years old or less. (Additional supportive studies include NBER and Kauffman Foundation) These companies are funded by the Main Street investors because as startup companies, they are not yet bankable. They don't have the revenue to meet the bank's requirements for lending.
The most recent rules for 506c, are reflective of an attempt to manage Main Street investment activity like Wall Street investment activity. The rules are onerous for startup companies that don't have money to begin the formation of their companies. The rules require more legal assistance, and thus more startup costs for which the founders are trying to raise. This defies logic. They are raising capital, but don't have the capital to raise capital.
It is understandable that as an early stage company grows, the need to engage larger financial sources would be appropriate. The legal costs increase because these additional financing rounds are much more complicated to structure. However, a startup company is a "startup" company. They have little to no financial resources. Additional complicated legal steps in initial business formation does not serve the market process.
Furthermore, the nebulous definition of "general solicitation" impacts the startup market dramatically. For over 50 years, founders of companies have relied upon Demo Days, Venture Fairs, and Business Plan competitions to raise startup capital. Main Street investors have also relied upon these regional events as a means to source and create a healthy portfolio of startup companies. It has been part of the ecosystem for years.
Yes, general solicitation has always been illegal, but for years the SEC has never put a stake in the ground and declared Demo Days, Venture Fairs, and Business Plan competitions illegal. And as a result, the market has been well served by this activity -- as evidenced by the net job creation in the US marketplace since 1980.
However, we now have 506c with a clear onerous penalty for using general solicitation, which in its purest form, seems to include Demo Days, Venture Fairs, and Business Plan Competitions. Or doesn't it?
Does it mean because these events were ignored while there was only 506b that they will be continued to be ignored with 506c? Or does it mean, we'll sit and wait to see which state regulator will take action first and then, assess the damage after 5 years of job losses? The domino effect of job losses would likely be much greater because this would impact the jobs created by venture capital investments as well. Venture capital typically follows the investment of the Main Street investors.
Does it now mean that all startup companies will be "fair game" to see who will be the first to be penalized by daring to attend a Venture Fair, Demo Day, or Business Plan Competition?
I am a practical Main Street angel investor. Can we have practical guidance for the marketplace from the SEC?
Real job creation is at risk. Net job creation is at risk.
A market practical definition of general solicitation would remove the guess work and allow the marketplace to move with confidence, efficiency, and effectiveness.
Thank you for your consideration.