September 4, 2013
To Whom It May Concern:
My name is Mitchell Kapor, and I am the founder of Lotus Development Corporation, the founding Chair of the Mozilla Foundation, and the co-founder of the Electronic Frontier Foundation. Over the past 28 years I have made over 200 seed- and early-stage angel investments in high-tech startup companies. I am currently managing partner of Kapor Capital which makes 20-25 new investments each year in seed stage tech companies with a positive social impact.
I am writing today as an angel investor concerned that the SEC's proposed regulations regarding Form D filings will hurt investors and companies alike. Early stage technology investing is a corner of the financial market that has functioned very smoothly, even through the downturn with minimal fraud or bad practices, and maximum formation of new companies that seek to improve our lives.
While I may not have an opinion on general solicitation itself, I feel very strongly that the proposed regulations are the wrong way to go about collecting data on companies that use it. Rather than tracking what is happening, the proposed regulations would prevent the very activity among honest startups and savvy investors the JOBS Act was passed to promote.
The new rules, such as the 15-day-advance notice and the requirement to constantly file any small change in a startup's materials with the SEC (which happens very frequently), are quite difficult for startups. Since the proposed penalty is a one-year ban on fundraising, it will put cash-flow-negative early startups out of business thus, the package throws a cold blanket over startup fundraising. In fact, if these regulations are adopted it looks like it will be far more difficult for honest small businesses to raise money from sophisticated investors than before the JOBS Act passed, clearly the opposite of what Congress and the White House intended.
Practices that have worked well without incident for decades could suddenly become unintentional minefields for honest startups and sophisticated investors alike. Demo days, where startups present to investors and press, will most certainly be called "general solicitation" by the law firms advising startups (and likely by SEC enforcement as well). This means that some of the most high profile ways new startups raise money transparently may now cause those same startups to go out of business if the penalties are enforced.
This means that investors like me will have less transparent ways of getting information about companies - leading to more potential fraud, more difficult ways to fund companies, and a general slowdown in investment activity. I will also be concerned about investing in any startup we find through those means, since until things are clarified further, great startups that I invest in may find themselves pushed out of business through unintentionally tripping over one of these regulations.
I believe the motives behind the regulations are good. The SEC should track investment activity using general solicitation to tune the regulations. General solicitation should be difficult for fraudulent companies and bad actors.
However, there are far better ways to collect this information given the typical practices in modern technology fundraising.
First, if the goal is to monitor financing activity, there is no reason the notification must happen before the financing occurs. The SEC has stated in the proposed rules that they are unlikely to review the materials before the financing. I saw some letters claiming that this will allow state regulators to see data prior to the financing so they can help investors navigate potential bad actors. However, there is no way to let first-time fundraisers know that when they see others financing publicly, they had filed a form before they began. In other words, the regulators would just get overwhelmed with honest companies, not be aware of the fraudulent ones.
Second, since the SEC will know about the financings after they occur, they can certainly ask for the materials used with investors at any time after the offering occurred. In fact, honest companies tend to use the open, transparent platforms that keep histories - Twitter, Facebook, AngelList, the tech press, etc. While fraudulent companies will avoid those platforms for the same reason, they won't file fraudulent materials with the SEC either. In other words, you would get a very good pulse on what's happening in the honest world by asking the platforms - as good or better a pulse as you would by putting onerous filing requirements on the companies. Check in with Twitter (already public), Facebook (likewise), AngelList (I'm sure open to sharing), or others and they will help.
Finally, a one year penalty for not helping the SEC monitor seems excessively harsh, given that the most likely scenario isn't ill intent but honest ignorance. The penalty should apply for filing false materials, not for simply seeing other startups fundraising publicly and copying what they do without knowing about the new rules.
The tech startup and investor community is actually very supportive of providing the SEC what it needs to do its job well. I think you'll find most of the players will be very open to sharing the investing data they have. However, putting the onus on the young startups rather than seeking the help of the intermediaries appears to have the exact reverse effect of the intent - making it harder to protect investors while simultaneously making capital formation more difficult.
I look forward to the revised regulations with interest.