Legislation That Keeps The Bubble Alive

Posted: November 17th, 2011 | Author: saldarji | Filed under: business | Tags: Angels, Caveat Emptor, H.R 2167, New Bubble, Private Company Flexibility and Growth Act, VCs | No Comments »

This congress is considering legislation that will prolong the current funding bubble. The Private Company Flexibility and Growth Act (H.R. 2167) aims to “amend the Securities Exchange Act of 1934 to change the threshold number of shareholders for required registration under that Act.” Although the changes it proposes may seem minor, they could have far-reaching and disastrous consequences.

Here’s what the bill does:

• It revises the Securities and Exchange Act of 1934. Companies were forced to register with the SEC when their assets reached 1 million dollars and held by 500 persons. The proposed change would extend the limit to 10 million dollars and 1000 persons.
• The proposed bill exempts accredited investors and employees.

There are some differing ideas about why this legislation is needed. Sure, you can give in and say that it will help keep private companies private, and protect that piece of our economic landscape. I think the legislators would argue that its noble purpose is to allow private companies more runway to grow before going to the public markets for capital funding. If you are a cynical person you might think that the true purpose is to keep SecondMarket alive by fixing inherent flaws in their business plan.

However, there are many overlooked consequences of the bill. As others have pointed out, the bill could delay IPOs and exits for VCs. It will further depress the number of IPOs in a depressed IPO market.

The real danger of the bill is that it allows companies to grow larger and attract more investors before having to disclose material facts about the company. Combined with the current bubble in early and late stage funding, it’s a setup for a catastrophe.

There is no doubt that there is a bubble in angel and VC funding. As everyone has been saying for the last year, young startup companies are flush with cash from Angels and VCs. They will now have a secondary market to sell stock in their fledgling companies. If the only rule is “caveat emptor”, Angels and VCs will dump underperforming investments into a secondary market, rather than take the coming losses. Pension funds, investment managers and employees, regardless of their investment skill, will be entangled in another toxic asset class. So will anyone else chasing quick bucks in the technology sector.

The Securities and Exchange Act of 1934 was passed to mitigate risk of fraud for consumers and investors when investing in securities by providing transparency. By changing a few small provisions, this bill will open the door for unscrupulous salesmen to create new financial WMDs. Furthermore, it is going to pump the bubble and keep the funding Ponzi scheme alive.

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