Illustration: Markus Hofko
Here’s a hot stock tip: Buy Facebook. Sure, the company’s valuation has bounced around over the past six years, but now it’s believed to be around $20 billion and likely to keep climbing. If you buy a chunk of Facebook and flip your shares in a few years, you could make millions.
Oh, but wait: You can’t. Facebook isn’t a public company. The only people who can invest in it already are millionaires.
The hot IPO market of the 1990s, which allowed Regular Joes to buy stock in new companies, has been replaced by a rich insider’s club that trades in pre-IPO equity sales. The middle-class folks who daytraded their way through the dotcom boom are now locked out. And that’s a problem. The current government regulations just make the rich richer, and they block alternative avenues of investment at a moment when funding is hard to find. It’s time to change the rules.
Here’s how the current system works: Even though no IPO is in sight, a company can still give contractors, advisers, and employees equity to keep them fat, happy, and working. But SEC rules limit the number of shareholders to 500. To get around this, talent can be granted something called restricted stock units, which they can get without being official shareholders. Then the contractors, consultants, and employees who leave the company can sell their vested stakes privately in what’s called a secondary market. “We have seen explosive growth in the private market across dozens of different companies,” says Barry Silbert, CEO of SecondMarket. “We are on track to do $500 million in private-company transactions this year.”
But the Securities and Exchange Commission doesn’t let just anyone buy shares in a corporation that hasn’t gone public. Pre-IPO sales are limited to “accredited investors,” people with a demonstrated net worth of $1 million or a yearly income of $200,000. It’s been that way since 1982, when Rule 501 of Regulation D of the Securities Act went into effect. The measure was intended to protect less-informed investors—widows and orphans, in Wall Street parlance—from gambling away their savings. So who has bought pre-IPO Facebook stock? A reported 10 percent of the company went to the Russian investment group Digital Sky Technologies, whose backers include one of that country’s richest oligarchs. In other words, the extremely wealthy.
Today, Rule 501 does less to protect widows and orphans than it does to prevent risk-savvy investors from playing the secondary market. Sharp, up-to-the-minute financial advice is no longer beyond the reach of the middle class. We’ve got the Motley Fool to keep us abreast of stocks. TheFunded.com spills the dirt on startup investors. And trading sites SharesPost and SecondMarket have automated, aggregated, and simplified the process of buying pre-IPO stock, reducing lawyer and broker fees from secondary market trades.
With that kind of access, you’d think today’s small-time stock traders would be allowed to get in on the pre-IPO action, effectively making them micro angel investors at a time when startup capital from established fund managers is hard to find. But no. As part of the financial reform bill introduced by senator Chris Dodd of Connecticut, Congress even tried to raise the bar to $2.3 million in the bank or $450,000 of income. The plan was dropped only after the Angel Capital Association, a trade group of US startup investors, screamed that it would drive two-thirds of them out of business.
It’s time to lower the bar: The pre-IPO market should let everyone in. Today’s Internet stock rockets are social networks built by the active participation of their members. Preventing Facebook users from buying a stake in the company they helped create is an injustice. These millions of people should be able to take part in the financial ups and downs of Facebook, Zynga, and whatever comes next. I’m not saying it will reverse the recession. But at least the masses could once again play a role in America’s thrillingly adventurous startup economy without having to land a job at Twitter.
Paul Boutin (paul@venturebeat.com) wrote about the virtues of getting laid off in issue 17.08.
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