Investing
Investing

Pre-IPO Investing: Making the Rich Even Richer

| by Reason Foundation

By Brian Doherty

Paul Boutin in the new Wired about one of the more aggravating allegedly pro-little guy investment rules that keeps the "unaccredited" out

of being able to help with, or be helped by, investing in pre-Initial Public Offering companies. The details, and colorful explanations of how the obscure Rule 501 of Regulation D is hurting your ability to help yourself, poor li'l investor:

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....

Oh, but wait: You can’t. Facebook isn’t a public company. The only people who can invest in it already are millionaires.....

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....

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....So who hasbought 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....

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.