This piece was written as an angry response to a specific event, but it’s broader theme is of general concern to me; the context is self-explanatory. It was submitted to the San Jose Mercury News and to the public radio program Marketplace; neither published it.
14 November 1996
It takes money to make money. Especially here in the Silicon Valley, where high rewards come from high risks bankrolled by big bucks.
We celebrate and remember the spectacular success stories, companies which make people rich beyond the dreams of avarice. We nod sagely at the spectacular failures, confident we would never be so foolish, and politely ignore lesser failures, afraid that we might be so foolish after all. And we hope and wait for an “in”, a connection to that rare company that is primed for greatness.
For who makes this money? The insiders. Sometimes it is the idea-men, the founders, if they are smart and lucky enough to have reserved themselves a piece. Occasionally it is the employees, although their share is typically scaled as incentive rather than payoff. Always it is the money-men, the venture capitalists and investment bankers, who gamble with fortunes and lose more often than they win. But when they win, they win big.
To be in that category, to be a big winner, you must be in early, and that requires a stake. And not a small stake — high tech companies require high-budget research and engineering. They need amounts in the millions, not the thousands.
But occasionally, if you watch the signs, take a few well-designed and well-timed risks along the way, you, the little guy, can luck onto an opportunity. You work on a key piece of technology. You provide a critical service. You befriend someone on the inside. You find the door open to a small investment.
Such an opportunity recently fell into my lap — or more accurately, I saw to it I was in a chair when it wanted to sit, and I invited it to join me: I have been doing some work for a start-up with potential, I knew they were arranging funding, and I asked how I could join them.
The deal was set. Papers were signed. A check was written.
Enter Big Brother.
In recent years judges have agreed that many people, having lost their money in high-risk investments, could sue to get back what they had lost. The reasoning was that they, unsophisticated in the art of finance, were not competent to judge the risks involved and were, therefore, defrauded by those soliciting the investments. It’s along the same lines as “informed consent” in medicine: if they could not understand the risk to which they were consenting, no consent existed.
The desire for justice was sound. Average Joes who have been fast-talked into investing their life-savings in swamp-land resorts or dry oil-wells make sympathetic plaintiffs. Unfortunately, high-tech startups were swept into the same category as snake-oil salesmen.
The SEC, to safeguard the flow of capital to legitimately risky ventures, established provisions in the securities laws to limit liability for losses in investments which fall within so-called “safe harbors”. The main constraint on these investments is that the investors must be “sophisticated”, a concept defined by law. Investments which are only offered to “sophisticated”, or “qualified” investors are “private” and fall into this category; all others are “public” and don’t. To ensure they can’t be sued for not succeeding, start-up companies can only take money from “qualified” investors.
According to the SEC, I am not “qualified” to make this investment. So I’m out.
How smart or experienced I am, or what I actually know, is irrelevant to this. I’m developing the technology; I know all the ways it could fail to work. I’ve been a co-founder in two startups, one which failed when it couldn’t raise enough capital to go into production, one which failed through the abysmally bad fortune of shipping its first products just as a recession eliminated the market for them. My wife, with an MBA, is also a veteran of several less-than-successful startups. We know the risks.
Our financial position is ripe for this. We both have small but productive consulting businesses. We invest enough to provide for a comfortable retirement. The money we were to invest in this venture is money we can spare: losing it would not significantly affect our present or future lifestyles, nor would investing it in conventional, low-risk vehicles. A large return on a high-risk investment could significantly enhance both.
But none of this matters to the SEC. What matters is that our net worth does not exceed one million dollars, and our net income is less than several hundred-thousand dollars per year.
In other words, because we don’t already have a lot of money, we are not allowed to make investments that could earn us a lot of money. So says our federal government. Kindly Uncle Sam, protecting us poor ignorant children from ourselves.
If you think this stinks, I agree. If you think the solution is worse than the problem, I concur. If you think it’s ludicrous to protect poor and middle-class people by making rules that ensure they stay poor and middle-class — well, what’s new?
The next time you are outraged that only the rich can get rich, and curse the capitalists and robber barons and corporations that make it so, add to your list of miscreants the consumers-rights lawyers and federal judges and SEC bureaucrats and congressmen and presidents who are so convinced they know what’s good for us that they won’t let us act in our own interest.
As for me, I’m going out to found another risky startup, before they decide I’m not “qualified” to do that, either.
© Copyright 1996, 2005, Augustus P. Lowell