The private markets have an accredited investor requirement that limits private investing to the wealthiest few. While it was meant to protect unsophisticated investors, it has resulted in economic segregation that has amplified wealth inequality over the last 50 years. And the trend is accelerating. The Securities and Exchange Commission (SEC) accreditation requirement is overdue for reform. Once changed, we believe this can be a major catalyst that can pull more wage-earners out of the debt stack and into the equity stack.
What is an accredited investor?
An accredited investor is a person or institution who can invest in securities that are not registered with financial regulators (e.g. private companies). But in order to qualify as an individual, you need to meet these requirements (among others):
- You need an annual income of at least $200,000 per year (or $300,000 combined with your spouse) for the last two years, and you expect to make that amount again.
- Or have a net worth of at least $1 million (not including the value of your primary residence).
These requirements have been in place since 1982. The only change came in 2010, when President Obama signed Dodd-Frank into law, which made the requirement more stringent by removing the value of an individual’s primary residence from net worth. The result: 90% of US households are effectively shut out of private stock ownership by law.
Why does the accredited investor requirement exist?
The SEC accredited investor requirement was created to delineate “sophisticated investors” from novice ones and protect novice investors by restricting their ability to buy unregistered securities. The intention was to ensure that people who do invest in private assets can handle the risk of losing the investment.
But capital markets are continually evolving. The accredited investor rule hasn’t changed, while market conditions have. Private markets have been growing, and they are here to stay.
Accredited investors and private markets
As financing has moved into the future, retail investors have been left behind. 15 years ago in the U.S. there were 8,000 public companies. Today, there are less than 4,000.
See Where Have All the Public Companies Gone? Bloomberg Opinion, (April 9, 2018). Data sources: Jay R. Ritter, Warrington College of Business Administration, University of Florida; University of Chicago Center for Research in Security Prices.
Thanks to larger funding rounds, private companies have lengthy runways to stay private longer. Between 2001 and 2018, the median age of IPOs was 11 years, up from 8 years between 1990-1998. This trend of private companies staying private longer and fewer companies going public has resulted in mostly private investors benefiting from major returns, rather than the general public.
Here are two examples of how this plays out:
- Amazon raised $54M in its IPO at a $438M valuation. Uber raised $8B in its IPO at an $82B valuation. If retail investors in Amazon’s IPO held and sold their stock at the company’s peak value (around $1 trillion), they made a 2,256x return on their investment. Guess what valuation Uber would have to achieve for their IPO investors to see a similar result to Amazon’s? $157 trillion. That’s more than 2x the global GDP in 2018.
- We estimate that an investment of just $1,000 in Facebook in 2004 (when the company was founded) would have been worth over $2M on the date of its IPO. Compare this to a $1,000 investment in Facebook’s IPO, which would have returned around only $5,000 if sold in recent years.
Because of the SEC accreditation requirement, average Americans can’t invest in companies on a growth trajectory. Regular investors don’t get to earn a 20x-100x return like accredited, rich, investors do. They are resigned to settle for the slowing 10% annual growth of large cap public companies.
The SEC’s request for comment
In June, the SEC requested public comment on possible changes to the regulatory framework that governs private markets. This is great progress. This release is a comprehensive review by the SEC of the laws and rules surrounding private markets. The SEC is seeking industry input on how to refactor a large body of law that has evolved in a fragmented way over the last ~90 years.
We believe that an enhanced definition of “accredited investor” will democratize access to private company investment.
Read our full response on the SEC’s website.
The next generation of wealth creation
Private equity is the world’s fastest growing asset class. It’s where the majority of new wealth is created. Fixing the private markets benefits the economy as a whole. We are excited to work with the SEC to bring modern financial oversight to private markets and establish new regulations that open up accreditation to more investors; a move that will lead to the next generation of wealth creation. The future is bright.
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