Raising capital as an entrepreneur. Retail investor access to private markets. Expanding ownership to more investors and more employees.We have a new administration, new leadership at the Securities and Exchange Commission (SEC), and a new Congress. How will policymakers approach these critical issues, and what can private companies and their investors expect?
These are the questions we covered when Carta CEO Henry Ward spoke with Congressman Patrick McHenry, ranking member of the House Financial Services Committee and the architect of policies that shaped crowdfunding and private market capital formation.
Capital formation and entrepreneurship
The nature of business has evolved and so have the funding constraints. In the past, businesses often had material assets to borrow against, but today more businesses are knowledge businesses so they must raise equity capital instead.
Taking inspiration from his father’s experience starting a business on a credit card, Congressman McHenry set out to remove the hurdles to raising that capital.. As a legislator, he has brought an increased focus to capital formation, including Regulation Crowdfunding (Reg CF).
Reg CF was enacted following the passage of the JOBS Act in 2012 to enable startups to raise capital cheaply and efficiently across the country by regulating the crowdfunding portals through which capital is raised. This past decade, McHenry says, has revealed that the SEC’s focus on preventing fraud and investor protection can create unnecessary complexity. A dozen pages of legislative language can become a 600-page rule. There is a give-and-take between investor protection and raising capital, and policymakers have to find an appropriate balance.
Initially, Reg CF had a higher regulatory burden than other SEC exemptions did; in fact, the burden to raise $1 million through Reg CF was higher than it was to raise $50 million through other avenues. Since then, policymakers have improved Reg CF and are now seeing more use of the exemption as a means of raising capital. McHenry noted that this is particularly important as the creator economy grows. As we see more entities use these capital formation tools effectively to, for instance, serve creators, we can shift away from a “conservative vs. liberal” conversation around private markets to a more bipartisan conversation.
There is an increasing separation in society, creating an inequality we largely define in terms of wages. The dramatic distinction, however, is in equity ownership—people who have ownership in the brand they are helping to build. For instance, how do we get the Uber drivers and other gig economy workers connected with startups? Equity. Pay them fair wages, but also give them long-term ownership. That makes the difference for a family that can do well in a gig economy. Linking capital and labor helps the family and the broader society.
Skeptics of private markets will point out that most startups fail, and we do not want to replace wages with worthless equity, McHenry said. We can address some of these risks by granting equity in addition to wages, providing employees a long-term linkage with the company’s success.
Retail investor access
The average investor can’t buy shares of Carta because it’s a privately held company—but the same investor can buy cryptocurrencies. What is the future of the accredited investor definition, which determines whether a retail (aka individual) investor can purchase private market securities?
We must remedy the standard, said McHenry. He noted that the current one-size-fits-all approach to defining accredited investors blocks opportunities more than it helps protect people. We should rebalance this to allow people to test in to become an accredited investor. Unfortunately, he said, there is “an ideological fixation” among progressives to raise the standards to become an accredited investor. In the short term, he believes that it will be difficult to expand this definition further given the priorities of the majority party to prevent fraud in the private markets.
But there is a retail investor revolution taking place, said McHenry, and policymakers should recognize the growing interest in investing. Rather than just examining retail stocks, we should holistically reconsider existing rules with the goal of giving more people access to a wider array of investment opportunities, including private markets. This will enable smarter investing that can help close the wealth gap.
Public vs. private
Policymakers struggle with a tension between tightening private markets to push companies into the public market and liberalizing private markets to promote capital formation. McHenry believes that we should liberalize markets, both public and private, because doing so reflects the desires of the American people. He also said that it’s in the national interest to establish a rules-based regulatory regime that attracts capital globally, noting that the historical trend is toward freedom and expanding access to our markets.
“Should individuals decide what they want to do with their money and investments or should it be governmental policy? We can have a reasonable debate about that, but I think the securities laws have tipped the balance toward governmental policy, and we need to rebalance,” McHenry said.
“Elections have consequences, and those consequences are policies,” said McHenry. “The White House and the majority party will largely get their way over time on tax policy. But the idea that we’ll tax capital at a higher rate than labor by increasing the capital gains rate is the wrong approach. This deters capital formation and economic growth. It will be a hard-fought battle, but I’m optimistic President Biden will not be able to advance such broad tax increases.”
Thank you to Representative McHenry for sharing your time and insights with Carta.