A recent Harvard Business Review article provided a response to SEC Chairman Jay Clayton’s initiative to allow for increased individual investor access to private tech startups. The article says that after a closer look at the system of private investments put into early-stage startups, neither parties are likely to have serious interest.
Should the Average Investor have Access to Young, Private Startups?
The new article, co-authored by four academics, claims that despite the SEC’s recent comments to expand private tech startup investments to unaccredited, individual investors, such a vision is unlikely to see any fruition.
Chairman Clayton provided specific goals in the new initiative. He wants small-time investors to have a chance at big-time investments, to include the likes of private tech companies such as Uber and AirBnB.
A closer look at the details of early private investing— much of which is currently done by large, experienced, and wealthy venture capitalist (VC) firms— illustrates the unlikelihood that individual investors would have interest in such a space, according to the authors.
As explained below in further detail, the article provides three main reasons behind such thought. They center around the riskiness associated with early private investments, the convenient partnership value and exit options tied to large VCs, and the long timeline which is typically required before adequate returns are seen.
Potential Problems Faced by Individual Investors in the Private Sector Explained
Many technology startups aim for speedy growth, which can frequently result in large losses. Besides the obvious investment risk, such an atmosphere typically results in a startup’s need to initiate secondary investment rounds. This is generally understood by most VCs, but has the potential for grave misunderstandings— and ultimately a lack of investment interest— from individual investors.
Further, with large VC investments come a significant amount of partnership value and exit opportunities. When a private company goes public, they’re subject to strict levels of regulatory compliance, legally mandatory financial reporting every quarter, and the requirement of answering to public investor demands for profits. The security embedded in large buyouts from previously involved VCs frequently seems much more attractive from many startups’ perspective.
Additionally, the timeline associated with returns on investment is thought to be much longer than individual investors would expect. The median holding period is five years, and many investments can require double. To take things a step further, the median age of technology firms performing an IPO is currently eleven years.
How the Tokenization of Securities can Potentially Provide a Remedy
Such conditions have clearly led some to conclude that individual investors are not well-suited for young, risky, technology-based startups. From the reasoning above, we can see how this applies to both parties involved: investors and startups.
However, is it possible that the authors seemingly overlook the benefits of the upcoming security token industry?
Many advocates have explained how added liquidity and a decrease in barriers to investor access will result in the next major wave of capital markets.
The real-world use-case of security tokens has already seen implementation.
A real estate fund has been tokenized on Ethereum. Investment giant Fidelity has expanded operations to include digital assets. Securrency has released the world’s first multi-ledger security token protocol. Hollywood is experiencing new forms of motion picture funding.
The benefits of security tokens are currently being experienced by investors, firms, and entire industries alike. Whether or not they will eliminate the concerns raised above, has yet to be determined.
What do you think about the potential problems faced by individual investors upon entering the sphere of private investments? Will such problems carry over into the security token industry, or will they be overcome by the benefits of tokenized securities? Let us know what you think in the comments below.
Image courtesy of Harvard Business Review.