We’ve written earlier regarding the possible unintended consequences of the recent general solicitation rule changes by the SEC. While we fully understand the rationale behind this rule change, there are very good reasons why the rules were formulated the way they were in the first place. While it’s commendable for governmental authorities to try and spur the economy by letting companies get more investors and spread the word about investment opportunities, there is a reason why the rules were as tight as they were. Obviously, there is a lot of fraud issues and misrepresentation issues on the table.
Leaving that aside for a moment, one of the bigger problems is that there is a more practical reason why the rules were they way they were. The problem is that if you have relatively unsophisticated investors or investors that are highly excitable and would throw money at the first business pitch that seem to make sense, it increases the valuation of that business. In other words, the pre-money valuation of a business jumps up because there’s already money in the business. While this may seem like a good thing for startups that are hard up for capital and need their ideas funded so they can take their company to the next level, this kind of opens a whole new can of worms because other investors who know what they are doing and investors with a lot more money might not want to touch the startup because the pre-money valuation has gone sky high.
This is a serious threat and it can actually result in the SEC rule change creating an effect that is the opposite of what it intended. Instead of opening up the market place to more money and more investments, this might actually create a flight to quality. Instead of creating a democracy in the market place, this might actually push more and more sophisticated investors and more importantly investors with a lot of money to “tried and proven” startups. When that happens, this is pretty much bad news for the average startup which needs capital. This is definitely food for thought. It would definitely be interesting how this will pan out in the future but considering the wild roller coaster rides of valuation in the stock market in general, this impact of the rule change should have been considered more carefully.