The new math of value creation

The math of the tech company investing game has changed over the past 15-20 years, and most likely not in your favor. Yes, top public tech companies can still offer a great return. Yet more investors should know the truth about a dramatic and long-standing shift in value creation from the public to the private market.

Who's affected? Anyone who invests in or is exposed to the public stock market--Baby Boomers, Generation X-ers, Millenials, family offices, endowments, institutions. In other words, pretty much everyone. What's the problem? We face one of the biggest financial shifts in recent US history, possibly since the NYSE was founded in 1792.

Once upon a time, top tech companies like Microsoft, Apple, and Amazon entered the public market early enough for risk-tolerant public market investors to take a relatively early bet. When successful, those investors could profit immensely from their early support of innovation.

Amazon's market cap on the day of its IPO was $438M, which came three years after it was founded. An investor investing at that price and holding through today would have enjoyed a 670x return. That's a venture-sized return for a venture-timed bet.

Today, the above scenario is fantasy. While tech companies continue to offer some of the highest returns of any investment category, today's top tech companies are deferring IPO, leaving the bulk of returns out of public investors' reach.

Facebook waited till its valuation had reached $100B before its IPO. For those following along on the math, that's over 200x higher than that of Amazon's. Uber is a $60B private company with no near-term plans for IPO. Airbnb is a $25B private company. Looking at baskets of representative companies, multiple industry experts have concluded that most value creation that used to occur on the public market now occurs privately. My own online VC firm, FundersClub, is an early investor in multiple startups now valued at well over $1B but that continue to remain private.

A grave imbalance

It is no wonder that VCs, the money managers who invest in private tech companies, saw record inflows from private investors in Q1 of 2016, topping the last decade of investment in venture capital. Yet if you're not wealthy, you're not legally permitted to be a private investor in the US. That's due to well-meaning laws put in place by Uncle Sam dating back to the Great Depression and designed to protect you from losing your shirt on risky investments.

It could be complete coincidence, but during this shift of value creation from the public market to the private market, and since the popularization of tech VC starting in the 1970s and 1980s, income inequality in America has continued to steadily grow.

The intrepid journey of entrepreneurs and their early investors is one activity that truly captures the spirit of the American Dream: You can start with nothing, but work hard, tackle real problems, take calculated bets, prosper greatly, and help others prosper greatly from your efforts.

Unfortunately, the neon glow of success stories from Silicon Valley and beyond belie a more sinister truth--The American Dream is fading fast, at least as it pertains to the accessibility of the innovation economy to the vast majority of Americans, i.e., their ability to participate in the upside of the success of tech.

Evan Engstrom, Executive Director of Engine, a non-profit advocacy group focused on the growth of technology entrepreneurship remarks, "...limiting the pool of available capital would likely have a significant detrimental effect on job creation and economic growth."

Startups indeed have a huge impact on our economy. The Kauffman Foundation notes in a recent report, "Policymakers often think of small business as the employment engine of the economy. But when it comes to job-creating power, it is not the size of the business that matters as much as it is the age. New and young companies are the primary source of job creation in the American economy."

And tech specifically also has a large impact on our economy and is part of our nation's future. President Obama recently called for a sweeping overhaul and increased funding and support for computer science in our nation's education system.

A new hope

With the momentum of a revolution occurring in Washington D.C., and with your support, it's not too late to course-correct. The opportunity to recapture the entrepreneurial spirit that has driven our economy to date and helped us to inspire the world is real, and is coming in the form of a new law.

No, it's not the JOBS Act or Title III, which has so far failed to make a dent on democratizing access to top tech company returns. To be fair, the JOBS Act was primarily targeted at enabling investments in businesses that are traditionally overlooked by top VCs, not at top tech startups.

The new law is called the Fair Investment Opportunities for Professional Experts Act. It doesn't roll off the tongue as easily as the JOBS Act, but it's rolling through the halls of Congress with much greater ease, in part a reflection of its simple and common sense approach to the problem. Passed with near unanimous and bipartisan support by the House this past February (347 yays, 8 nays), the law awaits passing by the Senate and signing into law by the President.

The basic premise of the law is to preserve the wealth-based qualification criteria for private investors, but to also introduce a new path to qualify as an accredited investor if you do not meet those wealth thresholds. As proposed, qualifying through this second route would require studying for and passing an exam of private investing sophistication, or having existing government-issued financial credentials.

This shifts the burden to the investor to demonstrate that they're financially sophisticated. This is in contrast to the JOBS Act, which forces startups to jump through hoops and incur steep overhead costs to take non-accredited investor capital, creating an adverse selection filter. That is, tech companies that pursue Title III JOBS Act crowdfunding will tend to be those that are turned down for funding by tech VCs and angel investors, given the relatively greater amount of work and much higher overhead cost of pursuing JOBS Act funding. The new law puts no such burden on startups. The great news is the new law will help all private businesses with greater access to capital, not just tech startups, and conversely will make private investing more accessible to Americans.

In spite of the overwhelming and bipartisan support for the law in the House, according to GovTrack, only 21% of bills that made it past committee in 2013-2015 were ultimately enacted. Given 2016 is an election year, it can be even more difficult to get any law passed all the way through Congress.

Opportunities to help correct a fundamental economic imbalance and to economically empower millions of Americans do not come by often. If I were a senator today, I would be championing this legislation in the Senate. Startup investing is risky and should not be undertaken by those who would lose their well-being were they to participate. However, in the land of the free, we should not be actively disenfranchising those with demonstrated financial sophistication and preventing them from supporting entrepreneurship.

If you care about this issue, be sure to write in your support to your senator today for the Fair Investment Opportunities for Professional Experts Act.

Published on: Apr 18, 2016
The opinions expressed here by Inc.com columnists are their own, not those of Inc.com.