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SEC Considers Changes That Could Hammer VCs and Angel Investors

The SEC is considering a change in the rules for raising money that could affect many start-ups and even rising stars such as Facebook and Twitter. Young companies might even be able to crowd source investments through social networks.

The changes, if they happen, would have an enormous impact on how companies get funded in the U.S. In the process, they could put a damper on a traditional area for angel investors and venture capital firms. They would also give hot companies a tool to keep their dealings private, even while raising large amounts of capital, creating a competitive advantage over companies that have already gone public.

SEC chairman Mary Schapiro described the concepts in a letter she sent to Rep. Darrell Issa, chairman of the House Committee on Oversight and Government Reform. One part you might call the the Facebook exception. Currently, a company is limited to having no more than 499 shareholders before it must report as though it were a public company. Facebook worked with Goldman Sachs (GS) to finagle engineer a private placement that would restrict the technical number of owners while still raising money.

Why did Facebook go that route? Because an IPO means releasing sensitive information. You can learn a lot about a company and its strategies through SEC filings. By contrast, if you could crowdsource investments widely enough, a company like Facebook could theoretically raise billions without having to disclose its finances and other details, giving it a significant advantage over competitors.

Furthermore, when companies don't have to make regular public disclosures, they're less likely to see their valuation deflated by inconvenient analyses that contrast new information with what a company has previously filed. Also, if a hot company can go directly to investors, VCs have little leverage to get the good deals that can provide enormous returns.

On the very small company front, entrepreneurs could raise up to $100,000 by going directly to investors, even using social media to make connections. The need to find one person willing to pony up the full amount becomes unnecessary, and the influence that any one investor might then have is limited.

All in all, if the SEC continues to move in this direction, it would have a huge impact on how companies do business today.

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