Zaarly on Capitol Hill: Why the Startup Ecosystem Matters

5/13/11

On Tuesday, May 10, 2011, I had the opportunity to participate in a hearing convened by the U.S. House of Representatives Committee on Oversight and Government Reform. This was an incredible honor as an entrepreneur to sit on a distinguished panel and speak directly to leaders in the House of Representatives and from the Securities and Exchange Commission on matters that impact startups.

The hearing was called “The Future of Capital Formation” and was designed to discuss ways that the government could reform existing rules and regulations to help entrepreneurs, small businesses and startups better gain access to capital. As a former startup lawyer that worked with lots of entrepreneurs and startups, and a current entrepreneur here at Zaarly, I know firsthand how important this issue is. And that’s why I felt it was important to share some lessons from the front lines of the startup world.

One of the most important lessons that Zaarly has taught me is how crucial it is to have access to funds in order to build a business and build it quickly. I consider us extremely fortunate to have presented our idea at Startup Weekend Los Angeles and quickly used our success that weekend to raise funding to help build the business. That initial capital helped Zaarly build its prototype for South by Southwest, make our first hires, open an office and ready our product in record speed. All of that fast-success is thanks to having available funds to grow the business and not to have to spend time and energy fundraising.

If anything, the story of Zaarly is a perfect example of why streamlining the rules and regulations for raising money is so crucial. And that’s why I’m so thankful for this opportunity and passionate that it is our duty and responsibility to help others in the startup ecosystem.

My Recommendations to Congress and the SEC

I don’t begin to say that I’m an expert on anything, but I have spent a significant portion of my career helping entrepreneurs think about raising capital. And what I know is this: raising money is not easy; rules governing raising money are complicated and working with a lawyer to decipher them is expensive; and we need to rethink the rules that limit the ability of startups to raise money.

With those things in mind, I came up with four key recommendations for Congress and the SEC that I presented to the leadership. While these are not a silver bullet nor will they necessarily help all entrepreneurs, I think that these are part of a package of reform to help:

—Private Company Fundraising and Financing Regulations:

In general, I believe that regulations governing private company financing be thoroughly examined with an eye to decrease the regulatory scope, simplify procedures, and ensure that the cost-benefit of regulations for raising funding for small investments be met. Investors continue to be in the best position to protect themselves in their investment decisions. This may include contractual requirements for audits of financial statements, seats on a board of directors, or the receipt of regular financial statements.

First, I encourage the removal of the Ban on General Solicitations, which limits the ability of private businesses to locate and identify prospective investors.

Second, I encourage the creation of regulations to extend/expand the concept of accredited investors to individuals that are deemed to be sophisticated based on their knowledge, experience, education or training, thereby allowing these individuals to participate in the private company investment market. We should find ways for smart, savvy individuals to make investments in private companies even if they do not yet have $1 million in assets.

I know many smart individuals that do not have $1 million in net worth that want to help make small investments and know the risks. We should make it easier for entrepreneurs to raise money from smart and savvy individuals – even if they aren’t millionaires.

—Private Market Regulations:

For many fast-growing private companies, there are two traditional paths to providing for liquidity of their stock for investors: a sale of the company or an offering on the public markets. Yet with the increasing costs of public company compliance and offerings, a third approach has developed that now offers shareholders and employees limited liquidity while reducing some of the burden on these fast-growing businesses: private markets.

For later-stage businesses, these private markets offer an alternative to a sale of the company or a public offering to provide liquidity to investors and employees. At the same time, this provides a greater sense of visibility and market pricing into the valuation of a business. This alternative option has an added benefit for early-stage businesses – it provides confidence for early stage investors that more than a single path to an exit event exists. Now, investors have the option of public or private offerings and a merger or acquisition event.

I urge the creation of more flexible rules and regulations to permit businesses to remain private companies, while allowing for the additional liquidity these private market provide. This includes modifications to the 499 shareholder threshold rules and the related solicitation regulations. This may not seem like it impacts early-stage entrepreneurs, but by increasing liquidity options (ways for employees and investors to get their money back from their investments) helps when those individuals reinvest back into the startup eco-system.

—Community-Funding Opportunities:

Today’s businesses are looking for funding from new sources (community-powered investment, angel investors, alternative loan structures, revenue-factoring, etc.) Dozens of organizations are powering microloans, crowd sourced social entrepreneurship and group-powered projects, most of which remain focused on international entrepreneurs or for non-profit aims. Yet the reality is that these structures provide a unique and powerful solution for current funding shortfalls affecting today’s small businesses and startup companies. Imagine a day when a community can come together and fund community-centered businesses through microloans, micro-investments or crowd-sourced funding. It is important for the continual protection of investors, but we should take lessons from organizations using microlending and crowd sourced funding to alleviate poverty in other nations to also spur private investment in community-organizations.

I encourage the investigation of regulations to permit groups of individuals, businesses and organizations to make investments in private companies, small businesses and startups.

—Immigration Reform:

As an entrepreneur and supporter of the entrepreneurial eco-system, I also believe it is crucial to consider the importance of immigration reform in the long-term success of this sector. While not directly related to the hearing I attended, I urged Congress to examine two key programs which directly support and benefit the startup ecosystem:

Expansion of visa programs for individuals intending to work at early-stage businesses. Talent remains at a premium and there is a clear shortfall of citizens and foreign residents with the technical and scientific skills required to build businesses required in the innovation economy.

Startup Visa. Proposed legislation described as a “Startup Visa” to provide a mechanism for foreign individuals starting qualified businesses in the United States to remain here so long as they meet certain pre-set criteria. This legislation will encourage investment in foreign talent intending to build businesses in the U.S. that increase jobs and build long-term economic value.

I believe talent is one of the most important resources required for building a successful business. I have worked on the Startup Visa initiative for the past two years and hope that we can eventually find a solution in that issue. America continues to serve as a location where individuals from the world-over hope to come and participate in the entrepreneurial ecosystem. We should leverage this fact to help support existing businesses as well as new businesses that can or will be formed by these foreign entrepreneurs.

Conclusion

I am fortunate to have the opportunity at Zaarly to build something I’m passionate about and believe can have a big impact on local economies. However, I recognize that this would not be possible without support of our investors – who have made a bet on our team and this idea. Therefore, I believe it is crucial to do everything in my power to help other entrepreneurs out there trying to build their company, attract investment and create a great company.

Pushing for these reforms may seem like a slow and uphill battle, but its crucial for us as members of the startup ecosystem. So thanks for the opportunity fellow entrepreneurs – and let’s continue to work to make entrepreneurship as the centerpiece of our economy.

This post originally appeared on the Zaarly blog.

Eric Koester is co-founder and COO of Zaarly and an attorney, formerly with Cooley LLP. Follow @

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  • Gary Masner

    Eric,
    Great ideas, but let me add another piece to focus on. I retired after 10 years in Silicon Valley VC trade, and have been volunteering helping Colorado startups raise money. Most of these are good business ideas, but will never go public or raise VC money. They don’t want a C corp structure and look to angel investors for equity. The problem is the complexity of K-1 reporting for investors and the treatment of income. Investors are often repaid out of cash flow.
    We need a new form of tax structure for startups. Maybe a 10 year transition to a C corp structure, with investor paybacks being tax deductible to the company and capital gains to the investors.

  • marshall sterman

    concur with Eric’s recommendations/thoughts/observations but they do not address the need to change the mentality/anti-capitalistic/we versus them mentality of our regulators. The excess time/costs/inordinate delays over language/munitia in getting to final approvals has killed more financings than any rules and regs that most of us also regard as excessive.

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