5 Misses in Mark Cuban’s Angel “Bubble” Post
Mark Cuban’s blog post about why angel investors are fueling a technology bubble contains several arguments that he would be hard pressed to support. Nonetheless, the post has been covered widely by several media outlets, which is fairly typical anytime a startup world celebrity puts “bubble” in the title of an article or tweet. I do find Mr. Cuban’s explanation on CNBC a bit more reasoned than the post, but I still think the overall points are sensationalized and incorrect. Here are 5 flaws with Mr. Cuban’s post and perspective:
- Angel investor networks and groups are helping to educate new investors in the market, reducing the risk of poorly educated investors and faulty valuations. Mr. Cuban cites an Angel Capital Association (“ACA”) statistic regarding the number of angel investors in the U.S., but he fails to discuss how groups like the ACA and its member organizations provide a critical educational function helping to protect angel investors from the very risks he identifies. By the ACA’s account, angel investors provide up to 90% of outside capital to early stage businesses. Angel investors (properly defined) have long been a major driver of economic growth and startup businesses. In addition, groups like the ACA are on the forefront of policy efforts to balance the definition of “accredited investors” with adequate safeguards. Full disclosure: I am on the Public Policy Advisory Committee of the ACA and a board member of NO/LA Angel Network (although this post is not a communication on behalf of or approved by either).
- Mr. Cuban confuses “Angel Investor” with “Average Investor”. An “angel investor” is generally someone who (a) puts his/her own money at risk by investing into one or more ventures, and (b) satisfies the definition of “accredited investor” under Rule 501 of Regulation D of the Securities Act of 1933. An “accredited investor” individual is someone who has $1M net worth (excluding the value of his/her home) and/or has an annual income of at least $200K for the past 2 years with the expectation of the same or higher salary in the year of investment (or, $300K if married). Generally, an accredited angel investor is able to lose some of his/her portfolio in angel investments and still get a healthy return. Perhaps many of Mr. Cuban’s deals have angels in them that do not meet these definitions, but it is not clear why he thinks that accredited angels cannot adequately protect themselves. The blurring lines between angels, super-angels, VCs and all of the other entrants in the early stage company market explains rising valuations of private companies, not the entrance of many small investors at $5,000—at least at this point. One could easily make the case that newcomers to the private markets (not angels) are helping fuel bubbles in valuations of private companies. Lots of crowdfunding sites, like AngelList, are helping less sophisticated angels spread out risk with more experienced investors and “syndicates” so that their small investments have a greater chance of succeeding. This is a positive development.
- Mr. Cuban confuses Crowdfunding (which is not happening now) with equity crowdfunding under Rule 506(c) crowdfunding (which is working now). The SEC has not issued regulations allowing inexperienced, non-accredited investors to invest $5,000 in equity of companies. The proposed rules would allow investors to invest the greater of $2,000 or $100,000, depending on their financial situation. So, there are no inexperienced, non-accredited angels flooding the markets with low amounts of cash, spiking up valuations. The only equity “crowdfunding” legal now refers to the ability of a company to raise money by making a “general solicitation,” but companies using this new technique must then verify that investors are actually accredited investors. This helps ensure that “angels” are qualified to protect their investments. Many companies are using this new technique with great success (e.g., here). No one knows what effect the true “crowdfunding” regulations will have when released, but one thing is certain: non-accredited investor equity crowdfunding is not causing a rush to invest in private companies with no liquidity because it is not yet happening on a wide enough scale. Only a minority of states allow this, and I have seen no data that this type of crowdfunding investment has had any effect on professional investment rounds.
- Acquisition exit strategies can still work. On the phone with CNBC, Mark Cuban said that the answer to whether or not an investor should invest into a private company was simple. Basically, Mr. Cuban’s advice was this: if the exit strategy is an acquisition, “don’t do it.” However, corporate VC spending is at a high, leading many to argue that acquisitions with higher rates of return will continue with acquisitions. Observers expect continued strong buyer demand for startups. The IPO market is closed off to many companies that can still bring a successful rate of return to investors.
- This is the “valley of death,” not necessarily the “bubble,” argument. Mr. Cuban describes the scenario that a lot of companies are getting funded that potentially do not deserve it. This is undoubtedly true. However, this does not in and of itself mean that valuations are out of whack with reason. It simply means that a larger number of companies will not get funded by professional investors at later stages and the companies will simply fail. This has been aptly described as the “valley of death,” which I think is a more appropriate than calling the current phenomenon a “bubble.”
What do I think that Mr. Cuban got right? I think that the argument that there should be a better road to liquidity and growth capital for growing companies is right on. I think Mr. Cuban is correct that current regulations and realities choke off the public markets for growth companies by requiring them to stay private and illiquid longer. In fact, I have been arguing this since the recession. See my article here. In fact, there have been recent indications that the SEC may be leaning toward giving a nod of approval to “venture exchanges.” These types of venture exchanges have the goal of supporting companies not yet mature enough to trade on the larger exchanges, but requiring the growth capital and liquidity that might help prevent otherwise good companies from failing due to the regulatory bottleneck forcing IPOs to be larger to be successful. Structured correctly, I think these might be good ideas. The TMX and other exchanges have been cited as examples in the past.
When Mr. Cuban speaks, lots of people listen—and, even more talk back. I think some of the sentiment in the “bubble” post was right, but I think a lot of the specifics were lost and not properly addressed. I also think that the post fell short in that it confuses an “angel investor” with an “average investor” and it associates angels with a problem that is very much being fueled by non-angels.
By Mark Graffagnini, President, Graffagnini, L.C. Mark is an attorney who represents investors and companies in financing transactions, general corporate matters, M&A deals and public offerings and securities reporting.
Disclaimer: This post discusses general issues, but it does not constitute legal advice in any respect. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel. Graffagnini, L.C. and the author expressly disclaim all liability in respect of any actions taken or not taken based on any contents of this post. The views expressed herein are personal opinion and not the opinions of any affiliated organization.
By Mark Graffagnini, President, Graffagnini, L.C. Mark is an attorney who represents investors and companies in financing transactions, general corporate matters, M&A deals and public offerings and securities reporting.
Disclaimer: This post discusses general issues, but it does not constitute legal advice in any respect. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel. Graffagnini, L.C. and the author expressly disclaim all liability in respect of any actions taken or not taken based on any contents of this post. The views expressed herein are personal opinion and not the opinions of any affiliated organization.
Mark Cuban’s blog post about why angel investors are fueling a technology bubble contains several arguments that he would be hard pressed to support. Nonetheless, the post has been covered widely by several media outlets, which is fairly typical anytime a startup world celebrity puts “bubble” in the title of an article or tweet. I do find Mr. Cuban’s explanation on CNBC a bit more reasoned than the post, but I still think the overall points are sensationalized and incorrect. Here are 5 flaws with Mr. Cuban’s post and perspective:
- Angel investor networks and groups are helping to educate new investors in the market, reducing the risk of poorly educated investors and faulty valuations. Mr. Cuban cites an Angel Capital Association (“ACA”) statistic regarding the number of angel investors in the U.S., but he fails to discuss how groups like the ACA and its member organizations provide a critical educational function helping to protect angel investors from the very risks he identifies. By the ACA’s account, angel investors provide up to 90% of outside capital to early stage businesses. Angel investors (properly defined) have long been a major driver of economic growth and startup businesses. In addition, groups like the ACA are on the forefront of policy efforts to balance the definition of “accredited investors” with adequate safeguards. Full disclosure: I am on the Public Policy Advisory Committee of the ACA and a board member of NO/LA Angel Network (although this post is not a communication on behalf of or approved by either).
- Mr. Cuban confuses “Angel Investor” with “Average Investor”. An “angel investor” is generally someone who (a) puts his/her own money at risk by investing into one or more ventures, and (b) satisfies the definition of “accredited investor” under Rule 501 of Regulation D of the Securities Act of 1933. An “accredited investor” individual is someone who has $1M net worth (excluding the value of his/her home) and/or has an annual income of at least $200K for the past 2 years with the expectation of the same or higher salary in the year of investment (or, $300K if married). Generally, an accredited angel investor is able to lose some of his/her portfolio in angel investments and still get a healthy return. Perhaps many of Mr. Cuban’s deals have angels in them that do not meet these definitions, but it is not clear why he thinks that accredited angels cannot adequately protect themselves. The blurring lines between angels, super-angels, VCs and all of the other entrants in the early stage company market explains rising valuations of private companies, not the entrance of many small investors at $5,000—at least at this point. One could easily make the case that newcomers to the private markets (not angels) are helping fuel bubbles in valuations of private companies. Lots of crowdfunding sites, like AngelList, are helping less sophisticated angels spread out risk with more experienced investors and “syndicates” so that their small investments have a greater chance of succeeding. This is a positive development.
- Mr. Cuban confuses Crowdfunding (which is not happening now) with equity crowdfunding under Rule 506(c) crowdfunding (which is working now). The SEC has not issued regulations allowing inexperienced, non-accredited investors to invest $5,000 in equity of companies. The proposed rules would allow investors to invest the greater of $2,000 or $100,000, depending on their financial situation. So, there are no inexperienced, non-accredited angels flooding the markets with low amounts of cash, spiking up valuations. The only equity “crowdfunding” legal now refers to the ability of a company to raise money by making a “general solicitation,” but companies using this new technique must then verify that investors are actually accredited investors. This helps ensure that “angels” are qualified to protect their investments. Many companies are using this new technique with great success (e.g., here). No one knows what effect the true “crowdfunding” regulations will have when released, but one thing is certain: non-accredited investor equity crowdfunding is not causing a rush to invest in private companies with no liquidity because it is not yet happening on a wide enough scale. Only a minority of states allow this, and I have seen no data that this type of crowdfunding investment has had any effect on professional investment rounds.
- Acquisition exit strategies can still work. On the phone with CNBC, Mark Cuban said that the answer to whether or not an investor should invest into a private company was simple. Basically, Mr. Cuban’s advice was this: if the exit strategy is an acquisition, “don’t do it.” However, corporate VC spending is at a high, leading many to argue that acquisitions with higher rates of return will continue with acquisitions. Observers expect continued strong buyer demand for startups. The IPO market is closed off to many companies that can still bring a successful rate of return to investors.
- This is the “valley of death,” not necessarily the “bubble,” argument. Mr. Cuban describes the scenario that a lot of companies are getting funded that potentially do not deserve it. This is undoubtedly true. However, this does not in and of itself mean that valuations are out of whack with reason. It simply means that a larger number of companies will not get funded by professional investors at later stages and the companies will simply fail. This has been aptly described as the “valley of death,” which I think is a more appropriate than calling the current phenomenon a “bubble.”
What do I think that Mr. Cuban got right? I think that the argument that there should be a better road to liquidity and growth capital for growing companies is right on. I think Mr. Cuban is correct that current regulations and realities choke off the public markets for growth companies by requiring them to stay private and illiquid longer. In fact, I have been arguing this since the recession. See my article here. In fact, there have been recent indications that the SEC may be leaning toward giving a nod of approval to “venture exchanges.” These types of venture exchanges have the goal of supporting companies not yet mature enough to trade on the larger exchanges, but requiring the growth capital and liquidity that might help prevent otherwise good companies from failing due to the regulatory bottleneck forcing IPOs to be larger to be successful. Structured correctly, I think these might be good ideas. The TMX and other exchanges have been cited as examples in the past.
When Mr. Cuban speaks, lots of people listen—and, even more talk back. I think some of the sentiment in the “bubble” post was right, but I think a lot of the specifics were lost and not properly addressed. I also think that the post fell short in that it confuses an “angel investor” with an “average investor” and it associates angels with a problem that is very much being fueled by non-angels.
By Mark Graffagnini, President, Graffagnini, L.C. Mark is an attorney who represents investors and companies in financing transactions, general corporate matters, M&A deals and public offerings and securities reporting.
Disclaimer: This post discusses general issues, but it does not constitute legal advice in any respect. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel. Graffagnini, L.C. and the author expressly disclaim all liability in respect of any actions taken or not taken based on any contents of this post. The views expressed herein are personal opinion and not the opinions of any affiliated organization.
By Mark Graffagnini, President, Graffagnini, L.C. Mark is an attorney who represents investors and companies in financing transactions, general corporate matters, M&A deals and public offerings and securities reporting.
Disclaimer: This post discusses general issues, but it does not constitute legal advice in any respect. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel. Graffagnini, L.C. and the author expressly disclaim all liability in respect of any actions taken or not taken based on any contents of this post. The views expressed herein are personal opinion and not the opinions of any affiliated organization.
