Jan 31 2021

The Importance of the Democratization of Capital

The democratization of capital may be messy at times, but it’s much better than the alternative. And it’s long over-due.

Robinhood’s actions to restrict trading in GameStop stock, as well as several other issuers, was completely the wrong response to an increasingly active capital class. It’s time to give up this old notion that small investors somehow need to be saved from themselves (as they claimed was the reason they halted trading in GME and other issues *). For years, capital investment has been the sole purview of the wealthy in the United States and elsewhere. We’ve long had a series of laws that restricted people’s abilities to invest in private stocks and at that same time, given fee structures and the general opaqueness of the public markets, it’s generally been the purview of only wealthy Americans. Both of those trends have started to change over the last handful of years – trends we should be encouraging not limiting.

The Jobs Act, passed in 2012, was a positive step in opening up private investment to more Americans. Title III of the JOBS Act (which was adopted in 2016) lets startups raise money from non-accredited investors. Previously, investors had to income (at least $200,000 a year over) and/or net worth (at least $1 million excluding your home) to be considered “accredited” and allowed to invest in any number of private assets. Title III allowed anyone to invest via equity crowdfunding. There are some challenges to Title III that still need to be addressed. For example, companies are limited to raising just over $1M million through this method, which limits the scope of businesses that can take advantage of capital formation in this manner. Additionally, there isn’t a mechanism for individuals to create “funds” under Title III to spread out their investment risk (they can only do so by investing project by project). Perhaps most importantly, there are significant per investor limits on their ability to participate in Title III Crowdfunding offerings that limit individual investor participation in crowdfunding marketplaces. But, opening up the ability to invest to a broader swath of Americans – democratizing capital – was a positive and long overdue step. At the same time on the retail side, platforms such as Robinhood have opened up public markets trading to more and more people eager to gain a foothold in the markets. To me, these trends are incredibly positive.

Capital ownership should be more broadly distributed. And while there need to be sensible regulations in place to prevent fraud, the notion that somehow people with less than a certain threshold of net worth can’t make intelligent investment decisions in the private markets is absurd. Robinhood restricting the trading of these stocks is just a continuation of old thinking. They’re a capitalist platform. They should believe in the capital markets and that, even if there are short term aberrations, ultimately the markets will figure it out. The fact that their actions helped stem a short squeeze that was hurting larger Wall Street traders and hedge funds exacerbates the perceptions that they’re not truly democratizing capital in the way that they have suggested that they are. Fred Wilson wrote a similar post earlier this week that I strongly agree with and would highly recommend reading as well. The solution to these sorts of aberrations in the market is to let the market play them out. In the long run, efficient markets will do exactly that (find the efficient price) and the long-term value of the stock will eventually trend back to its underlying and intrinsic value. 

* It’s worth noting that while Robinhood claimed they stopped trading to “protect customers” the true reason was perhaps a bit more complicated. After admitting that there were some “regulatory issues” that prompted the trading halt, the company eventually revealed that the company itself lacked the liquidity (capital) required to allow trading to continue at the levels it was seeing. It subsequently put together a hasty $1bn financing.

Also published on Medium.