October 13, 2021/US SEC
Remarks at The SEC Speaks in 2021
Good morning, and thank you for spending time today with the SEC learning about the breadth of work underway at the agency. One thing is certain: you should be clear by now that the views expressed are the speakers’ own thanks to copious disclaimers throughout this conference.
For most of us, the pandemic has increased the time we stare at screens, whether laptops, a home computer monitor set up, or mobile devices. Each morning I am greeted by a flooded inbox containing highlights of newsclips I flip through before starting the day. It’s no secret that the art of writing a headline, and inducing us to click to read the full article, is now algorithmic science, meshing search engine optimization and behavioral cues to drive eyeballs to articles. Those familiar with the journalism industry know that authors generally do not write their own headlines, instead turning the articles over to copy or section editors to craft alluring titles. The practice dates back to physically laying out spreads in newsrooms, only committing to headlines once you knew how much space with which you were working. Algorithms and social media have further changed the headline writing game, still with limited involvement of the authors.
If you’re taking in news by simply scanning the headlines—particularly those about capital raising activity—you’ve likely missed the story for some splashy titles. Today I’d like to delve into the story and facts behind the headlines about how entrepreneurs are raising capital from investors, deconstructing some of the big numbers we see in large print. To keep this conversation lively, I’ve taken liberties with some real headlines and had a bit of fun, with them admittedly now reading more like an Onion lead-in than a Reuters or AP distribution.
“Fashion Faux-Pas: Entrepreneur Pitches in Suit Instead of Logo Tee, Brandishing Major Red Flag for Investors”
The visibility of a small handful of entrepreneurs—hardly representative of the majority of founders—has created an archetype of the “model entrepreneur.” If I asked you to shut your eyes and picture an entrepreneur, too many people would envision a 20-something white male, wearing a hoodie, perhaps who dropped out of an Ivy League institution to build a revolutionary company with seed funding from a few prescient angels who spotted genius a mile away.
This headline is exciting! The person who takes wild risks, dropping out of college, or quitting their day job, evokes the David vs. Goliath urge to root for the underdog. Yet, the stories beneath the headline do not support this notion. Let’s tackle the real story from two angles.
“Entrepreneurs Should Quit Their Day Jobs; Paychecks are Irrelevant”
Many assume that unless an entrepreneur is focused on their startup 100%, they’re not truly dedicated. The reality for most entrepreneurs is that sticking with their day job before their side hustle has been de-risked is not only a smart financial decision, but often a necessary one. Our Office regularly hears from minority and women entrepreneurs who talk about building their companies while maintaining a stable income stream to support their families, pay off student debt, and avoid taking on too much dilutive capital too early. Their decision is a smart one. Entrepreneurs who keep their day jobs while building their businesses are 1/3 less likely to fail than those who quit and go all in from the beginning. Wharton Professor and author Adam Grant attributes this phenomenon to building a balanced risk portfolio, with the stability of the full-time job affording entrepreneurs the freedom to be more creative in their side hustle.
This is compounded by the reality that the average startup founder is not actually a 20-something. The average age of the highest performing startup founders is actually 45. Even among notable young founders, their entrepreneurial success peaks around this same age, with Amazon achieving its highest market cap growth rate when Jeff Bezos was 45, and Apple introducing its most profitable innovation, the iPhone, when Steve Jobs was 52.
“Who Needs Diversity? The Market Will Intuit Solutions for All”
It is also easy to buy into the narrative that if there is an unmet need among customers, the “market” will recognize that gap and deliver a solution. The reality is that problem-solvers only set out to solve the problems that they personally understand. Put another way: I can appreciate the challenges that you face, but I cannot fully understand or know them—much less solve them—unless I live them.
This is often the story with underrepresented entrepreneurs who see a need that majority entrepreneurs and investors have not experienced. For fans of Guy Raz’s How I Built This, you may be familiar with the story of Tristan Walker’s company Bevel. As a black man, Tristan battled embarrassing razor bumps from shaving. After surveying the market, he discovered that many men of color with coarse or curly hair shared the same struggle, which could be solved with a single-blade razor system. He began pitching a direct-to-consumer solution to investors, only to be repeatedly dismissed with “if this were really a problem, the incumbent players would have addressed it.” After a disheartening number of rejections, he finally secured funding, ultimately building a wildly successful brand that subsequently sold to Proctor & Gamble, making Tristan the first black CEO of a P&G subsidiary. His story demonstrates the importance of people who live the problem developing the solution.
While we have seen rising levels of entrepreneurship among underrepresented founders, they still struggle to connect to investors who see past the need to fit within the archetype of the hoodie-clad, 20-year-old drop-out. While many sophisticated investors recognize the perils of pattern-matching, it is critical that we empower diverse investment decision-makers who can support solutions to problems that they too face. Our Office’s recent Emerging Fund Managers series highlighted the importance of new, diverse voices among capital allocators who value ROI potential differently.
“Capital Is Easy to Come by, with the Right Idea”
With record-breaking valuations and investments this year for a small handful of technology companies, it is easy for the headlines to overshadow the reality facing most entrepreneurs that capital raising is still hard. The challenges are blurred by two misleading headlines: technically savvy founders are fluent in securities lingo, and our capital markets are flooding all startups with funding.
“Fluency in Securities Legalese an Indicator of Product-Market Fit”
For this audience, fluency in securities laws is job security. Now take the most technically sophisticated entrepreneur, whether a biomedical researcher commercializing a pharmaceutical patent, an app developer pioneering novel code, or an industrial innovator scaling a cleantech solution. We should, of course, expect them to be experts in their product category; that is their competitive advantage. Yet great entrepreneurial insight does not translate into fluency in 80+ years of layered securities laws. When our Office meets with brilliant entrepreneurs across the country, consistently we have been asked to help make the language of capital raising and the menu of options more accessible so that basic compliance is not a game measured in 0.1 hour increments.
In response to requests for support, our Office is iteratively launching new educational content. We took a nod from our colleagues’ wonderful work with Investor.gov and started with our Cutting Through the Jargon glossary, which demystifies much of the lingo used in capital raising. Today I am excited to announce that we are beta-launching our new Capital Raising Navigator, an interactive digital tool that helps entrepreneurs narrow their options for raising capital based upon their expressed needs, from how much money they need, to whether they know their prospective investors, to where they plan to raise. It is part of a suite of evolving content we are creating on www.sec.gov/capitalraising that is directly targeting a gap in accessibility of how to comply with our rules. I encourage you to take a look, and importantly, share feedback with us on what other resources are needed.
Sneak peak of Capital Raising Navigator
“Flush with Capital, Private Markets are Booming for Everyone”
If you stopped at the headlines on capital raising, or didn’t recognize how skewed they are by a handful of outsized deals, you might assume that once the rules are clear, the rest of capital raising is easy going. If you take a cursory glance at the numbers behind recent headlines, you’ll see increasingly large funding rounds raised by companies before they go public. The aggregated capital raising figures back up this headline, but they miss the story. The late stage “venture” (and I intentionally use that word in quotes) capital raising game has changed in recent years thanks to the increasing presence of crossover investors investing in pre-IPO companies. These non-traditional investors—such as mutual funds and others who historically invested solely in the public markets—have dramatically changed the dynamics of capital raising pre-IPO. The following figures illustrate the magnitude of these crossover investors’ impact:
- Crossover investors only invest in 5.3% of venture deals by count, but make up 36% of venture deal value. In other words: they invest in a tiny portion of deals but have an outsized impact.
- The median venture round without crossover investors hovers just below $3 million. The deal size involving crossover investors swells to a median of nearly $60 million, an almost 2000% increase.
The story beneath the headline is that the private markets have not changed as much as the public market players have created a new game. The sheer check-writing capacity of crossover investors has enabled a small percentage of private companies to raise hundreds of millions of dollars. However, the vast majority of companies are not basking in a unicorn valuation, but instead are fighting for investor visibility and savvy capital to scale.
“Entrepreneurship and Innovation Are a Waste, as 9/10 Startups Fail”
Much has been written about the challenges of survival among startups. It is the very reason that the most sophisticated angel and venture investors build diversified portfolios: they aim to have a small handful of companies “return the fund,” with the others being a wash. For investors in early-stage companies, the construction of a diversified portfolio is essential, a point we more broadly underscore throughout the SEC’s investor outreach.
To fully appreciate the dynamics of startup building and innovating, we need to dig further into the story rather than just skimming the headline and concluding: innovation=bad, startups=bad, and (most critically) failure=bad. We need to deconstruct the headlines about who succeeds and the importance of competitive failures.
“If You’re Not First, You’re Last”
If I were to poll the audience on who has the best competitive advantage: first movers into a new product category, or follow-on market entrants, most of you would probably assume the early bird gets the worm, corners the market, and dominates. The headlines you see likely have skewed this perception. However, when measuring across hundreds of product categories, a classic study found that first movers are 6x more likely to fail—a 47% failure rate—than second movers—an only 8% failure rate. For those scratching your heads and wondering “yes, but I bet the first movers who do survive capture greater market share,” wrong again. Even for the first movers who survive, they capture on average only 10% of the market share for their category. The second movers capture 28%, almost 3x as much. Take as a tangible example of this phenomenon the devices you’re using to tune in right now, whether an Android or iPhone mobile device (second movers to the Palm Pilot and Blackberry), or any number of laptop models (most dominant manufacturers of which are second movers).
We need first movers, and plenty of second movers, to drive innovation forward. To build successful companies, startups need savvy investors who bring industry experience, customer connections, and strategic guidance for the companies to scale and thrive. However, the accessibility of professional angels and venture capitalists are outside of many entrepreneurs’ personal and geographic networks, which can dramatically impact survival versus failure prospects. Developing solutions to bridge social and professional networks is a game changer for building more companies that succeed.
“If Companies Could Stop Failing, Innovation Would Improve”
Looking at cohorts of first and second movers pushing innovations across sectors, the benefits of competitive market forces should be clear. In the race to develop vaccines against COVID-19, we enlisted a myriad of approaches by many pharmaceutical companies to deliver not just one, but multiple solutions to solve one of the greatest healthcare challenges we have seen. Taken as a whole, the broad scale effort was a resounding success, with the fastest delivery time of a new vaccine in history. Here we take the big picture view, measuring success by the innovative outcome: delivery of an efficacious vaccine. Few take the view that the endeavor was a failure because not every involved pharmaceutical company found success individually.
Investing in the startup ecosystem likewise demands a big picture mindset. Competition among startups breeds success. That competition among companies pushing each other to develop a better solution is the cornerstone of our capital markets.
Headlines used to sell papers; now they sell clicks. In an age of information overload, it’s all too easy to consume the headlines and skip over the stories. When scrolling Twitter or your news feed, none of us has time to click on every story. However, as we look ahead to decisions about how our laws and regulations should evolve, it is critical that we continue to read the story, not just the big print. Failure to do so leaves behind a whole cast of characters who are underrepresented, and often unseen, by what fits in a two-line summary.
Our team is laser focused on the stories of the underrepresented entrepreneurs—the people we don’t see in headlines—who are solving problems for our future. I hope you take away from today an urge to click the headlines you see on capital raising, to ask questions about the entrepreneurs you don’t see represented, and to delve deeper in creating solutions that serve the needs of innovators, creators, and problem-solvers and the investors with whom they work. Thank you for joining me today, and thank you to the team at PLI and the SEC for bringing this year’s event together. Most importantly, thank you to the incredible team I am fortunate to work with every day: Dean A. Brazier, Jr., Colin A. Caleb, Jenny J. Choi, Julie Zelman Davis, Sebastian Gomez Abero, Sarah R. Kenyon, Jessica W. McKinney, Amy Reischauer, Jenny Riegel, Malika Sullivan, and Todd VanLaere.
 This speech expresses the author’s views and does not necessarily reflect those of the Commission, the Commissioners, or other members of the staff.
 See Adam Grant, Originals: How Non-Conformists Move the World, Viking (2016).
 See Pierre Azoulay et al., “Research: The Average Age of a Successful Startup Founder is 45,” Harvard Business Review, (Jul. 11, 2018) available at https://hbr.org/2018/07/research-the-average-age-of-a-successful-startup-founder-is-45.
 See Guy Raz, “How I Built This: Live Episode! Walker & Company: Tristan Walker,” NPR, (Sept. 30, 2019) available at https://www.npr.org/2019/09/25/764355017/live-episode-walker-company-tristan-walker.
 See Office of the Advocate for Small Business Capital Formation, “Annual Report for Fiscal Year 2020” (2020) at 56, highlighting that founders are 21% more likely to be funded by investors of the same ethnicity than of a different ethnicity, available at https://www.sec.gov/files/2020-oasb-annual-report.pdf.
 See Martha Miller, Director, Office of the Advocate for Small Business Capital Formation, Opening Remarks at the Diversifying Opportunity in Venture Capital Series (Mar. 31, 2021) available at https://www.sec.gov/news/public-statement/miller-remarks-diversifying-opportunity-venture-capital-series-033121.
 See supra note 7 at 66, recommending “Education to Ease Challenges of Offering Complexity and Friction.”
 See Cameron Stanfill et al., “Analyst Note: Crossing Over Into Venture. A Look at Crossover Investors’ Impact on US VC Dealmaking,” PitchBook, (2021) available at https://pitchbook.com/news/reports/q2-2021-pitchbook-analyst-note-crossing-over-into-venture. See also United States Securities and Exchange Commission Small Business Capital Formation Advisory Committee meeting transcript (Sept. 27, 2021) available at https://www.sec.gov/info/smallbus/acsec/sbcfac-transcript-092721.pdf.
 Investments being a wash is the result of investments exiting through a minimally profitable acquisition, surviving as an unscalable “zombie,” or dissolving and liquidating assets. See Brad Feld and Jason Mendelson, Venture Deals: Be Smarter Than Your Lawyer and Venture Capitalist, Wiley (2019).
 Investor.gov. Beginners’ Guide to Asset Allocation, Diversification, and Rebalancing, available at https://www.investor.gov/additional-resources/general-resources/publications-research/info-sheets/beginners-guide-asset.
 See Gerard J. Tellis and Peter N. Golder, “Pioneer Advantage: Marketing Logic or Marketing Legend?” Journal of Marketing Research, (May 1993) available at https://ssrn.com/abstract=906046; see also Fernando F. Suarez and Gianvito Lanzolla, “The Half-Truth of First-Mover Advantage,” Harvard Business Review, (Apr. 2005) available at https://hbr.org/2005/04/the-half-truth-of-first-mover-advantage?registration=success.
 See supra note 7 at 68, recommending “Regulatory Clarity to Bridge Networks between Founders and Investors.”
 See Philip Ball, “The Lightning-Fast Quest for COVID Vaccines – and what it Means for Other Diseases,” Nature (Dec. 18, 2020) available at https://www.nature.com/articles/d41586-020-03626-1.