The GOP debate brought more talk of a “wet blanket of regulation” weighing on economic activity.  Apparently even President Obama thinks that environmental regulation is at issue here and has sadly rolled back some clean air standards.  That’s quite ironic at a time when the Chinese are tightening their air quality standards and when we should be looking at creating (clean) tech jobs (as opposed to smoke stack ones) is biting.

Instead we should be looking at the cost of financial regulation that was designed for larger companies but is now imposed on much smaller companies.  My favorite example here of something absurd are 409A valuations.  These are the requirement for startups to get an outside firm to produce an options valuation.  The cost for these valuations runs between 3,000 and 10,000 dollars.  Not a lot of money one might argue but they have to be redone after every venture round and also more often for companies that are growing rapidly (even if the growth is just in users not revenues).

Prior to 409A, the board had the discretion to set the option price and usually a range of 10-30% of the preferred price was the norm.  Most 409A valuations come out somewhere in this range especially for early stage companies anyhow and so add no value.  But worse yet because the 409A firms don’t want to be held responsible they tend to price common too high especially when there have been second market transactions in common.  They also use an option pricing approach where they base volatility on publicly traded stocks which is utter nonsense for early stage companies.  In these instances startups face a much bigger cost than paying the 409A consultant: they now need to issue way more equity than they had to in the past.

Let’s say an Internet startup is spending $10,000 a year on 409A that is $10,000 not spent on building a feature, or growing the community or providing customer support.  Given startup salaries this is roughly the tradeoff between a couple of days of employment for a 409A financial person compared to around a quarter for an entry level full-time employee.  If you are going to require something, then another use of $10,000 that would be vastly more valuable to Internet startups would be an external security audit (more on that in a separate post).

So if we are going to talk about a “wet blanket of regulation” let’s please look at what is weighing down the future, not the past.

The GOP debate brought more talk of a “wet blanket of regulation” weighing on economic activity.  Apparently even President Obama thinks that environmental regulation is at issue here and has sadly rolled back some clean air standards.  That’s quite ironic at a time when the Chinese are tightening their air quality standards and when we should be looking at creating (clean) tech jobs (as opposed to smoke stack ones) is biting.

Instead we should be looking at the cost of financial regulation that was designed for larger companies but is now imposed on much smaller companies.  My favorite example here of something absurd are 409A valuations.  These are the requirement for startups to get an outside firm to produce an options valuation.  The cost for these valuations runs between 3,000 and 10,000 dollars.  Not a lot of money one might argue but they have to be redone after every venture round and also more often for companies that are growing rapidly (even if the growth is just in users not revenues).

Prior to 409A, the board had the discretion to set the option price and usually a range of 10-30% of the preferred price was the norm.  Most 409A valuations come out somewhere in this range especially for early stage companies anyhow and so add no value.  But worse yet because the 409A firms don’t want to be held responsible they tend to price common too high especially when there have been second market transactions in common.  They also use an option pricing approach where they base volatility on publicly traded stocks which is utter nonsense for early stage companies.  In these instances startups face a much bigger cost than paying the 409A consultant: they now need to issue way more equity than they had to in the past.

Let’s say an Internet startup is spending $10,000 a year on 409A that is $10,000 not spent on building a feature, or growing the community or providing customer support.  Given startup salaries this is roughly the tradeoff between a couple of days of employment for a 409A financial person compared to around a quarter for an entry level full-time employee.  If you are going to require something, then another use of $10,000 that would be vastly more valuable to Internet startups would be an external security audit (more on that in a separate post).

So if we are going to talk about a “wet blanket of regulation” let’s please look at what is weighing down the future, not the past.