How Trump could change the private investment market

When you think of startups like Uber or Airbnb that turned into large companies, wouldn’t it have been nice to invest in them during their early days? But unless you had access to the private market, that wasn’t an option. 

Ordinary investors — known as retail investors — are generally not permitted to invest in private companies that issue stock, or in venture capital/private equity funds that invest in these companies. The restriction is largely meant to protect retail investors from private market risks like low liquidity and the chances of a startup folding. Instead, wealthier individuals who qualify as accredited investors are able to invest in the private market, as regulators generally deem that they are in a better position financially or informationally to handle these risks.

The rules could change under the Trump administration, particularly if Trump’s nominee to lead the Securities and Exchange Commission, Paul Atkins, is confirmed. But before you get excited about finding the next Ubers of the world, it’s important to recognize the risks that could come from any changes in the current setup. 

Private market returns sometimes — but certainly not always — exceed public market performance. With greater risk can come greater reward. Plus, companies are staying private for longer and the number of private equity-backed companies is growing, which potentially furthers the wealth gap, given that high-income individuals have access to investments that the general public does not. 

Broadening access

The exact ways the SEC could expand access to the private market remains to be seen, but looking at past changes and statements could provide some clues.

In the previous Trump administration, the SEC “definitely had more of a lenient stance and was more pro-capital formation and allowing greater access to the market, including private markets,” said Amy Lynch, founder and president of FrontLine Compliance. 

Under SEC chair Jay Clayton, for example, the SEC made some changes to the definition of an accredited investor to enable qualification based on professional experience, rather than just net worth or income. The next SEC could go even further, Lynch said. 

“They could once again change the definition of an accredited investor to allow even more individuals to qualify,” Lynch said.

For example, the SEC could change the definition of an accredited investor to allow those who have professionally managed accounts to invest in private offerings, similar to what was initially proposed in 2019 but didn’t make it into the final rule changes in 2020, she said. 

The SEC could also could give companies more leeway in terms of how and to whom they can offer securities for sale, she said.

Risk vs. reward

By broadening access to the private market, more people could benefit from diversification and the potential for private company growth. Even though both involve stocks, the public and private markets have different risk/reward profiles and aren’t perfectly correlated. 

“Increased diversification is a way of also streamlining risks. And by allowing your assets to have different timelines and liquidities, etc., then you can spread the risk out,” Lynch said.

Yet private market investing can also substantially increase risk. Liquidity can be a big concern, as private funds often have lock-up periods, and even when sales are possible, they generally take much longer than public market transactions. The average investor might not have the flexibility to wait to get their money out.

Plus, there’s the overall risk that private investments might not pan out. The same can be said for the public market, but the odds of a large, established public company quickly collapsing, for example, are typically lower than that of a startup folding.

So, while keeping retail investors largely shut out of the private market may seem unfair, “I think the argument by the regulator is that the chances of hitting big are slim. And there are many more losers than there are winners,” Lynch said.

“The venture capitalists and the investors that invest with them are of the caliber and of the financial means to absorb losses when they occur. And they understand there’s going to be a lot of losers,” she added. “The typical retail investor cannot have that many losers.” 

Another issue is cost.

“You can invest in the entire public stock market for basically free,” said Alexander Platt, associate professor of law at The University of Kansas. With private funds, however, “you’re going to pay 2% or more to a series of intermediaries to get access to these other investments, which may or may not beat the public market.”

That said, costs and complexity could ease somewhat. Under SEC chair Gary Gensler during the Biden administration, the agency tried to issue a rule that would increase private fund transparency and competition, but it ultimately was struck down.

But if an Atkins-led SEC expands private market access, that could end up achieving Gensler’s goal of shining more light on what can be an opaque private market, such as if funds have to provide more uniform disclosure and face more competition for retail dollars.

“I think it could be understood as trying to solve the same problem, which is we have this enormous private equity market, an enormous part of the economy that’s outside of not just disclosure, but kind of regular competition and market forces that public companies have to deal with. And maybe everybody would benefit if those folks were incentivized to come a little bit closer to the light,” Platt said.

Plus, even if private market investing is riskier than public market investing, there are plenty of other ways for retail investors to take big risks today.

While 10 years ago it might have sounded more reasonable to say ordinary people need to be protected from speculative investments, “today, it’s just a little harder to worry about that,” said Platt. 

With sports gambling increasingly legal and the proliferation of crypto investing, plenty of people are making risky bets, he said.  Even the rise of commission-free public stock and options trading — while a win for consumers on cost — increases the potential for speculative trading, he noted.

“People are engaged now in this huge volume of highly speculative, risky activity with very questionable social benefits,” Platt said.

While those are legal, investing in something like a climate tech startup or biotech venture capital funds, which could help society, might not be allowed under current securities law, he noted.

“That seems asymmetrical,” said Platt. “And I think it does make sense to revisit that.”