Feb 072011
 
Startup Financing Cycle
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VARIOUS pieces of legislation now making their way through Congress would require private pools of investment capital to be registered with the Securities and Exchange Commission. The goal is to curtail abuses and protect the public from questionable practices. The proposed laws would cover the range of funds that deal in derivatives, auction-rate and mortgage-backed securities, highly leveraged transactions and a slew of other instruments so complicated as to defy description.

In registering, these funds would need to open their books to the government so that they could be duly monitored, thus limiting further risks to the financial system.

Unfortunately, however, with good intentions, the Obama administration and some members of Congress are aiming this legislation at all pools of private capital. That includes venture-capital funds, which pose no systemic risks and which, especially now, should be kept free of any new reporting rules and allowed the freedom to flourish.

Venture-capital funds deal solely with privately purchased equity securities in start-up companies, which are not traded in public markets. They have as their limited partners only people who meet the S.E.C.’s definition of a “qualified client” (meaning they possess a substantial amount of money to invest). These investors, who typically allocate a small percentage of their portfolios to venture capital, are familiar with risk, but it is long-term risk, stretching out 7 to 10 years. They put their faith not in publicly traded securities but in entrepreneurs, emerging technologies and new markets.

Because their business is contained within the ecosystem of limited partners, venture-capital funds and the companies in which they invest absorb all the risk: there can be no domino effect in the world financial system.

Venture-capital funds do not leverage investments with debt either, so they’re not tied to commercial banks. They don’t sell short, trade in public securities or employ any hedging techniques.

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