On April 4, a group of Senate Banking Committee Republicans, led by Ranking Member Senator Pat Toomey (R-Pa.), released an important legislative discussion draft called the JOBS Act of 2022 to mark the 10th anniversary of the JOBS Act of 2012, and to further enhance access to capital for new and small businesses. The package of nearly 30 individual bills is an attempt to solicit feedback from both Republicans and Democrats regarding ways to cultivate new business formation and growth, encourage young firms to trade on public markets, protect retail investors, and amend regulations to support new and small companies.
Some bills in the package already have bipartisan support. A provision co-sponsored by Sens. Steve Daines (R-Mont.) and Robert Menendez (D-N.J.), for example, would eliminate certain fees and expense line items from business development company prospectuses to expand access to capital for small and medium-sized companies. Another, co-sponsored by Sens. John Kennedy (R-La.) and Tina Smith (D-Minn.), would require the Securities and Exchange Commission to study access to private capital in rural areas of the country.
One provision of the package that deserves bipartisan support is the Expanding American Entrepreneurship Act, co-sponsored by Sens. Jerry Moran (R-Kan.) and Tim Scott (R-S.C.). Just 13 lines in length, the bill would expand the range of entrepreneurs who ultimately secure capital to include more women founders and entrepreneurs of color by broadening the diversity of investors participating in funds that invest in new businesses.
Launching a new business requires money. Entrepreneurs need money to pay expenses, develop their product or service idea, research the marketplace, develop and implement a strategy for identifying and targeting customers, and, hopefully, begin paying initial employees. Because such costs typically arrive long before the first dollar of revenue, capital and credit are the lifeblood of any new business.
Many new businesses — particularly those that have the potential to grow very quickly — rely on investors who provide early-stage capital in exchange for an equity stake in the company. At present, the overwhelming share of equity capital goes to entrepreneurs who are white and male. In recent years, women entrepreneurs have reportedly received only about 2 percent of total equity capital while entrepreneurs of color have received about 1 percent.
This unbalanced distribution of equity capital is attributable to both explicit bias on the part of some investors, but also to unintentional bias. Recent research has documented a phenomenon known as “homophily” — investors tend to invest in entrepreneurs who look like them, have similar backgrounds and life experiences, and who are launching companies that investors relate to. Historically, startup investors have been predominantly white and male, with the predictable result that most of the startups in which they invest are launched and run by white male entrepreneurs. Greater diversity among those who invest in startups would result in more capital being directed to women founders and entrepreneurs of color.
The Investment Company Act of 1940establishes the legal framework for the establishment, operation, and regulation of investment funds. Many private investment funds are organized under section 3(c)(1) of the Act, which requires fund participants to be accredited investors and limits the number of investors to 100. The limit on the number of permitted investors reinforces deficiencies in diversity among startup investors — and, therefore, among entrepreneurs who successfully secure funding — because it keeps the contribution from each investor, except for very small funds, high. For example, in the case of a $30 million fund — very small by industry standards — the average investment is $300,000, too large for many accredited investors, particularly investors of color.
In 2018, Congress passed and President Trump signed into law the Economic Growth, Regulatory Relief, and Consumer Protection Act, the principal purpose of which was to ease certain aspects of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which Congress passed in 2010 following the 2008 financial crisis. The Act also amended section 3(c)(1) of the Investment Company Act to allow funds smaller than $10 million to have up to 250 investors.
The increase in the number of permitted investors improved circumstances for 3(c)(1) funds in two ways: 1) it helped get more capital to early-stage companies; and, 2) it allowed more accredited investors to allocate smaller amounts of capital to a potentially lucrative asset class.
But the $10 million fund cap remains highly problematic. First, funds of less than $10 million are too small to have a meaningful impact on the diversity of entrepreneurs who secure financing. Moreover, funds larger than $10 million are still subject to the 100-investor limit.
The Expanding American Entrepreneurship Act would address this problem by expanding the parameters of the 2018 subcategory change to section 3(c)(1). First, the bill would quintuple the cap on permitted funds from $10 million to $50 million — still small by modern fund standards, but providing emerging funds managers significant additional capacity to invest in a more diverse range of entrepreneurs. Second, the bill would raise the number of permitted investors from 250 to 500, keeping the contribution of individual fund participants comparatively small, meaning that more accredited women investors and investors of color could participate.
Together, the higher fund cap and higher number of permitted investors would promote greater diversity among investors and emerging fund managers — and, therefore, more investment in women founders and entrepreneurs of color.
Thriving entrepreneurship is the essential pathway back to the strong economic growth, job creation, and opportunity expansion the American people need and deserve — particularly following the impact of the COVID-19 pandemic. And yet entrepreneurship in American has been in decline in recent decades. Revitalization of American entrepreneurship requires much higher rates of participation by women and entrepreneurs of color.
The Expanding American Entrepreneurship Act is a critical public policy step toward that goal.
John Dearie is the president of the Center for American Entrepreneurship