Wall Streeet: The Entrepreneur's Worst Friend
Redburn, Thomas
Wall Streeet: The Entrepreneur's Worst Friend by Thomas Redburn What this country needs is a central financial marketplace (in, say, New York City), where businessmen with good ideas but no...
...The big debate on our board was whether to find some industrial corporation that would buy a substantial share or whether to go the venture capital route...
...If you think we already have such market-on Wall Street-you’re crazy...
...Rather than a dynamic marketplace, the New York Stock Exchange has become a multi-billiondollar paper chase, providing the wellcapitalized firm with more capital than it can use profitably, while denying the undercapitalized firm the resources it needs to grow...
...New ventures are inherently risky investmentsmany of them fail, and it is usually the individual investor, the little guy, encouraged by the brokers to purchase overpriced growth stocks late in a bull market, who takes a bath...
...You see, once you accept these venture capital groups, you are pretty much committing yourself to sell out to a big company so that the investors can get some liquid assets, money they can spend...
...These entrepreneurs don’t have enough retained profits to invest, they can’t sell bonds, and won’t get government handouts...
...In developing a new technology, it is the small companies which usually lead the way...
...Wall Street has been in one of its manic up-phases ever since...
...The institutional investors that dominate the market invest nearly totally in a relative handful of glamorous blue-chip stocks, like IBM, Only when the market enters a wild, speculative period does money flow to less secure investmentsthe kind that attract the gamier instincts of individual investors...
...If not, they die a quiet death, and no one worries about finding a government-guaranteed loan to keep them solvent...
...Bill Simon, for example, spent the best years of his life on Wall Street and would hate to see the old girl go under...
...It’s a pretty close-knit fraternity and they always want to bring their friends in on a deaL All the groups want representatives on the board of directors, and you end up with a board heavily skewed toward financial people...
...Thomas Redburn is a contributing editor of The Washington Monthly...
...Even as he was attacking a bail-out for New York City, Simon was drafting a rescue plan for Wall Street in the form of new tax breaks for stock market investors...
...Since they would be helping the economy as much as themselves, investors in such new issues should have a special, low-rate tax on the income they receive from the sale of shares in a successful new business...
...But investment in new issues is high-risk, and it would be equitable to offset this risk by a tax benefit...
...By applying it to the capital gains tax, the government could go a long way toward making the stock market actually serve the function which its apologists claim for it...
...Xerox, Polaroid, Hewlitt-Packard, TRW, and Texas Instruments are all recent examples of companies that started small and grew fat and profitable by developing a useful product or service...
...But it is important to anticipate some of the ways by which it could be manipulated...
...they need at least that much just to grease the wheels so that their seven to ten per cent amounts to something...
...There aren’t that many choices for a relatively new company looking for capital,” says Dell...
...This is bad for the businessmen , but more important, it is bad for the rest of us, since these smaller businesses play an important role in encouraging the innovation and competition necessary for economic growth...
...So the Combustion Power Company is now a division of Weyerhauser, a huge lumber combine...
...Brokers are certainly getting rich on the new bull market...
...The result is that the companies with proven track records absorb most of the investment money...
...He went into business in 1969, and he wanted to make it on his own as an independent businessman...
...Unless the new bull market lasts for several years, the situation isn’t likely to change, for the dilemma that haunts the entrepreneur is that new issues are the last to benefit from a favorable market...
...So a tax incentive for only the original purchasers might be just as unfair as the present pattern...
...If they are successful, they become big companies...
...Not surprisingly, this inefficient capital market has fallen on hard times in recent years, causing the friends of Wall Street considerable distress...
...At the very least, such a system would encourage more new issues and stimulate entrepreneurship...
...If we could have gone public back in 1970, the original investors would have been in a position to become liquid...
...Wall Streeet: The Entrepreneur's Worst Friend by Thomas Redburn What this country needs is a central financial marketplace (in, say, New York City), where businessmen with good ideas but no capital can sell shares of their businesses to the public: The market (let us call it a “stock exchange”) would encourage the transfer of idle savings accumulated by the public into investment in the most efficient and creative new companiesand thereby provide a continual burst of energy for the economy in the form of new jobs, new techniques, new products...
...So far we’ve been able to raise enough money from private investors, but we’ve now reached the stage where we need to find Deoule willing to invest $200,000...
...Rather than a source of new capital for exciting, productive new ventures, Wall Street bas become a place where shares of old, already capitalized firms are traded back and forth...
...Yet huge sums are tied up in speculating about tenths of percents in the quarterly earnings reports of these giant corporations, while the Edisons, Bells, and Fords of the future struggle along without adequate capital to turn their ideas into salable products...
...And they also want preferred stock, giving them a position over and above the original investors in the company...
...In many cases these stocks are then sold to individual investors, who assume the primary burden of risk...
...But they are capable of generating capital from their own retained profits, from bonds and from government financing in the form of guaranteed loans and defense contracts...
...Take Bill Dell, head of the Combustion Power Company...
...But after several years of attempting, and failing, to raise sufficient capital, he found that the only way he could keep his company afloat was to sell it to a capital-rich conglomerate...
...We raised $1.75 million that way...
...It bears almost no resemblance to our hypothetical “stock exchange...
...Or, more probably, you’ve been paying too much attention to Treasury Secretary William Simon, the Securities Industry Association, and others who promote the traditional mythology of Wall Street: that it is the backbone of the free enterprise system, the friend of the struggling entrepreneur, the source of new capital for new ideas, the engine of efficient economic growth...
...We needed a couple million dollars if we were going to get off the ground...
...If you are unable to find buyers for your original purchase, you are unlikely to invest in new issues, regardless of the tax incentive...
...On the other hand, a good solid company that needs some money to produce an important product, but can’t promise to be the next Xerox, is in real trouble...
...By far the greater part of the exchange business is now in second-hand dealing in paper representing finance that was invested long ago...
...The companies just entering the market depend almost exclusively on speculative booms...
...To disguise the we1 fare-f or-stock br okers aspect of his proposals, Simon has referred to them as remedies for a vaguely defined “capital shortage...
...We should remove the capital gains tax break for normal trading of stock, but retain it exclusively for new ventures...
...But anyone who assumes that the economy as a whole is benefiting should think again...
...In effect, the market is operating on a trickledown theory...
...They have no place to turn if the stock market is closed to them...
...And the more you grow, the more difficult it is to find the capital to sustain that growth...
...Dell explains the psychology of some venture capital groups that are designed to invest in young, promising companies...
...Generally the first buyers of new issues are the professional traders, who acquire them in the hope of making a quick and substantial profit on the resale...
...churning up commissions for brokers, to be sure, but doing very little for the rest of the economy...
...Two years went by and our backers started getting anxious to see some real money...
...He had a good, socially useful product: research and development of pollution control equipment...
...To raise money on a major exchange the brokerage houses expect you to capitalize at least $5 million or it isn’t worth their trouble...
...The function of such a market would be so important that a sensible government would consider giving a special tax break to people who are willing to take a risk on a good new business by buying its stock issues...
...Instead it is an overgrown, top-heavy, monopolistic old industry-dying of its own inefficiency as surely as the shoe manufacturers of New England...
...Our tax system ought to reflect this principle: he who takes the risk should get the reward...
...Investors would be rewarded for contributing to true investment instead of for investing in second-hand stocks...
...but when you can’t sell new issues, there isn’t any other route but to sell out to a big company...
...But in January Simon was back with a new scheme, which would offer a tax break only to those poor souls earning less than $40,000 a year...
...Even worse-all these venture groups talk to each other...
...But there isn’t much choice...
...We’ve talked to brokerage houses about going public, and we probably could find a local exchange, but that tags you as a Mom-and-pop operation...
...The founder of the company, Joseph Lindmeyer, worked at COMSAT as director of the physics lab...
...Their goal is to double their money in five years or so...
...They’re always happy to talk to a company that has an explosive growth potential...
...It isn’t that money shouldn’t be invested in large corporations-they do occupy a central place in the economy and deserve a fair share of the capital wealth of the nation...
...If you are a company stuck somewhere between $1 million and $5 million, it’s difficult, very difficult, to find money...
...One such company is Solarex, which is in the business of making solar cells to produce electricity...
...New issues are also dependent on an orderly market for the resale of stocks...
...Such a pattern, of course, has a great deal of logic behind it...
...What about the new company that isn’t willing to sell out, one which was founded by people who were sick of working for a giant corporation...
...In 1970, Dell explored the possibility of going public, but after a sudden downturn in the market, brokers refused to handle the issue...
...Wall Street should be helping along a new generation of innovators, but interviews with several businessmen suggest that it isn’t doing the job...
...The alternatives were pretty stark...
...Solarex hasn’t had much trouble raising sufficient capital-yet-but Anthony Clifford, their financial officer, talks about some of the problems a company like Solarex faces in finding capital with which to grow: “A company like ours has to maintain a strong growth record...
...Once you get past the first stage of raising money from friends and relatives, it gets pretty tough...
...The income from normal trading of stocks-the paper chase-is usually low-risk, and there is no reason why it should be given preferred treatment over “earned” income from wages and salaries...
...He was involved in developing solar cell technology there but felt that the best way to reduce the cost and advance the technology would be to form his own company...
...And, rather than encouraging risk-taking, the tax break for capital gains (whereby “unearned” income from sale of stock is taxed at half the rate of “earned” income) merely encourages the paper-shuffling, commissionchurning waste of the present system...
...His first proposal, to end the “double-taxation” of dividends, was so riddled with inconsistencies (see “The Capital Crisis: Crying W-olf on Wall Street,” The Washington Monthly, November 1975) that it was withdrawn...
...Thus, a reformed capital gains tax would require a healthy national stock exchange with continued trading in established stocks...
...Unfortunately, the stock market, as currently constituted, is nothing of the sort...
...The “venture capital route’’ isn’t as smooth (or as likely to maintain a firm’s independence) as it sounds...
...Businessmen who have good ideas but no capital are not being helped by Wall Street even in this expansive phase...
...This reward for risk-taking might be called a “capital gains tax...
...By encouraging investment in new issues, a reformed capital gains tax might solve that paradoxical problem of the 1970s: how to pry capitalism loose from the deadly embrace of Wall Street...
Vol. 8 • March 1976 • No. 1
