For nearly a century, companies raising money from investors were not allowed to advertise. The rules go back to the Securities Exchange Act of 1934, created after the stock market crash. The goal was to protect investors by requiring clear financial information.
That changed in 2012 when Congress passed the Jumpstart Our Business Startups Act (JOBS Act), signed by President Barack Obama. Title II of the law allows for companies to advertise their private placement offerings, both debt and equity, to potential investors, often online.
The idea sounded logical. If more people see the opportunity, more people might invest.
“You would think that advertising would broaden the market, and firms would be able to raise more capital,” said Professor of Finance Anup Agrawal.
The data showed something different. Agrawal’s recent paper, “Does General Solicitation Improve Access to Equity Capital for Small Businesses? Evidence from the JOBS Act,” published in the Journal of Financial and Quantitative Analysis, compares private companies that advertise their private offerings with those that do not. He, along with co-author Yuree Lim of Texas Woman’s University, looked at five measures of success:
• How much money the company raises
• The extent to which the fundraising effort succeeds
• Whether the company eventually gets venture capital funding
• How many rounds of venture capital funding it receives
• Whether the company eventually goes public or gets bought out
On every measure, companies that advertise perform worse.
“We find that if they choose not to advertise… they do better in every dimension,” Agrawal said.
Why would advertising hurt? Agrawal says it appears to send the wrong signal. Investors might think if this deal was so good, it wouldn’t need to be advertised in the first place.
Private investing is already risky and many of these companies do not have long financial histories. As Agrawal puts it, investors are sometimes giving money to “a black box.” Because of that risk, investors generally prefer to back local startups they can keep tabs on. Online ads may reach more people but carry less personal connection and trust.
Plus, firms that advertise their offering need to verify that each investor who invests in the offering is “accredited” per the SEC’s definition. Such verification is a cumbersome and expensive process.
There are two exceptions. Advertising seems to help (1) new companies entering this funding market for the first time, and (2) firms that use registered brokers because they, “owe a fiduciary duty to their investors,” Agrawal said. This adds credibility.
Title II took effect Sept. 30, 2013. Agrawal said companies tried it right away and then it tapered off. Most firms raising private capital still choose not to advertise.
The findings are surprising. Advertising usually helps sell products but in private investing it may do the opposite. Sometimes, saying less says more.