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Abstract

Unlike traditional regulatory approaches applied to Wall Street-style transactions, seed financing in Silicon Valley has developed with benign neglect from lawmakers; meaning that securities laws were out-of-sync with the financings but regulators ignored enforcement of violations. Meanwhile, seed investors have achieved fraud prevention, a smoothly functioning market, and other policy objectives in different ways. Now that the explosion of startup financing has garnered the attention of the SEC, we argue that regulating seed financing should differ from the methods used in larger, traditional financings, otherwise compliance costs will severely impede financial activity without improving investor protections. Although the federal government made a great leap forward in passing the JOBS Act and issuing no-action letters beneficial to seed financing, a host of regulatory barriers and ambiguities still remain. This article does not recommend specific regulations, but does recommend seven principles that are important in funding innovative-technology markets, where the markets are defined by high levels of asymmetric information and small transaction amounts. These principles should guide regulators and lawmakers as they consider how to encourage more small-scale financing of innovation, without introducing new opportunities for fraud or creating bad experiences for investors and companies.

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