Changing the rules for who is allowed to invest in startups

By now, you've probably heard that the SEC is considering making changes to the accredited investor definition.

The definition is important to entrepreneurs, angel investors, and the startups they work on together, because it defines the standards for who is, and who is not, allowed to invest in startups and private emerging companies.

6a01156e3d83cb970c01bb079a0c65970d-580wiRight now, the standards are financial: if you earned more than $200,000 in each of the last two years ($300,000 in the case of a married couple), and have a reasonable expectation of achieving that income level in the current year, or if you have net worth of at least $1 million (excluding the principal residence), then you are "accredited."

It's a bit unnerving that the accredited investor definition is up for reconsideration. There are many voices - among consumer advocacy groups, and among state regulators, to name just two categories - who want the financial thresholds of the definition indexed to inflation. Were this to happen, people who currently meet the standard would drop out of the eligible pool of angel investors.

But it's not as though we haven't had a couple years to prepare for this. A review of the accredited investor definition was mandated by Dodd-Frank. In retrospect, one wishes the subsequent JOBS Act had intervened to make the risk of this upcoming review less potentially perilous. But that didn't happen.

You might be saying to yourself, ah ha, didn't the JOBS Act democratize startup investing, by allowing general solicitation? Good thought, but, perhaps ironically, that liberalization in the rules only made the accredited investor standard that much more important: if you generally solicit and want an exemption under Reg D, then your purchasers must all be accredited investors – no room for a single purchaser who is non-accredited – And you must take heightened measures to verify the accredited status of each of your purchasers.

If you are a serial or parallel entrepreneur, or if you are an active angel investor, you should be concerned about this review of the accredited investor definition.

But the sky is not falling. Not yet. There is time to read up, get educated and get involved in this policy review.

Recently, an investor advisory committee to the SEC, a body which had been formed by Dodd-Frank, made some recommendations to the agency on how to go about changing the accredited investor definition. The recommendations include ideas on how to measure "sophistication" by means other than income or net worth.

The recommendations of this committee are not the same thing as rules proposed by the agency. But these recommendations might fairly be thought of as "trial balloons." The SEC chair, Mary Jo White, was in attendance at the meeting last week at which the committee approved their recommendations. So we know the SEC is listening.

Here are some resources for you to check out on this topic. Most important is the first one, a blog post on the topic by Marianne Hudson, the Executive Director of the Angel Capital Association.

Here also are reactions I tweeted (using Dave Winer's Little Pork Chop app) immediately following the committee meeting webcast last week:

Some observations about the Investor Advisory Committee recommendations on changing the accredited investor definition (having just watched the bulk of the discussion on the topic, via SEC webcast):

first, this topic is of existential importance for startup and emerging company financing – it will impact who is allowed, and who is not allowed, to invest in early-stage companies;

second, Barbara Roper seemed to say that the aim of the changes should be to keep the pool of accredited investors as large as it is today, or, slightly expanded – this is a good thing, though I don't know if that aim can realistically be served if there is a increase in the current financial thresholds;

third, Roper expressed the view that membership in an angel group, following best practices, might satisfy the definition (presumably the Angel Capital Association's CAG, or "certified angel group," would be the standard?);

fourth, there seems to be appetite to institutionalize, or at least study the pros and cons of institutionalizing, third-party verification, for both private and generally solicited Reg D deals;

fifth, much talk of non-financial means of satisfying the accredited investor test (go out and get your Series 7 everyone, if you want to be accredited?), and other ways of measuring "sophistication" in order to participate in private deals.

Picture: Rubblebucket at Chop Suey, Seattle, October 10, 2014.


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