66 posts categorized "Accredited Investor Definition"

ACA Webinar on Accredited Investor Definition and Established Angel Group Certification

I've just listened to an archived recording of an excellent webinar presented by the Angel Capital Association last week (I had intended to listen in real time, but got pulled away): ACA Webinar on Accredited Investor Definition and Established Angel Group Certification.

Presented by ACA Executive Director Marianne Hudson and ACA Chair David Verrill, the hour long webcast covers how the accredited investor definition might change (and how that might impact the startup investing ecosystem) and what the Angel Capital Association is doing to facilitate the transition to the brave new world of general solicitation.

The chief initiative of the ACA is the "Established Angel Group" certification program, which is designed to help issuers implement the "principles based method" in satisfying the heightened accredited investor verification burden under new Reg D Rule 506(c) (which allows general solicitation). The Established Angel Group (or "EAG") certification program has potentially broader implications as well - for instance, if the accredited investor definition changes to put more weight on, or define an alternative path to accreditation based on, investor sophistication, the EAG could be important for purposes of both Rule 506(b) and Rule 506(c).

Inside baseball stuff, I know, but if you're interested in the history of how it came to be that only high net worth people were allowed to invest in startups, how that situation was seemingly democratized (somewhat) by the 2012 JOBS Act, and the rearguard action of state securities administrators and others to put a lid on the reforms, giving an hour of your time to this webinar will help fill you in.

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.

If it ain't broke, don't fix it

Incredibly, there are interest groups in the US who are taking advantage of a provision in Dodd-Frank to try to throttle angel investing.

CaptureFor context, see this excellent press release put out today by the Angel Capital Association.

Here's the money quote:

“'We appreciate the importance of regulation to protect investors from fraud, however regulations need to be focused in areas with a proven need for added oversight.  The angel investment asset class has experienced very little fraud, because angel investors have strong processes for due diligence and investment terms, and ongoing entrepreneurial support,' said Marianne Hudson, ACA’s executive director."

As the SEC revisits the accredited investor definition, there should also be opportunity to bring some non-financial criteria to the definition, hopefully as alternatives to the income and net worth thresholds. But the financial criteria have, in effect, over time, been permitting more and more citizens to qualify as accredited. This is democractic and investor protection has not suffered. Arguably, investor protection has improved because of the expansion of angel investing.

Photo: "Banksy Bullet Proof Angel in Great Eastern Street London," Cyberslayer / Flickr.

Three longer reads for where we are after General Solicitation Day

We are now living in the second day after General Solicitation Day. All trying to take stock of what has happened, and how the landscape is different.

And there is no shortage of media coverage! (Here, from a news angle, is a good overview from the Wall Street Journal: General Solicitation Brings Startups Capital, Risks. I was interviewed for this article and love the quote they got from me: "The government is doubling down on the idea that accredited investors can fend for themselves.")

PhotoBut today I wanted to call out three different, longer-form pieces of writing, each published within the last week. Each, in a different way, lends a deeper perspective on where we in the startup financing ecosystem are now.

Each will be a reference piece in the weeks and months to come.

1. Paul Spinrad's take on where we are, how we got here, and how all the different pieces fit together.

Here is an article that Paul Spinrad published on a PBS website: Online Platforms Give the First Public Look at Private Equity. As I said on Twitter yesterday, Paul's is the best written, broadest article yet on general solicitation and the changes to private financing rules.

Among the delights of Paul's well written survey are: an explanation of how public offerings came to be squeezed into a private exemption framework; the balance or contrast of considerations when approaching policy for accredited and non-accredited crowdfunding; and how private equity platforms are rolling out new features to facilitate the new rule set.

On Monday in GeekWire, I tried, not very effectively, to point out some of the new features on some of the leading online platforms. Paul's take on the same topic is far more accomplished. And that topic is only one facet of his survey.

2. Trent Dykes', Megan Muir's and Kiran Lingam's whitepaper on do's and do not's at demo days and pitch events.

This one, Demo Days, Pitch Events and the New Reg D, is controversial. I've had an earful from several people already on how this whitepaper may get one or another thing wrong.

But I greatly admire the ambition and timeliness of it. The question that the rest of us hem and haw about – am I automatically generally soliciting if I show up at a demo day or pitch event? - they tackle.

Whether or not you agree with the protocols and checklists they lay out, Dykes, Muir and Lingam are calling out the right factors to consider and giving laypeople the means to educate themselves about general solicitation.

3. The Gunderson law firm's comment letter to the SEC on the proposed Reg D rules.

This is a letter published on the SEC's received comments page, signed by a Gunderson partner, Sean Caplice.

There are a ton of comment letters on the proposed rules, none too few from big law firms.

What's remarkable about the Gunderson letter is that it provides answers to all 101 "requests for comment" posed by the SEC in its proposing release.

Most commentators either cherry pick which of the SEC's questions they want to answer, or skip the agency's questions altogether and comment from the perspective of the commentators' own agenda or frames of reference. For tackling all 101 requests for comment, and for that reason alone, I think the Gunderson comment letter is a touchstone. (Kudos to Joe Wallin for pointing the letter out to me.)

Thoughts on yesterday's SEC webcast

First of all, let's be clear that yesterday's meeting was not a meeting of the commissioners of the Securities and Exchange Commission.

It was, instead, a meeting of an advisory group to the SEC.

And so, necessarily, there could be no important votes taken, no new rules authorized, nothing as momentous for startup and emerging company financing as the July 10 meeting of the Commissioners, when two final rule sets were approved and a radical new rule set was proposed.

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But the meeting was important. The advisory committee was there, key SEC staff were there, an important state securities regulator was there.

And so many of the right policymakers were either there in person or represented, and got the benefit of hearing David Verrill, Chair, and Marianne Hudson, Executive Director, present, on behalf of the Angel Capital Association, an excellent overview of how important angel financing is in the startup financing ecosystem and to America's overall innovation economy.

Yes, it continues to be important to educate policymakers about some of the things those of us in the startup financing ecosystem take for granted.

I understand from Jean Peters that the ACA slides presented yesterday will be posted to the ACA site. I'll try to remember to link to that when I see it.

The most dramatic moment of the meeting yesterday was when Catherine Mott (pictured above), a member of the advisory group, former Chair of the ACA, and angel investor, asked the staff whether demo days and pitch events - common features of today's startup financing ecosystem, ostensibly okay in the past under old 506 - constituted general solicitation.

I was going to write that Mott asked the question "pointedly." But that would be misleading. Mott is one of those fearless individuals who disarms others with unfailing politeness and charm.

When she did not get a straight answer to her question, Mott persisted. It is exactly the right question to ask, of course. Come September 23, people are going to need to know what box to check: 506(b) or 506(c). So they necessarily need to know what "general solicitation" is, or what activities which today are ostensibly under 506(b) will transfer over to 506(c).

At the same time, you can understand staff reluctance to opine on this matter. They cannot tacitly admit, I don't think, that the current prohibition on general solicitation in Rule 506 offerings is being flaunted. (Which it is.)

Joe Wallin, Doug Cornelius, Lori Smith and I were live blogging the meeting. See the transcript here.

Joe went absolutely nuts with delight when Mott pressed her question. You can see his almost real-time summary of the exchange at minute five of this video. (Yes, Joe was doing double duty, liveblogging on my blog and at the same time participating in Broc Romanek's Spreecast on Reg D!)

Reuter's article on Startupequality.org's letter to the SEC

Yesterday's Reuters article by Sarah N. Lynch aptly summarizes both the point and the context of Startupequality.org's petition to the SEC.

6a01156e3d83cb970c019aff4dd4d9970dLooks like Reuters attempted to get the SEC to comment, for the journalistic record, on the petition. But the article says that an SEC spokesperson declined.

It does, however, looks like the spokesperson may have pointed out the strictures on the SEC's ability to modify the accredited investor definition, strictures imposed in 2010 by Dodd-Frank.

Question for us: is there anything in Dodd-Frank that would keep the SEC from tweaking (reporter Lynch's verb; I like it) the accredited investor definition by providing an express definition for the term "spouse," as used in the accredited investor definition? One might presume that the agency would be required to do some tweaking or clarifying, in light of the Supreme Court's ruling in Windsor.

What I find, reaching back to Section 413 of Dodd-Frank for the legislative stricture, is that the new net worth standard of the accredited investor definition (imposed by by Dodd-Frank) is grandfathered for four years.

I believe the SEC can indeed legally consider how to remedy the unlawful discrimination in the accredited investor standard. I believe the US Constitution requires that it do so.

Same-sex relationships and angel investing

Encouraging to see the US Treasury Department and the Internal Revenue Service rule "that same-sex couples, legally married in jurisdictions that recognize their marriages, will be treated as married for federal tax purposes."

"However," the government press release goes on to state, "the ruling does not apply to registered domestic partnerships, civil unions, or similar formal relationships recognized under state law."

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We took a different approach for StartupEquality.org. For purposes of ending discrimination against gay, lesbian and transgender persons in the rule set for angel investing in the United States, we propose that domestic partnerships, civil unions, and similar relationships recognized by state law should count. 

Here's the regulatory recommendation submitted today to the SEC by StartupEquality.org:

A spouse of a natural person shall mean another person, regardless of gender or sexual orientation, whose relationship with the person specified: (1) may be characterized as such person's (i) husband, (ii) wife, (iii) spouse, (iv) domestic partner, or (v) designated beneficiary under any applicable state law for the purpose of ensuring that each person in a two-person relationship has certain rights or financial protections based upon such designation; or (2) is that of the other party to a civil union with such person.

The recommendation is part of a comment letter signed by 58 people who are, in the words of the petition, "business persons; members of angel groups, trade associations and advocacy groups; partners and associates of venture capital funds; startup founders; individual angel investors; and other persons interested in the health and vibrancy of America's startup ecosystem."

The comment letter has been submitted in connection with the SEC's open call for public comment on changes to Regulation D, which is the foundational rule set for the startup financing ecosystem in the United States.

One thing the StartupEquality.org petition might have done, but didn't, was cover the point covered in the Treasury/IRS ruling - namely, that a valid marriage for purposes of the accredited investor definition stands up, regardless of the law in the jurisdiction in which the given investor resides. But I am glad we chose to say that civil unions, domestic partnerships, and similar relationships should count.

I'll update this post when the comment letter is posted to the SEC site. It usually takes a few days.

Update 09/05: the letter is up on the SEC site already! Here is the link.

Photo: King County, WA / Flickr.

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