Potential changes to securities laws could decrease the number of households qualifying as accredited investors from approximately 8.5 million to 3.7 million.[1]  These accredited investors are the primary source of early stage capital for startups and small businesses.

If the rules are changed as feared, then startups will find it much more difficult to find early stage investors, thus stifling our startup ecosystem and ultimately killing job creation and economic growth.

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The SEC is currently in the process of revising these laws pursuant to the Dodd-Frank Act and in particular is considering whether the financial thresholds to qualify as an accredited investor should be raised.  Such a change would be devastating for startups.

The Definition

An accredited investor is a person that the SEC deems is sophisticated enough to protect themselves in making investment decisions and therefore does not require certain additional protections under certain securities laws.  Currently, to be an accredited investor as an individual, you must (1) earn $200,000 (or $300,000 jointly with your spouse) in income over the last 2 years or (2) $1 million in net worth (excluding home value).

A Large Increase in the Accredited Investor Dollar Thresholds would be Disastrous

The U.S. Startup Funding Ecosystem is the Envy of the World

Current startup funding markets are the envy of the world, global talent and capital flock to the US startups.  Communities around the world are trying to replicate Silicon Valley in their own countries.  Moreover, angel investor communities are not only active in Silicon Valley, but also in communities across the country (both rural and urban), including the Upstate Carolina Angel Network (Greenville, SC) and New Mexico Angels Inc (Albuquerque, NM).  According to the Angel Capital Association, nearly “one-third of ACA Members in those areas would no longer qualify [as accredited investors].”  The loss of this capital in these areas where traditional venture capital is limited would be devastating to economic growth in these communities across the country.

The Stakes are High

“According to the Center for Venture Research, 70,730 entrepreneurial ventures received angel funding in 2013…  Kauffman Foundation research has established that were it not for new businesses, there would be no net job growth in the U.S. Economy.”[2]

Furthermore, according to a just released report by the European Trade Association for Business Angels, “on average, the employment rate more than triples” for companies that take on angel investments.  “While the average number of employees was five at the time the first angel investment, this figure grew 231% by year three when on average the same companies employed 16.7 people.”[3]

Bottom Line:  Angel funded companies hire often and aggressively for high quality jobs

An increase in the accredited investor thresholds would substantially disrupt the startup funding ecosystem, destroying jobs and the U.S.’s competitive advantage.  Ultimately, such a change could lead to a stagnated U.S. economy and talent and capital being diverted to other parts of the world.

No Tangible Benefit to Increase

At the core of any policy decision is a cost-benefit analysis.  We have not seen any evidence that an increase to these thresholds would have any substantial positive effect on investor protection.

According to the GAO, Investor and industry associations said that “any changes to the thresholds might provide only marginal increases to investor protection” and that “increasing the thresholds would limit capital formation.”

The Wrong Metrics

The definition relies solely on financial metrics and ignores any other factors.  Consider that the following people are probably not accredited investors (i.e. not sophisticated enough to protect themselves):

• Your U.S. Congressman (the annual salary $174,000)
• Your securities lawyer (outside of major markets of NY, SF, LA, CHI etc.)
• Average Harvard Professor ($151,262)
• Federal District Court Judge ($186,000)
• Your stock broker ($131,000)

Some of these people are charged with protecting other members of the public, yet they are not deemed to be able to protect themselves.

The definition is fundamentally flawed by assuming that a person’s wealth or income determines how sophisticated they are.  A person’s experience, knowledge and credentials should be determinative of their need for protection from the government, not how much money they have.

Unequal Treatment under the Law

Additionally, a pure financial standard does not treat all citizens equally.  It ignores cost of living discrepancies across the country.  $200,000 in New York City is a lot different than $200,000 in Houston, TX.  The standard disproportionately excludes people in lower cost of living areas.  People in Houston in the same financial condition should have the same opportunities to invest in startups as people in New York.  Even more stark, the joint marriage threshold (i.e. $300,000 jointly for married couples) inappropriately excludes certain same sex couples.

Generally, in order to invest in private companies, a person must be an “accredited investor.”  People falling outside of the “accredited investor” definition are not allowed to invest in any private companies.  Thus these affected individuals in lower cost-of-living areas or in same sex couples are therefore disproportionately prohibited from participating in the wealth creation occurring in the private markets (see WhatsApp: acquired for $19 billion without ever touching the public markets).

The ultimate goal here should be that the accredited investor definition is refined so that (i) it treats people fairly and equitably and that it is based on real metrics indicating sophistication and (ii) is based on publicly available or non-sensitive information so that people will be comfortable verifying their accredited investor status.

The only way to treat people equally under the law is to look to knowledge and experience based standards.

Knowledge and Experience Based Standards should Prevail

Here are some proposed categories of people who should be deemed by be able to “fend for themselves” and therefore should be added to the accredited investor definition:

• Passing a Test. Individuals who pass a standardized accredited investor test with publicly available test results.
• Advanced Degrees. Individuals holding an advanced degree in business/law related fields (i.e. MBA, J.D., Masters or PhD in Finance, Economics, Business, etc.)
• Professional Designations. Individuals with Professional Designations (i.e. J.D., CPA, CFA, CISP, etc.)
• Securities Licenses. Individuals who hold Securities Licenses (Series 7, Series 63, etc.)
• By Order of a Court, the Commission, a State Securities Administrator or other governmental entity.  An established governmental authority should be able to determine that a person is capable of fending for themselves with respect to investments.  This would allow for more of a real-world practical approach to the application of the definition.

Each of these items is far more likely to indicate financial sophistication versus a blanket financial threshold.  Individuals may have acquired wealth by inheritance or may have saved their entire lives to accumulate $1M in net worth.  Those individuals are no more likely to be sophisticated than, for example, a person with a MBA degree.

Our Recommendation

We’ve submitted a comment letter to the SEC to urge the Commission to:

• Restrain from increasing the dollar thresholds of the accredited investor definition.  If such an increase is required, it must be indexed to inflation starting from today and not retroactively.

• Modify the definition to provide for additional knowledge and experience mechanisms to becoming an accredited investor as described above.

Conclusion

The SEC is currently seeking public comment on these rules and your voice is critical.  Please support the cause by joining our Thunderclap:

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