Let’s Open Up Angel Investing’s Country Club Rules

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In one of the greatest movie scenes ever, Carl Spackler (played by Bill Murray) asks Ty Webb (Chevy Chase), “You got a pool over there?” To which Chevy replies, “We have a pool, and a pond. The pond would be good for you.”

The relevance of this scene to the startup community? Well, this is how angel investing works today. The average guy–Carl Spackler? Can he go for a swim in the pool of angel investing? No, he has to swim in the pond, with the “natural spring.”

In all seriousness, do you want to become an angel investor? If you do, you have to qualify for the country club’s rules–$1M net worth, excluding your primary residence, or $200K in income or $300K with spouse in each of the last 2 years with the expectation of the same this year. This is how almost all angel investment rounds work.

Why is this? Because this is how Regulation D promulgated under the Securities Act of 1933, as amended, defines the term “accredited investor.” Why does this definition matter? Because almost all private companies limit their securities offerings to “accredited investors” only, so that they can qualify for the “safe harbor” afforded by Rule 506 of Regulation D and not have exhaustive (SEC registration level) disclosure obligations to prospective investors (The rule as described by the SEC: “Companies must decide what information to give to accredited investors, so long as it does not violate the antifraud prohibitions of the federal securities laws. But companies must give non-accredited investors disclosure documents that are generally the same as those used in registered offerings.”)

Is this a good public policy, to limit “accredited investors” to only those who meet these strict financial thresholds? To make it harder for startups to raise capital? Do we really need the federal government to make it harder to invest in startups? To make it harder for startups to raise capital? I don’t think so. I think that given the key role startups play in job creation in this country that the Congress ought to be making it easier for startups to raise capital.

The Dodd-Frank bill went in the wrong direction, putting a significant crimp in who qualifies as an angel investor–precluding wealthy individuals from including the value of their primary residences in the net worth definition–unless the primary residence is upside down in which case the home has to be deducted from net worth. This means that owning a primary residence can only count against you in determining whether you are accredited! In my mind, an absurd result, but absurdity and the law go hand in hand, it appears.

And it gets worse. The Congress has directed the SEC to:

[U]ndertake a review of the definition of the term ‘‘accredited investor’’, as such term applies to natural persons, to determine whether the requirements of the definition, excluding the requirement relating to the net worth standard described in subsection (a), should be adjusted or modified for the protection of investors, in the public interest, and in light of the economy.

Increasing the financial thresholds to qualify as an “accredited investor” would be, in my opinion, horrible public policy because startups create jobs (but they need to be able to raise capital to do so).

Again, Congress ought to be making life easier for startups, including making it easier for them to raise capital. My radical proposal is that we reduce the financial thresholds down to almost zero. I know, many people will object to this as too radical. That the government has to play a role here. That the Carl Spacklers of the world need protection. My rebuttal–there is protection already in the courts. There is no need to crimp startup company financings in this manner.

Making life easier for startups, and job creation, ought to be our public policy priorities.



About Joe Wallin

Joe Wallin focuses on emerging, high growth, and startup companies. Joe frequently represents companies in angel and venture financings, mergers and acquisitions, and other significant business transactions. Joe also represents investors in U.S. businesses, and provides general counsel services for companies from startup to post-public.
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