The definition of an accredited investor is of paramount importance to angel investing. The Securities and Exchange Committee has been considering changes to the definition. The problem is if the SEC makes the requirements more stringent, they will reduce the amount of capital available to early stage companies.
Here’s a brief primer and explanation of why this is so important.
During the midst of the great depression, Congress passed the Securities Act of 1933. This act set for the basic framework governing securities sales. Under this law, all companies selling securities must register them with the Securities and Exchange Commission, unless an offering qualifies for an exemption. Registration is a long and expensive process and simply not feasible for most early stage companies. Therefore, most sell their securities under one of the available exemptions.
One such exemption is the private offering. The 1933 Act provided an exemption for transactions “not involving any public offering.” However the act didn’t define what was a private offering. In 1953 the Supreme Court ruled “An offering to those who are shown to be able to fend for themselves is a transaction ‘not involving any public offering.’”
So who is able to fend for themselves? The SEC adopted Rule 506 of Regulation D, which allows for sales to “accredited investors” that do not involve “general solicitation.” The assumption is that if an investor has sufficient wealth, he or she does not need the protections afforded by registration with the SEC.
The SEC defines an accredited investor under Rule 501. “A natural person who has individual net worth, or joint net worth with the person’s spouse, that exceeds $1 million at the time of the purchase, excluding the value of the primary residence of such person” or “a natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year.”
In 2010 the Dodd-Frank Act in 2010 required the SEC to periodically review its definition of an accredited investor. It has not yet done so, but has asked its Investor Advisory Committee to make recommendations. Over the past six months there has been much discussion as to whether the definition should be revised. One of the proposals was to index definition to inflation, the result of which would be to decrease the pool of eligible accredited investors from about 50%.
My own view is that this is a solution in search of a problem to solve. And I believe we need more angel capital, not less. I support the Angel Capital Association view that the definition should focus on financial sophistication of the investor, not an arbitrary net worth level.
Happily, on October 9, 2014 the Investor Advisory Committee to the SEC recommended that the SEC consider adopting rules that would enable individuals to qualify as accredited investors based upon their financial sophistication, but did not recommend changing the net worth level at this time.
The above was originally published in the October 22, 2014 issue of the Business Insider, the business magazine of the Idaho Statesman