Fraudulent private equity was a key driver in the Great Depression. The SEC was formed out of this crisis and one of the first things it did was outlaw all private equity investing and sales. But, without private equity investing, startup companies can’t survive. So, the SEC put in place the standards for private equity investing in 1933, which was amended in 1934. At the time, one million dollars in 1934 was fabulous wealth. That number did not change until 2008, when in the Great Credit Contraction, the SEC acted to remove the primary house from the individual’s net worth calculation. In short, the country minted “angel investors” for almost 80 years without a change in the requirements.
With the JOBS Act of 2012, Congress mandated the SEC lift long standing restrictions on the sale of private equity and crowd funding was born. Initially, the SEC resisted the desire to make changes to the traditional definition of an accredited investor. But, it seems obvious that some changes are coming. And, they will be good and bad.
- Increase in the monetary thresholds from on million to two and a half million in network.
- New classification for “sophistication” investor designated as an accredited investor.
- Crowdfunding for nonaccredited investors
- Under $100k, 2% of income
- Over $100k, 10% of income
4. Crowdfunding for accredited investors will remain the same, but additional verification of your status may be required.
The challenge with allowing nonaccredited investors is simple. First, no company wants 1000 $2000 investments. The amount of time spend on shareholder relations is directly proportional to the number of shareholders if not geometrically greater. Large, sophisticated shareholders rarely bring action against a company. And, if they do, there is a good reason. However, small shareholders tend to be not sophisticate shareholders and thus, the squeaky wheel. 1000 squeaky wheels is the death of an otherwise healthy company.
Second, Venture capital will not touch a company with more than 10 nonaccredited investors, especially if they are not founders, friends, or family for the reason outlined above. They perceive each and every non-accredited investor as liability of the company if a nonsophisticated investor was to become disenamored with the process or finds the need to liquidate their holdings prematurely and try to demand repayment of their investment. And, with the new crowdfunding rules, which expose the INVESTOR to legal liability in the event a mistake is made, the liability is increased.
If a company elects to pursue crowdfunding, they will not be able to access the vast majority of traditional angel or venture capital and thus severely limit their future funding options, which is never a good idea.
So, this begs the question, are we creating a new Chasm (a la Moore)?
Be assured, changes are coming. Be prepared. The Angel Capital Association and others are fighting to maintain the status quo for traditional angel and venture capital. Our Congressional Leaders and the SEC should recognize that private equity is absolutely critical to our economy. This is THE source of job growth in our economy. Fraud in this market is extremely rare and the investors tend to be sophisticated..the two are directly related! Don’t shoot the golden goose in the name of protecting the public.
This is the highest performing asset class in the market and for good reason, low regulatory oversight and a true market economy. You can’t have high rewards without high risk. In other words, you can’t prescribe public sector investor concepts or practices on this market. They are different beasts. And, more regulatory oversight and hurdles in the way of startup companies is just one more barrier to success for the startup.
Copyright Eric L. Dobson, 2016