Will Angels Lose Their Wings?

Shriram Bhashyam
Jul 2nd, 2014
The SEC is due to review the definition of accredited investor ("AI") this summer. The results of that review could lead to big changes, including raising the bar for qualifying as an accredited investor, which would disqualify many current angel investors from investing in startups. In this post we anticipate what the SEC will be looking at when it revisits the accredited investor criteria. Note: this post is based on a our recent white paper (available below) that goes into greater detail on this topic.

Most startups raise capital through private placement transactions pursuant to the SEC's Regulation D ("Reg. D"), and in practice, investor participation is limited to those who qualify as an AI.  So, angel investors must generally qualify as AIs. The Dodd-Frank Act requires the SEC to review the AI standard this summer and every four years thereafter.

In our latest white paper, we anticipate what the SEC will consider in its pending review, which will be a strong indicator of changes to come for the AI standard.  Currently, for an individual investor to qualify as an AI, she must either have $200K in income each of the last two years (or $300K with her spouse), or have a net worth (excluding the value of her primary residence) in excess of $1 million. These thresholds were established in 1982 and have remained largely unchanged since then. What might the SEC look at?
  • Whether the income and net worth thresholds should be adjusted, for example by indexing for inflation. By some measures this would decrease the number of qualifying investors from the current 8.5 million to 3.7 million, dramatically limiting the pool of investors available for startups to raise capital from.
  • The SEC ought to also consider other proxies for investor sophistication. Income and net worth are rather blunt instruments for determining investor sophistication. For example, why not allow relevant certified professionals, such as CPAs and CFAs, to automatically qualify as AIs?
Here are a few more interesting data points from our white paper:
  • Most private placements are conducted pursuant to Rule 506 of Reg. D. An SEC study based on Form D filings made in 2009 and 2010 reveals that of issuers claiming a Reg. D exemption, 55.4% issued securities under Rule 506, 21.1% issued securities under Rule 504, and 19.4% issued securities under Rule 505.
  • The accredited investor standard has been relatively untouched since its adoption in 1982 as part of Reg. D. Since its adoption in 1982, the accredited investor standard has been twice amended. In 1988, the joint income threshold of $300,000 was introduced. The standard was last amended in 2011 (taking effect in 2012) pursuant to Dodd-Frank Act, which required that the value of one's primary residence be excluded from the calculation of net worth.
Check out (and download) our full white paper here.

We'll be closely watching progress on this review and the subsequent report to Congress, as it can have vast ramifications for the startup and VC ecosystem. Stay tuned. 
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