Editor’s note: Investor and entrepreneur David Gardner is founder of Cofounders Capital in Cary and is a regular contributor to WRAL TechWire.
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CARY – I have been following with interest the current debate over the definition of an “accredited investor.” The SEC mandated this year a reexamination of how investors are accredited. The full video from earlier this month of the latest House Financial Services Hearing on the limits of the accredited investors definition can be watched here.
The Current Definition and Why It Matters
At risk in this debate is literally who can invest in an early-stage company and who can entrepreneurs accept investment dollars from. For years the definition of an accredited investor has been anyone making over $200K per year ($300K with spouse) or having over a $1M net worth excluding one’s primary residence. If you meet this definition, an entrepreneur can accept your investment without unreasonable fear of being sued should the investment not turn out well.
David Gardner (Cofounders Capital photo)
Why an Accredited Investor Definition is Needed
The world is full of bad actors, snake oil salesmen and get-rich-quick scams. That uncle in Nigeria must have received enough money by now…right? Unfortunately, such ruses can be disguised as legitimate startup opportunities and the elderly are often the targets of such scams. The Securities and Exchange Commission (SEC) has many regulations to protect investors from scams where public stock is concerned but private offerings are not required to adhere to those SEC reporting requirements.
The accredited investor definition was created in part to protect seniors from being scammed out of their life savings by requiring certain income or asset levels. It assumed that higher income and financial sophistication come together which is itself a loose correlation at best.
The Proposed New Definition
Proponents of a definition change argue that the current definition was set over a decade ago and considering inflation is in effect a much lower threshold today. They argue that a $5M net worth requirement is needed today. Pat Gouhin, the president of Angel Capital Association (ACA), told me that such a change would significantly hurt startups and innovation in general on a national scale. Such a change could disqualify as many as half of the current ACA members and create an even larger funding gap for startup entrepreneurs. Like leaders in the National Venture Capital Association, Gouhin argues that wealth and investing sophistication should never be linked together. To his point, I know several venture capitalists managing early-stage funds that would not meet such a definition but who are obviously very sophisticated professional investors.
A Better Way to Protect Investors
Those closest to the debate who understand startup ecosystems argue that there is a far better way to protect the public and avoid hurting startups and innovation. Investors could be required to pass a test or gain a certification in the basics of venture investing. It is unlikely that grandma would give a scammer a quick check if she had to pass a test first! Investors could also be required to be an active member of a recognized angel investor group that provides educational classes and debates such investment opportunities. Most importantly, legislators need to remove the wealth/income test from their accredited investor definition altogether.
Conclusion
It has always seemed odd to me that the government does not seem to have a problem allowing the public to go to Vegas to gamble away life savings but they feel compelled to vigorously protect the public from early-stage investing. It is important to note that investors often do so with more than financial return goals in mind. I have personally invested in local breweries, hotels, kombucha and other main street ventures while fully knowing that there were more lucrative opportunities available to me but I wanted to invest where I live and see those types of businesses succeed in my community. Government should learn from the rule that doctors are taught early in their training…” first and foremost, do no harm.”
