Dave Neal – VC

Accredited Investor Definition – SEC Proposal – Index Net Worth and Income Requirements to Inflation

This proposal is similar to the SEC proposal discussed earlier. It seeks to address the fact that the income and net worth requirements for an accredited investor have not been changed since 1983. In the previous case covered on this blog the SEC proposal was to take the 1983 numbers for income and net worth and increase them immediately by the cumulative inflation multiplier since 1983. This proposal starts with the original 1983 numbers and suggest that we increase them yearly by inflation.

Obviously, in 1983 $200K-$300K per year in income or $1M of net worth placed someone in a loftier percentile of the U.S. economic strata than it does now. In fact, these qualifications were met by only 1.8% of U.S. households in 1983. By 2013 4.1% of U.S. households met at least one of these standards. This is still a distinct minority of the households in the country. It’s difficult to argue that these standards enable people who shouldn’t consider investing in private offerings to do so. These households are in the top ~4% of the U.S. population. In the abstract that does not strike me as enabling those without the financial capacity to assume the risk to invest in private offerings.

The apparent intent is to tighten the accredited investor definition in a way that would stabilize the percentage of the U.S. population would be able to invest in private offerings. The SEC could argue that this is a matter that has been left unattended for too long. By this logic you would also be saying that the percentage of the population (doubling from 1.8% to 4.1% from 1983 to 2013) is the ceiling on the portion of Americans that should be able to make this type of investment.

Thinking only of investments in tech startups, it’s hard to justify leaving out 96% of American households. It has become easier and safer to invest small amounts into private offerings for this type of startup. Firms like AngelList, FundersClub and SeedInvest have made this possible. These online investment players have also provided an extra margin of safety.It’s easy today to follow an investor syndicate, assess its capabilities and cast your lot with an investor or syndicate that you are comfortable investing along side.

This SEC proposal works to limit access by raising the income and net worth standards each year. Could it be that the income and net worth standards are being made obsolete by the development of new ways to invest? It’s possible to do $5k-$10k investments on the sites listed above. In my view it’s hard to argue that interested Americans should not be able to risk such amounts as long as the risks are clear.

This proposal would keep the ability to invest some portion of savings in private offerings away from the vast majority of U.S. households. At a time when these opportunities are becoming more available, transparent and de-risked indexing the income and net worth requirements to inflation is a move in the wrong direction.

Accredited Investor Definition – SEC Proposal Two – Higher Net Worth and Income Requirements

As covered before in a previous post, the net worth and income requirements that define an accredited investor have remained the same for more than three decades. During that time the dollar figures for those two standards have not been adjusted for inflation. As a reminder the standards are:

• An individual with an income of $200,000 or more the last 2 years (and expects that income this year)
• A married couple with an income of $300,000 or more the last 2 years (and expects that income this year)
• Or an individual or married couple that has a net worth of $1 million exclusive of the value of the primary residence

Experts calculate the rate on inflation since these standards were set in multiple ways. Should the SEC decide to adjust for inflation even the lesser impact method would change the thresholds above to:

• • An individual with an income of ~$430,000 or more the last 2 years (and expects that income this year)
  • A married couple with an income of ~$528,000 or more the last 2 years (and expects that income this year)
  • Or an individual or married couple that has a net worth of~ $2.1 million exclusive of the value of the primary residence

According to an SEC study published in July of 2013,  Regulation D financing was used in 40,000 financings by non-financial isuers averaging a bit under $2 million each in the four years 2009-12. The total financing under this rule (the bulk of which went to meet the needs of U.S. small business) approached $80 billion over those four years. From the comparison above it is apparent that the number of individuals and families that could meet the definition of “accredited investor” would fall materially.

The SEC should be very careful in considering higher qualification minimums. The ~$80 billion mentioned above is only one part of the private offering market in the U.S. As discussed earlier in my “Heart of the Matter” post, the number of eligible households in the U.S. would shrink by more than 50%. The withdrawal of this much capital via regulation would create a huge headwind for early stage companies seeking to raise capital. Many worthy companies would not be started and others would die on the vine.

The articial capital shortage that such increases in the accredited investor income and net worth levels would cause also needs to be assessed with regard to one question. Why? It’s true that a higher percentage of households are now defined as accredited investors. Many of them don’t particpate in private offerings where this definition matters. Any of you who have tried to raise capital from qualified investors who made their money outside of tech have observed that phenomenon up close and personal.

People who make these type investments into early stage tech companies self-select into this group. They have available capital. They usually understand the early stage tech environment. They are aware of and educated about the risk they are taking. And most important, they are willing to take this type of risk. When all those things are true, why shouldn’t these investors be able to take risks that they are comfortable taking? My verdict is that the current income and net worth standards should stay in place.