Angel Investing

How Rich Is Rich Enough to Invest in Startups?


How Rich Is Rich Enough to Invest in Startups?

Photograph by Sami Suni/Getty Images

Could the SEC shrink the number of Americans qualified to invest in startups by more than half with the stroke of a pen? That’s what angel investors fear might happen when the agency reviews rules for “accredited investors” next year.

At issue is how rich you need to be for the government to say, essentially, “you’re on your own, buddy,” when it comes to investments. The answer, right now, is you need to be worth $1 million, excluding the value of your home, or you need to earn at least $200,000 a year. If you’ve got that kind of cash, the Securities and Exchange Commission considers you an “accredited investor.” You’re not limited to stocks and bonds like most ordinary Joes and Janes. The SEC says you’re wealthy enough to invest in hedge funds and private equity funds or, as many angel investors do, put money straight into startups with no revenue, products, or even prototypes.

The $1 million net-worth and $200,000 income thresholds were set in 1982 and haven’t really been adjusted much since. In 2011, as required by the Dodd-Frank financial reform law, the SEC excluded the value of an investor’s primary home from calculating net worth. Dodd-Frank also makes the SEC review the standard every four years, starting in 2014. In deciding how rich is rich enough to invest in startups, the agency has to balance the goal of protecting investors with allowing businesses to raise capital. (The question got a lot more salient last week after the SEC lifted the 80-year ban on advertising unregistered offerings.)

Adjusting the thresholds for inflation would wipe out more than half of the country’s accredited investors, according to a new report from the Government Accountability Office. You’d need to have about $2.3 million of today’s dollars to have the equivalent of $1 million when the threshold was set. Making that change would shrink the pool of Americans able to open their checkbooks for startups from of 8.5 million to 3.7 million, according to the GAO.

That’s enough to make angel investors worry. “It would be catastrophic for the angel investing community,” says Curtis Gunn, chairman of Desert Angels in Tucson. The 97-member group was among the six most active angel groups in the first quarter of 2013, according to the Halo Report. “I’m sure it would have detrimental affects on most angel groups in the country.”

The term “accredited” investor is a little misleading. There’s no organization handing out accreditations. It’s simply a threshold of wealth and income, and inflation has broadened the pool of people that the government says don’t need the same protections as nonmillionaires. When the levels were set, fewer than 2 percent of U.S. households were considered accredited investors, GAO estimates. Under the current standard, even excluding the value of a primary home, more than 7 percent of American families can put their money at risk.

There’s no indication that the SEC would make such a big move. The GAO suggests other criteria might help evaluate whether people should be able to risk their money on a startup. For example, the SEC could require investors to have a certain level of liquid investments, such as stocks and bonds, before investing in riskier, illiquid funds and private placements. Or the agency could require using a registered investment adviser. In its comments on the report, the SEC broadly agreed with those ideas. The alternative measures might be a better gauge of whether investors are prepared for the risks they’re taking than simply how rich they are.

John_tozzi
Tozzi is a reporter for Bloomberg Businessweek in New York.

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