Changing the rules for who is allowed to invest in startups

By now, you've probably heard that the SEC is considering making changes to the accredited investor definition.

The definition is important to entrepreneurs, angel investors, and the startups they work on together, because it defines the standards for who is, and who is not, allowed to invest in startups and private emerging companies.

6a01156e3d83cb970c01bb079a0c65970d-580wiRight now, the standards are financial: if you earned more than $200,000 in each of the last two years ($300,000 in the case of a married couple), and have a reasonable expectation of achieving that income level in the current year, or if you have net worth of at least $1 million (excluding the principal residence), then you are "accredited."

It's a bit unnerving that the accredited investor definition is up for reconsideration. There are many voices - among consumer advocacy groups, and among state regulators, to name just two categories - who want the financial thresholds of the definition indexed to inflation. Were this to happen, people who currently meet the standard would drop out of the eligible pool of angel investors.

But it's not as though we haven't had a couple years to prepare for this. A review of the accredited investor definition was mandated by Dodd-Frank. In retrospect, one wishes the subsequent JOBS Act had intervened to make the risk of this upcoming review less potentially perilous. But that didn't happen.

You might be saying to yourself, ah ha, didn't the JOBS Act democratize startup investing, by allowing general solicitation? Good thought, but, perhaps ironically, that liberalization in the rules only made the accredited investor standard that much more important: if you generally solicit and want an exemption under Reg D, then your purchasers must all be accredited investors – no room for a single purchaser who is non-accredited – And you must take heightened measures to verify the accredited status of each of your purchasers.

If you are a serial or parallel entrepreneur, or if you are an active angel investor, you should be concerned about this review of the accredited investor definition.

But the sky is not falling. Not yet. There is time to read up, get educated and get involved in this policy review.

Recently, an investor advisory committee to the SEC, a body which had been formed by Dodd-Frank, made some recommendations to the agency on how to go about changing the accredited investor definition. The recommendations include ideas on how to measure "sophistication" by means other than income or net worth.

The recommendations of this committee are not the same thing as rules proposed by the agency. But these recommendations might fairly be thought of as "trial balloons." The SEC chair, Mary Jo White, was in attendance at the meeting last week at which the committee approved their recommendations. So we know the SEC is listening.

Here are some resources for you to check out on this topic. Most important is the first one, a blog post on the topic by Marianne Hudson, the Executive Director of the Angel Capital Association.

Here also are reactions I tweeted (using Dave Winer's Little Pork Chop app) immediately following the committee meeting webcast last week:

Some observations about the Investor Advisory Committee recommendations on changing the accredited investor definition (having just watched the bulk of the discussion on the topic, via SEC webcast):

first, this topic is of existential importance for startup and emerging company financing – it will impact who is allowed, and who is not allowed, to invest in early-stage companies;

second, Barbara Roper seemed to say that the aim of the changes should be to keep the pool of accredited investors as large as it is today, or, slightly expanded – this is a good thing, though I don't know if that aim can realistically be served if there is a increase in the current financial thresholds;

third, Roper expressed the view that membership in an angel group, following best practices, might satisfy the definition (presumably the Angel Capital Association's CAG, or "certified angel group," would be the standard?);

fourth, there seems to be appetite to institutionalize, or at least study the pros and cons of institutionalizing, third-party verification, for both private and generally solicited Reg D deals;

fifth, much talk of non-financial means of satisfying the accredited investor test (go out and get your Series 7 everyone, if you want to be accredited?), and other ways of measuring "sophistication" in order to participate in private deals.

Picture: Rubblebucket at Chop Suey, Seattle, October 10, 2014.

Where I've been

Friends, I want to thank you for all the support you've given this blog over the past three or four years.

It's been a good run. Two or three years ago, I started blogging every day, and that was the ticket for making a vibrant community here.

This blog became America's number one securities law blog, and number five IP law blog. We sustained that ranking for many months, perhaps well over a year.

But my writing muse has taken me in different directions this year. You might say, back to my roots, writing in a manner reminiscent of how I spent my 20s, combined with the influence of what I read in my teens and early 20s.

So I'm going to pursue that.

My new direction does not mean I don't appreciate the loyalty and attention you gave my work on this blog over the past few years.

Will I again blog about startup law and public policy issues that impact emerging companies?

I hope so. Not daily; and probably not on this blog.

I'm hoping LinkedIn, or some other platform, will feel like the right way to occasionally opine on issues impacting the emerging company ecosystem.

I remain very involved on public policy matters through my work on the Advisory Council to the Angel Capital Association. And - knock on wood, and thanks be to God - my law practice is currently insanely busy, so I remain deeply involved, on a day-to-day basis, with the practical implications of changes in securities law.

Until I find the new, occasional platform for writing about legal and tech stuff, please remain friendly with me via Twitter. Reminder: I am @wac6.

I love you, loyal readers, and will see you at the Machine House in Georgetown for a pint of bitter.

Where I've been

The world is not totally fucked up: Exhibit A

Here is Exhibit A for the proposition that the world is not, in fact, totally and completely fucked up: sculpture being readied, as we speak, at Jefferson Park in Seattle.

6a01156e3d83cb970c01a73ddbf7fe970d-580wiWhat's more, this public art is to be "skateable."

I exchanged nods with the welder, and chatted with another bystander on how beautiful the work is.

Imagine the satisfaction of being the person, or one of the persons, who put this sculpture together. Like the satisfaction of a poet who writes a verse that may someday unlock the strictures of another person's self-perception.

There is no app for that.

6a01156e3d83cb970c01a73ddbf802970d-580wiSheryl Sandberg on Facebook was in the news today, quoted as saying how happy she is that her boss finally turned 30.

She ought to send him back to get a college education. It's a travesty, how the barons of the Internet are even less imaginative then the robber barons of the 19th century.

But, like I say, you can turn them out.

The analog world is still pretty fucked up, but not totally and completely.

See Exhibit A.

If it ain't broke, don't fix it

Incredibly, there are interest groups in the US who are taking advantage of a provision in Dodd-Frank to try to throttle angel investing.

CaptureFor context, see this excellent press release put out today by the Angel Capital Association.

Here's the money quote:

“'We appreciate the importance of regulation to protect investors from fraud, however regulations need to be focused in areas with a proven need for added oversight.  The angel investment asset class has experienced very little fraud, because angel investors have strong processes for due diligence and investment terms, and ongoing entrepreneurial support,' said Marianne Hudson, ACA’s executive director."

As the SEC revisits the accredited investor definition, there should also be opportunity to bring some non-financial criteria to the definition, hopefully as alternatives to the income and net worth thresholds. But the financial criteria have, in effect, over time, been permitting more and more citizens to qualify as accredited. This is democractic and investor protection has not suffered. Arguably, investor protection has improved because of the expansion of angel investing.

Photo: "Banksy Bullet Proof Angel in Great Eastern Street London," Cyberslayer / Flickr.

David Rose's new book on angel investing

Just got David Rose's new book in the mail, on angel investing.

Definitely looks like it's worth checking out.

Those of us who hang out a fair bit on blogs and online will be familiar with many of David's precepts, from his long, detailed and popular answers on the topic on Quora.

But this book looks like a great way to organize his philosophy on angel investing in one place.

The angel lawyer in me is first drawn - naturally - to a deal form bank at the back, where there is what looks like a term sheet for a light preferred stock offering that combines the NVCA model forms with Ted Wang's Series Seed.

But, bigger picture, the book should be valuable for insights into David's practices as an angel. Chapter titles include "why everyone with six figures to invest should consider angel investing" and"why every angel needs to invest in at least 20 companies."

The first time I encountered how opinionated and direct David could be was when serving on a panel with him at a talk at an accelerator in DUMBO a couple years ago. The topic was crowdfunding, and David was confident that the right structure for non-accredited crowdfunding deals was revenue loans.

And sure enough, there is a revenue loan term sheet in this book! (But I'm swinging back again to being a lawyer.)

David Rose's new book on angel investing

Title III Do-Over

It is an absolutely glorious, summerlike morning in Seattle.

I'm walking to work, listening to a webcast of a hearing of the House Financial Services Committee, which is considering draft legislation to fix things not working with the JOBS Act (both the text of the original legislation, and the implementation of it).

6a01156e3d83cb970c01a3fcfe88cc970b-580wiIt's very gratifying to hear Representative Patrick McHenry openly admit that Title III was a failure from the get-go, and that the fault lies with Congress, not the SEC's prospective implementation. (Title II and the rulemaking surrounding new Form D filing requirements is a different story.)

Gratifying, but not surprising. Rep. McHenry made similar statements at the ACA Summit in Washington DC in March of this year.

State securities administrators are going to be heard on the non-accredited crowdfunding issue. Bill Beatty, the state securities administrator for Washington State, should be speaking at this hearing shortly.

With respect all sides, I think my Individual Crowdfunding Account concept may be part of a holistic, national solution.

When I get to a desktop, I will add links to relevant prior posts on that topic, just below.

Update; links on McHenry Do-Over / Individual Crowdfunding Accounts:

A Simple Act of Congress to Make Things Better for Startups

My friend Joe Wallin had an idea earlier today, which was, “how can Congress pass a single, simple law, to tell federal agencies to back off the rulemaking?”

His idea is borne of the frustration we all feel when Congress passes a reform intended to make life easier for startups, entrepreneurs, and the angel investors and VCs who support them, only to see that new law languish – or, worse yet, backfire – through rulemaking to implement the Congressional reform.

Here’s a simple bill we’ve come up with. With respect, we believe this bill, by itself, might help curtail the problem we’ve seen with rulemaking under the JOBS Act.

“In implementing any Act of Congress through rulemaking, or in construing the meaning of any Act of Congress through ruling or interpretation, the various administrative bureaus and agencies of the United States shall not make it harder or more difficult for entrepreneurs or emerging companies to raise money privately from accredited investors, and may expand, but shall not diminish, the pool of persons who qualify as accredited investors.”

What do you think? If it were to pass, and you were a clever person in a federal agency bent on drafting rules to frustrate this Act of Congress, how would you undermine it?