As it stands today, there are two separate startup investing ecosystems.
One is for accredited investors only, those who either make $200,000 a year in income or are worth more than $1 million. Accredited startup investing deals have been happening online since 2012 on sites like MicroVentures, AngelList and FundersClub.
Accredited investor deals are extremely easy to conduct. Startups use an exemption to securities laws called Regulation D. This means they don’t have to file a bunch of paperwork as they would with most security offerings. And they can raise unlimited funds.
Reg D deals have accounted for the vast majority of startup funding in the U.S. for decades. There is no regulator in the Reg D world, however, so it’s buyer beware.
The other startup funding ecosystem is the one for everybody else (nonaccredited investors). This is often called Regulation Crowdfunding, or Reg CF.
With Reg CF, companies can raise up to $1.07 million per year. Companies are required to post detailed financial and other information in a Form C filing. It’s not a cheap exercise.
Reg CF became available in 2016, so it has a shorter track record.
But already, we can see differences. Most companies still seem to prefer Reg D funding from venture capitalists (VCs) and angel investors, if they can get it. It’s been around a lot longer, and there’s a lot less paperwork, hassle and expense.
Fortunately for Reg CF investors, VCs and angels pass on promising deals all the time. And not every city has VCs or angel investors. So for many startups, Reg CF is the best option.
And we’ve seen some great deals so far. One of the first Reg CF deals ever, Beta Bionics, is seeing tremendous success. The company is building a bionic pancreas. It’s gone on to raise $126 million in new capital and was recently granted “breakthrough” status by the FDA. It goes to show how “crazy,” but inspired, ideas can pay off.
I’ve invested in both of these ecosystems, and there are more consistently good deals on the accredited side. It’s a shame that not everyone has access to the same deals.
Fortunately, this might be changing.
Opening Up “Accredited Investor” Status to More People?
Earlier this month, AngelList, the leading accredited startup investing portal, released a new report examining its investment returns so far. AngelList has a startup dataset like nobody else. And the company is doing incredibly well. More than 3,000 startup deals have been conducted on the AngelList platform. And it has more than 23 “unicorns” in its portfolio as of the end of 2018.
Here’s an excerpt from the report (emphasis mine).
Our results also suggest that startups staying private longer have created a powerful engine for unbounded wealth creation entirely outside the public markets; we conclude with an argument rooted in social equity for why retail investors should have access to a broad-based index of early stage venture investments.
AngelList, the leading startup investing portal in the world, is basically saying that it believes its product should be available to everyone (in the form of an index fund).
I could see AngelList eventually launching a product where everyone can access Reg D deals through a broad-based index of startups. This would dramatically reduce risk and maximize investors’ chances of hitting a huge winner. It would be a fantastic opportunity for nonaccredited investors.
Then this past Wednesday, the Securities and Exchange Commission (SEC) released a proposal to update the definition of “accredited investor.”
It starts out promisingly:
The Securities and Exchange Commission voted to propose amendments to the definition of accredited investor, one of the principal tests for who is eligible to participate in our private capital markets. The proposal seeks to update and improve the definition to more effectively identify institutional and individual investors that have the knowledge and expertise to participate in our private capital markets.
Unfortunately, it gets worse from there. Basically, it goes on to say that if you’re a stockbroker or otherwise employed at a financial institution, you might be able to qualify as accredited. And that’s about it. There are a few other minor changes, but nothing that would really expand the definition much at all.
The only hope is at the end of this paragraph (emphasis mine):
The proposed amendments to the accredited investor definition would: add new categories to the definition that would permit natural persons to qualify as accredited investors based on certain professional certifications and designations, such as a Series 7, 65 or 82 license, or other credentials issued by an accredited educational institution.
We don’t know exactly what this means. But it sounds like investors may be able to achieve some sort of certification as an accredited investor. I have no idea how this would work.
Fortunately, the proposal is up for a 60-day comment period. This is a window for us to give our feedback on the SEC’s proposed changes. You can read the entire proposal here, then send your comments via email to rule-comments@sec.gov.
I believe anyone who has the cash and wants to invest in a Reg D offering should be able to do so. Yes, it would mean investors are exposed to risk. But right now they can waste all their money on the lottery or penny stocks, and that’s perfectly legal. It’s crazy. I don’t think it’s a coincidence that the one thing that’s outlawed is the most profitable.
My advice would be to tell the SEC you want equal access to promising startup deals. It’s pretty simple. If it wants to make it a certification process, that would be an OK compromise. But the key must be that anyone can get the certification. An even playing field, with no restrictions based on wealth.
If you agree, please take the time to write to the SEC. Something is starting to happen here, and it could open up Reg D deals to more investors down the road.