What Can $5,000 Buy

So this is how the SEC’s proposed regulations for the non-wealthy are shaping up…

If your net worth is less than $100,000, you can only invest $5,000 a year for shares in a startup. And if you’re worth more than $100,000, you can invest up to 10% of your annual income or net worth, up to a maximum of $100,000 in one year.

My greatest concern?

That moneyed interests will come out of the woodwork to try to sabotage last year’s JOBS act. It provided the regulatory framework for average Americans (those making less than the top tenth of household income earners) to invest in startups.

But I have an even greater fear.

It’s that some people will misunderstand how the game is played.

The fact is, many if not most small businesses will fail to grow into monster companies.

Don’t let that discourage you. You don’t need a majority of winners in your portfolio to make a nice profit.

But you do need at least one company breaking into the big time.

So, to up the odds, you have to invest in several startups. I’d recommend at least 10 holdings.

Is that feasible with the government giving investors making less than $100,000 per year an annual $5,000 limit? Well, these are very small companies, and $500 per company would still buy you a fair amount of shares in each of the 10 you invest in.

My next question: Will investors be disciplined enough to pull that off? Or will they fall in love with the first company that excites them and put their entire $5,000 wad into this single startup?

I think the danger is real enough.

You have to  like these companies to pull the trigger on an investment. On the other hand, you don’t want to let your excitement get the best of you and lead to putting all your eggs in one basket.

So I have a suggestion on how to improve the current proposed rules.

Why not drop the $5,000 requirement and just go with the 10% rule? If you’re making $90,000, that means you can invest up to $9,000 in startups. If you’re making $30,000, you can only invest $3,000.

That makes more sense to me. It better calibrates limits on how much you can invest to how much you make.

You have two ways to lessen risk. To limit overall investment amounts. And to invest in several startups at once.

There’s an inherent tension between the two. The less you have to invest, the harder it is to build up a healthy number of holdings in your startup portfolio.

I don’t think the government gets this. But you need to.

When it comes to startup investing, the more companies the better.