Dodd Bill Could Drain Angel Pool, Make Startup Financings More Confusing

Most of the debate over Chris Dodd’s financial reform bill has involved the proposed creation of a consumer protection agency. But there also are some smaller provisions in the 1,139-page bill that would directly impact angel investors and startup companies.

First up is Section 412, which would change the requirements under which someone can qualify as an “accredited investor.” Since 1982, individuals have been considered “accredited” if they had at least $1 million in personal assets and/or annual income of $200,000 ($300,000 in the case of a joint filing). Under Dodd’s proposal, however, the threshold would become subject to “price inflation” adjustments at least once every five years.

The bill does not explain the metrics that would be used to determine “price inflation,” although a 2007 SEC report used a Department of Commerce price index to project a 90% hightening of the asset floor. That same index would have caused the individual and joint income tests to increase to $388,000 and $582,000, respectively.

Accredited investor standards were originally created under a thesis that richer folks would have a better understanding of financial risk than would poorer folks, or would at least have the resources to hire knowledgable financial advisors. Moreover, while an accredited investor may lose his shirt on a poor private placement investment, someone of lesser means might also lose his pants, shoes and house.

I sort of accept the original logic, but fail to understand why Dodd wants to raise the standards. One million dollars may not be what it was in 1982, but it’s still a boatload of cash (if you run in circles where it isn’t, just trust me on this). So is $200k in annual income. Moreover, it doesn’t seem that the doings of accredited investors — particularly those on the lower end of the qualification ladder — had one whit to do with the financial crisis, nor do they pose any future risk on a systemic level.

Not surprisingly, the National Venture Capital Association and the Angel Capital Association oppose Dodd’s proposed changes – arguing that they would drain the angel investor pool at a time when seed-stage capital is already at a premium. It’s a valid point, but only at the Midwestern margins. After all, how many active angels in startup-heavy states aren’t worth at least $2 million?

More valid is the NVCA’s issue with another bill provision, which would repeal the federal preemption of state laws regulating securities offerings under Regulation D. Today, a startup can raise money from accredited investors in multiple states, and file with the SEC under a common offering document. Rules overseeing the cash you raise from John in California are are the same as the ones overseeing cash you raise from Jane in Florida.

Dodd’s bill, however, would allow each state to create its own set of regulations. Not only could that become a paperwork nightmare (read: larger legal/accounting costs), but it also could delay startup fundings if one state has a longer waiting period than another. Moreover, it actually could favor startup formation in larger states at the expense of startup formation in smaller states (folks might just try to get all their cash in Cali or New York).

I’m not sure if Dodd threw this in as an olive branch to states-rights conservatives, or if it has something specific to do with his home state of Connecticut. Or perhaps, as NVCA president Mark Heesen suggested, it’s to appease state regulatory agencies that keep carping about continually having their job functions shifted federal.

I have put in a call to the Senate Banking Committee’s press office, but have not yet heard back. Really hoping too, though, because right now I can’t figure out any net-positive reason for these changes…


What follows are screenshots of each provision (sorry, I can’t get the second one to render well):