The Qualified or Accredited Investor Quandry

In the US, to invest in a startup, you must have a net worth of $1M or have earned over $200k a year consecutively for the past 2 years.  For everyone else, that was the end of the story, unless you happened to be friends with someone who founded a startup that you happened to want to invest in.  But that just changed, with Title III of the jobs act coming into effect on June 19th.

Until now, you must be wealthy to be legally entitled to invest, otherwise you were out unless you had contact with the founder prior to investment.  If you’re hearing this for the first time, it probably sounds arbitrary, classist, and even oppressive against the financially less fortunate.  There were, however, good intentions for creating these laws.  The problem is fraud.  Someone without investment experience may well be duped into investing into a junk company, whose value is only created by duping more inexperienced investors into investing, akin to what we saw in the dot-com bubble.

The SEC wanted to ensure that everyone who could invest in a startup knew what they were getting into.  Nothing wrong with that, right? But how do you make objective, enforceable criteria for that?  Even venture capitalists, experienced investors, get it wrong all the time, but the difference is that they understand the risk.  Most new businesses will fail, so you need to pick many that have decent chances, and hope that one makes it through and covers the losses of the others.  So how do you make sure that anyone investing in a startup knows that it is probably going to fail, and doesn’t put all of their retirement eggs in one basket? Instead of looking at the attributes of the individual, their qualifications, or their experience, the SEC decided to look at what all those things had earned them.  If you knew what you were doing, then you must have done it well enough to get rich. This is based on a 60 year old Supreme Court ruling that rich = savvy. Here’s where things start getting a little distasteful.

There are many ways to get wealthy, not all of which come from a solid understanding of business and finance. So wealthy people may not necessarily know what they are getting into.  You could argue that if they are wealthy then the loss of the investment will hurt them less, but the point of investor accreditation is not to prevent loss, but ensure understanding the risks. And if you have millions, you can still lose it all in one bad investment, but legally you’re deemed smart enough not to. What it does do, is prevent the middle class from bootstrapping themselves up using business investment.  Even an incredibly savvy middle-class investor can’t achieve success through startup investment. Ever wonder why all Kickstarter campaigns give you a crummy t-shirt for your dollars instead of a piece of the company?   It’s because they can’t without having the SEC jumping down their throats, not because they don’t want to.

This is not the end of the story.  The Jobs Act is in the process of reforming the laws involving accredited and non-accredited investors.  Title III of the Jobs Act addresses the crowdfunding issue, that would allow non-accredited investors to participate in equity-based online investment of startups.  This change came into affect on June 19th, and it still remains to be seen what the effect will be and how it will be used.  Several equity-based crowdfunding platforms opened their doors that same day, with the promise of giving non-accredited investors the ability to purchase equity in startup raising funds.  Check out StartEngine Crowdfunding right now to see that you really can invest in startups (for equity, not a t-shirt), though you will have to be the judge of wether or not you should.

 

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