New federal rules could strike devastating blow to startup capital
By Guest Contributor Matt Dunbar | Managing Director of Upstate Carolina Angel Network
In recent weeks on UBJ‘s pages, several exciting local startups have made the news for their significant national and international successes: The Iron Yard expanding its code school to cities across the Southeast; KIYATEC winning a rare grant from the National Cancer Institute and being featured at the upcoming BIO International Convention; and Selah Genomics realizing a highly lucrative acquisition by a European diagnostics company.
All three of these companies have relied on local angel investors (including the Upstate Carolina Angel Network) to help provide the risky, early-stage capital required to fund their achievements. They are not alone – across the country last year, more than 70,000 companies raised more than $24 billion from 300,000 angel investors.
But many of those angel investors may be endangered.
Disastrous regulatory changes
The Securities and Exchange Commission is currently considering regulatory changes that could eliminate more than 60 percent of eligible angel investors – a move that would be disastrous for startups, and for our economy.
Since startup companies consistently create all net job growth in this country, and since angel investors provide an estimated 90 percent of all outside funding for startups, it would stand to reason that our public policy should encourage more early stage capital formation from angels – not less.
But when Congress passed the Dodd-Frank Act in the summer of 2010, they called for the SEC to review the definition of “accredited investor” (is effectively synonymous with eligible angel investors) every four years. In order for startup companies to avoid the prohibitive costs and filing requirements of a public offering, they must rely on an exemption that limits their capital raising efforts primarily to accredited investors (i.e. accredited angels).
Currently, an individual is accredited if he or she has a net worth (with a spouse) of at least $1 million, or an income of $200,000 for the last two years and an expectation of the same in the current year (or $300,000 for a couple). When Dodd-Frank was passed in 2010, the net worth standard was changed to eliminate the value of the primary residence, which reduced the pool of accredited individuals at that time by about 20 percent to 9.5 million households.
Now, a new proposal could reduce the number of accredited investors much more drastically. Some state regulators and consumer protection activists argue that the accredited investor definition should be indexed to inflation from when it was first introduced in 1982 – ostensibly as an effort to protect gullible investors – even though there has been very little evidence of fraud in the angel investor market in those intervening 30 years.
Under the contemplated index adjustment, the accredited investor thresholds would increase to roughly $2.5 million in net worth or $450,000 in annual income. The General Accounting Office estimates that this change would immediately disqualify 60 percent of currently eligible investors from supporting startups with their capital (beyond potential minimal crowdfunding options which still remain in limbo with the SEC).
Financial blow for startups
Clearly this change would strike a devastating blow to startups that have little access to capital outside of their own bootstrapping pluck, perhaps some friends and family – and accredited angel investors. The carnage would be even more acute outside of traditional capital centers like New York, Boston and Silicon Valley – and particularly harmful in less wealthy states like South Carolina, where we rank 43rd in per capita millionaire households.
The Angel Investor tax credit that was passed by the South Carolina Legislature last year is helping to increase availability of capital to our startups, but new federal rules could render that hard-fought gain meaningless.
However, it is not too late to battle this misguided proposal. The SEC is currently taking comments on the accredited investor definition – and we need to make sure they hear loud and clear from emerging entrepreneurial ecosystems like ours that the proposed changes are unnecessary and counterproductive. We encourage you to add your voice to the many entrepreneurs, investors and concerned citizens who want to resist further regulatory overreach that would choke out vital capital formation efforts in South Carolina and across the country.
Add your voice
The Angel Capital Association has launched a “Protect Angel Funding” campaign to inform and engage those who wish to “preserve the health of early-stage companies and their role in job creation.”
To heed their call to action to send letters to the SEC, you can find a link to resources and templates on our blog at upstateangels.com. As part of the message, the ACA and UCAN are also encouraging the SEC to expand the angel market by broadening the rules to allow sophisticated investors with requisite expertise to invest as accredited investors, even if they don’t meet the stated financial thresholds.
We invite you to help us take up the cause to protect and broaden angel funding resources for companies like the Iron Yard, KIYATEC and Selah Genomics. Without angel investors, those companies would not have been able to commercialize technologies, create high-paying jobs, and generate wealth and know-how that is helping us build our economic future in the Upstate.
For those companies, and others like them, UCAN is working hard to create a more fluid marketplace for entrepreneurs to access early stage capital in South Carolina. The South Carolina Angel Network (SCAN) is growing with the launch of the Capital Angels in Columbia last week, and the Palmetto Angel Fund, which will co-invest with SCAN investors is scheduled for its first close this month.
We are always seeking more angels to join our efforts, so please contact me at the address below if you’d like to try on a pair of wings to fund promising startups – and a shield of common sense and entrepreneurial fortitude to protect the endangered angels.