Would a Higher Accredited-Investor Threshold Clip Angels' Wings?
Does raising the financial requirements to be an accredited investor reduce startup financing? The Angel Capital Association (ACA), a trade association of angel groups, claims that it does. But data on the angel capital market’s response to the 2010 increase in the threshold doesn’t support their view.
Later this year, the Securities and Exchange Commission will decide whether to raise the income and net-worth requirements to be an accredited investor, following the requirement in the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 to periodically reevaluate the current standard.
The ACA argues that raising the threshold would cause “grave disruption” to “the startup ecosystem” by reducing the number of accredited investors. Because the Securities Act of 1933 exempts businesses selling financial securities to “accredited investors” from registering their offerings with the SEC under certain rules, small companies can more easily raise money from accredited investors than non-accredited ones. As a result, adjusting the accredited-investor financial thresholds for inflation, as the SEC is considering doing, would reduce the number of accredited investors by 60 percent, a Government Accountability Office (GAO) study estimates.
Whether it would also reduce the number of active angel investors or companies receiving angel capital is less clear. To gain insight into what might happen if the government raised the threshold, we can look at what occurred the last time it did so. In 2010, the SEC changed the net-worth requirement to exclude the value of an investor’s primary residence, which raised the cut-off by approximately 25 percent. (Data from the Federal Reserve’s Survey of Consumer Finances show that the richest tenth of American households had a net worth of $1.86 million and a median home value of $531,500 in 2010.)
To figure out whether the 2010 increase in the threshold affected the angel capital market, I looked at data produced by the Center for Venture Research at the University of New Hampshire, which provides annual estimates of the number of angel investors, the amount of money invested by angels, and the number of companies receiving angel financing.
Despite the increase in the accredited investor threshold in 2010, between 2009 and 2013 the number of angel investors went up by 15.2 percent, and the number of angel-backed companies rose by 23.6 percent.
Comparing with 2009 might be unfair because that was a bad year for economy. Therefore, I contrasted the 2013 figures with those from 2007 (the last pre-recession-pre-Dodd-Frank-year). In 2013, there were 15.7 percent more angel investors and 23.8 percent more angel-backed companies, than in 2007.
More importantly, the change in the threshold didn’t slow the pace of growth in the number of angel-backed companies or active angel investors. From 2006 to 2009, the number of angel-backed companies increased by an average of 4.1 percent per year, as compared to 4.8 percent between 2010 and 2013. Similarly, the number of active business angels increased by an annual average of 3.6 percent between 2006 and 2009. Between 2010 and 2013, it went up by an average of 4.2 percent per year.
Comparing with 2009 might be unfair because that was a bad year for economy. Therefore, I compared the 2013 figures with the 2007 (the last pre-recession, pre-Dodd-Frank year) numbers. In 2013, there were 15.7 percent more angel investors and 23.9 percent more angel-backed companies than in 2007.
Raising the financial threshold to be an accredited investor, as the SEC is considering doing, might reduce the number of accredited investors, and that, in turn, might reduce the number of angel investors and the number of companies backed by angels. However, the 2010 increase in the threshold does not appear to have shrunk the pool of angels or angel-backed businesses. Therefore, we should not assume that a drop in angel activity would necessarily follow from an increase in the financial requirements to be an accredited investor.
Scott Shane is the A. Malachi Mixon III professor of entrepreneurial studies at Case Western Reserve University. His books include Illusions of Entrepreneurship: The Costly Myths That Entrepreneurs, Investors, and Policy Makers Live by (Yale University Press, 2008) and Finding Fertile Ground: Identifying Extraordinary Opportunities for New Businesses (Pearson Prentice Hall, 2005).