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Startups Get Hit By Shrapnel In The Banking Bill

102 points by ankeshk 17y ago

danskil 17y ago
>You have to be a qualified investor. Does this mean that startups can no longer take money from friends and family?
- bilbo0s 17y ago
  No. See comment from apinstein above.
jcnnghm 17y ago
When writing an article like this you should include the name of the bill, Chris Dodd's Restoring American Financial Stability Bill, and a link to where you would go to contact your senators, http://www.senate.gov/general/contact_information/senators_cfm.cfm http://www.senate.gov/general/contact_information/senators_c.... It's also wise to include a sample letter that people can quickly modify and send. Dear Senator Mikulski, In Senator Dodd's Restoring American Financial Stability Bill, there is currently a provision to change the definition of an accredited investor as defined in Rule 501 of Regulation D of the Securities Act of 1933. At present, an accredited investor is defined as someone with a net worth of over $1mm or net income of over $200k. Dodd's bill would increase that to $2.3mm and $450k respectively. And then index those numbers to inflation. Unfortunately, while these changes may look good on paper, in practice they will severely dampen the flow of money into job creating early-stage technology companies. Many early-stage technology companies are funded by one or more angel investors. Increasing the accreditation requirements will reduce the pool of potential angel investors, reducing the flow of money into the technology industry. Between 1994 and 2004, employment in the technology industry increased by 616,000, a staggering 8% annual growth rate. Through 2014, an additional 453,000 jobs are expected to be created by the industry as a whole. Reducing, and in some cases eliminating, the flow of investment capital into this industry will hamper the job-creation potential while our nation needs it the most. Early-stage technology companies are also responsible for the creation of innovative new products and services that spread throughout the world. Many of these companies are funded with small private investments; some have the potential to go on to become the next Google, Facebook, Twitter, or Apple. Entrepreneurial innovation has been in the character of this nation since its founding. Please oppose the modification of the definition of accredited investors in Senator Dodd's Restoring American Financial Stability Bill. Thank you for your time and consideration of this matter, jcnnghm include your address, telephone number, e-mail address, and congressional voting district (http://www.redistrictingthenation.com/search.aspx http://www.redistrictingthenation.com/search.aspx)
- anigbrowl 17y ago
  At present, an accredited investor is defined as someone with a net worth of over $1mm or net income of over $200k. Dodd's bill would increase that to $2.3mm and $450k respectively. Untrue. The bill would direct the SEC to review the existing financial thresholds in the light of inflationary changes since 1982 but does not mandate any particular change. The SEC might, for example, choose to leave the limits about where they are at and simply index to inflation from now on. I am not in favor of shrinking the pool of accredited investors unnecessarily. I am, however, in favor of accuracy when discussing the contents of the bill.
URSpider94 17y ago
While I plan on calling my Congresspeople in opposition to this measure, I think it's important to understand WHY it's a part of the banking reform bill. Start-ups aren't the only companies that operate under this exemption. So do hedge funds and folks like Bernie Madoff. A company that only sells shares to accredited investors doesn't have to provide information on its operations to its shareholders or the public, and so has much more opportunity to hide shady business practices. If the limit comes down far enough in real dollars, you open up the opportunity for a "shadow stock market" that essentially skirts the regulations that we voted into place. That said, my inner libertarian ranks the potential damage to legitimate start-ups much more highly than saving millionaires from ill-advised investments.
- dantheman 17y ago
  If you choose to bear the additional risk hat should be your choice.
  - sethg 17y ago
    Two words: counterparty risk. If you borrow from A (or if A invests in you) and lend to B (or invest in B, or, if B is a bank, deposit money in B), then any risk that B might default translates into a risk that A will have trouble getting its money back too. One could, of course, say that every lender is responsible for not only checking out its debtors but also its debtors’ debtors and debtors’ debtors’ debtors and so on, and if a lender finds itself on the end of a chain of defaults, them’s the breaks. However, the experience of the late nineteenth century—never mind the Great Depression or the recent unpleasantness—teaches us that when this idea is implemented as law (perhaps I should say, as absence-of-law), we have periodic crises where the whole engine of credit seizes up, the economy goes into the toilet, and impoverished workers take to the streets. Securities regulations weren’t passed to save you from the capitalist system. They were passed to save the capitalist system from you.
jakarta 17y ago
my comment from AVC: One of the things I really hate is how VCs are lumped with PE and HFs when it comes to financial legislation. I feel like with VCs role in helping create entirely new industries and the level of risk involved in the kinds of ventures they fund VCs should be held at a separate standard that offers more leniency/hands off. I think that one of the best things right now is how you are seeing an increase in angel investing, often by ordinary engineers who are choosing to invest in co-workers that are leaving to start new ventures... and now with this qualified investor rule, the Senate is potentially legislating to reduce that kind of activity.
fnid2 17y ago
This doesn't hurt startups, it hurts investors by making some people who are currently investors unable to invest in certain types of investments. It could help startups. We don't really know what the effect on startups will be. There's no clear evidence that investment in startups by outside forces is actually good for those startups. In fact, it may benefit startups in general by giving more of them a more level playing field for longer. A great startup without investment can compete more effectively against a lesser quality startup with investment, so I'm not convinced that this will really hurt startups. It's no wonder that it is investors who are claiming this law is going to hurt startups. There's lots of evidence that not getting investment can be good for startups, so I'd like to see some evidence that making it hard to invest actually hurts startups. If startups were more focused on generating revenue to keep themselves alive, we'd be less focused on seeking investment and perhaps be more likely to survive.
- borism 17y ago
  great point
- messel 17y ago
  I hadn't considered the absence of capital as a potential benefit before. Interesting inverse thesis. I think it depends heavily on the form of startup, and how much investment it takes to become a profitable business entity. By the way your kind of (in)famous on Fred Wilson's blog today. I still never heard back from you (beyond the initial Mark Pincus TC buzz) why you thought Fred was such a villain.
grellas 17y ago
A few observations: 1. Under federal and state securities laws, an issuance of stock can lawfully be done only if the issuance meets SEC registration requirements or if it is exempt from registration. 2. Registration is an elaborate and expensive process and is basically what companies do when they go public (it has many other variations as well). 3. Therefore, startups can realistically issue their stock only if any given offering is "exempt" from securities law registration requirements. 4. SEC registration requirements arise from the Securities Act of 1933. 5. The 1933 Act contains a statutory exemption under Section 4(2) for private placements. 6. Whether something is a private placement or a public offering is a factual question turning on such factors as the size of the offering, the number of purchasers, the use of advertising to induce investors to invest, the sophistication of the investors, etc. This is basically a highly murky area and it is therefore normally somewhat treacherous to structure an offering purely under Section 4(2). 7. Why treacherous? Because if you think your startup is doing an exempt private placement and investors can demonstrate that it was not truly exempt, then it is an illegal offering and investors can rescind and get their money back from the issuer and from its officers and directors. Thus, that great success you thought you had when you raised that $5 million can become a personal judgment against you as a founder who sat on the company's board when the offering was made. 8. In addition to federal law, all U.S. states impose their own forms of securities regulation. Therefore, in issuing stock to investors, a startup must make sure that all shares sold are exempt under both federal and state securities laws. In practice, this means that you need to fit the offering within an applicable exemption for each state in which one of your investors resides. Since state laws of this type are referred to as "blue sky" laws, this is known as blue sky compliance. 8. Regulation D, adopted in 1982, brought tremendous benefits to startups by taking the murky standards of Section 4(2) and blue sky compliance and simplifying them greatly. It did so by setting forth specific criteria that, if met, would ensure the startup that its offering was exempt. No more murkiness. That is why the relevant categories are known as "safe harbors." Regulation D also preempted significant aspects of state regulation, meaning that, if its standards were complied with, the issuer would not need to worry about states trying to impose special regulatory burdens in excess of whatever was required by Regulation D itself. 9. The "accredited investor" concept is an integral part of Regulation D and it lies at the core of its simplification of the offering process. In essence, if an issuer deals only with accredited investors, the process of keeping the offering exempt is highly certain and very easy. 10. In practice, this has meant that, if a startup sells stock to investors, the "securities law compliance" aspects are easy to meet and become pretty much a checklist item that is done by junior attorneys or even by paralegals working under an attorney at very little cost. 11. While the "accredited investor" concept thus worked to bring great rationality to this process, Regulation D itself does not preclude issuing stock to some non-accredited investors even under its own rules and, moreover, Regulation D did not and does not supersede the prior regime under Section 4(2), meaning that any startup can issue stock to any person (accredited or not) in any "private placement." Thus, startups can and do issue stock all the time to persons who are not "accredited investors." This can be done in many cases without problem, including to friends and family investors. The problem is that it is riskier to do, leaving the issuer and its officers and directors at greater potential legal risk whenever they issue stock to non-accredited persons. 12. The Dodd bill would sharply reduce the pool of persons who would qualify as accredited investors and would also require issuers in more situations to meet special regulatory burdens imposed by various states in which their investors reside. Since there have been no big problems in this area, I believe this is a step backward in the world of startup funding, and it will hurt startups in their funding efforts. With the Dodd changes in place, the pool of investors from which to draw will shrink and the process of complying with securities laws will likely go up significantly for many offerings for which formerly accredited investors will need to be treated as non-accredited.
sethg 17y ago
In fact, what we need is to eliminate all accredited investor requirements for small investments of up to $25k. Why does someone have to be a millionaire to invest in a friend's startup? I understand that we don't want someone mortgaging their home, or betting their entire life's savings on a startup. But for a small amount, like $25k, we should not be regulating angel investing. How many non-millionaires would have $25k lying around that they could throw at a friend’s startup without mortgaging their home or doing something equally rash? OK, maybe they wouldn’t have to bet their entire life savings, but cashing in a third of one’s 401(k) to put into a startup isn’t very bright, either.
- secret 17y ago
  What's funny (well, sad) is that the government considers one an accredited investor by virtue of having money, not actual investment knowledge. You could have a PhD in finance, on the other hand, and be considered by law unsophisticated enough to make an educated investment.
  - hga 17y ago
    It's not so much an "educated" investment but one you can afford to lose without significant pain.
    - secret 17y ago
      Good points (you and URSpider), it's just a regulation that really bothers me. Anyway, when I finish my MS in mathemetical finance, I plan to lose money through options instead :). (It's much faster that way lol!)
  - URSpider94 17y ago
    This isn't entirely correct. Regulation D also includes requirements that the investor be knowledgeable and experienced enough to evaluate the potential risks and rewards of the investment, and be able to tolerate those risks. However, the net worth/income test is a pre-requisite. Now, in practice, an investor's knowledge and risk tolerance are usually established by signing a piece of paper attesting to such, or at most by having the investor check "YES" in a check-box.
pxlpshr 17y ago
Repeal this bill here: http://gopetition.com/online/32354.html http://gopetition.com/online/32354.html
- anigbrowl 17y ago
  That'd be a nice trick, considering it hasn't even been debated or brought to a vote yet. Repeal is the process of reversing an existing law. Anyone who doesn't understand this basic concept isn't qualified to have an opinion.
  - pxlpshr 17y ago
    next time i'll more carefully monitor my word choice in haste, but then again why bother when I have trolls that auto-check my grammar for me? Maybe you should concern yourself with the proposed legislation, instead of illustrating that you have waaay toooo much time on your hands.
pierrefar 17y ago
Thinking out loud here without being well-versed in the details. If the US moves towards a state-by-state regulatory framework, wouldn't that set up competition between the states to attract investors? To rephrase this, wouldn't it set up a market allowing entrepreneurs and investors to shop around? If California wants to keep Silicon Valley, they're going to have to compete with other nascent and potential tech hubs, and those competitors will be doing their best to attract investors. Let me be clear; I do not like this scenario, but it could be an outcome that makes this item in the bill not as bad as it could have been.
- daeken 17y ago
  Why is that not a good scenario? If the states are competing with each other to make investments better in their state, how does this do anything but help out investors and startups alike? The only real downside is that you may end up going to Montana to get the best investment, but lots of people already go to the bay for investments as it is, not to mention things like tax incentives for starting datacenters in a given state.
  - pierrefar 17y ago
    I don't like this scenario as I think it adds too much hassle rather than promote healthy competition, that it becomes a net negative.
  - hga 17y ago
    Problem: as I understand it, the issue is with the state of residence of the investor(s). California today has a critical mass of angels (but how much further can the state decline before enough of them flee???). But let's say I was in Arlington, Virginia (not hard for me to imagine since I was there from 1991 to 2004 :-). My potential investor pool would ideally include residents of D.C. and suburban Maryland. If Dodd passes I've now got to worry about three different sets of state laws, and I'm sure at least one will be insane. As far as moving to Montana to get that great angel investment (hardly out of the question, look at Simplot and Micron in Idaho), well ... how likely are you to be successful there? Recruiting people to come there wouldn't be quite as hard as to Yellowknife in Canada, but, seriously.... There's reasons the SV startup ecosystem is so good, and Boston's is good enough to make it the undisputed #2. Expecting to go just anywhere and replicate the same success strikes me as unrealistic.
ojbyrne 17y ago
Umm, this article quotes the numbers on accredited investors from the Business Week article (http://www.businessweek.com/smallbiz/content/mar2010/sb20100318_367600.htm http://www.businessweek.com/smallbiz/content/mar2010/sb20100...) as fact, when it was clear they were poorly thought out speculation. How do people this stupid actually become VCs? Original discussion here: http://news.ycombinator.com/item?id=1213658 http://news.ycombinator.com/item?id=1213658
- davidw 17y ago
  Good point, but perhaps you could remove the name calling? Simply stating that he's using bad numbers as if they were facts is plenty.
  - ojbyrne 17y ago
    If it was some anonymous blowhard on the internet I was calling stupid, I'm sure few if any people would object. But it's a member of the elite, and therefore we have to be respectful. It's a stupid uncritical piece that reflects poorly on the writer.
    - davidw 17y ago
      Someone being an "elite" has nothing to do with it. I don't care who it is; you should talk as if you're talking to someone's face. This is a guideline that's been here for a while ("Be civil. Don't say things you wouldn't say in a face to face conversation.") because it works well in keeping the discussion focused on the issues, rather than degrading into pissing matches.
- skmurphy 17y ago
  see http://www.angelcapitalassociation.org/resources/public-policy/federal-policy-issues/highlights/ http://www.angelcapitalassociation.org/resources/public-poli... The Angel Capital association has looked at three sections o Sec 412 (page 380) Adjusting the Accredited Investor Standard for Inflation o Sec 413 (page 381) GAO Study and Report on Accredited Investors o Sec 926 (pages 816-819) Authority of State Regulators Over Regulation D Offerings and concluded "These 3 sections that threaten to reduce the number of accredited angel investors in the United States by about 75 percent and complicate the regulation of Regulation D offerings (which include angel investments) to increase the time needed for entrepreneurs to raise money and make it more difficult to get investors across state lines."
deleted 17y ago
[deleted]
apinstein 17y ago
> In fact, what we need is to eliminate all accredited investor requirements for small investments of up to $25k. Why does someone have to be a millionaire to invest in a friend's startup? IIRC, you don't have to be an accredited investor to invest in a friend's startup. You only need accredited investors if you're soliciting investment publicly. It's part of "Regulation D" of the SEC code: http://en.wikipedia.org/wiki/Regulation_D http://en.wikipedia.org/wiki/Regulation_D This bill looks like it might have negative side effects on the startup economy, but "friends & family" isn't one of them.
- bilbo0s 17y ago
  I thought that discrepancy was interesting too. You would think someone like Fred would have known that.
- TimothyFitz 17y ago
  While it's not illegal to take "friends & family" investment, it adds a lot of legal headache and it's something VCs really don't want to deal with. Startup Lawyer puts it better than I can: http://thestartuplawyer.com/convertible-notes/life-is-too-short-to-deal-with-non-accredited-investors http://thestartuplawyer.com/convertible-notes/life-is-too-sh...
mlinsey 17y ago
Naive question: if as described in point (2) of the OP, the bill would "eliminate federal pre-emption of state regulations of accredited offerings", would this not allow some states to create less burdensome regulations than other states or even than Federal regulations? State governments who wanted a Silicon Valley in their state could then take advantage of this to attract a much better community of investors and startups.
- anigbrowl 17y ago
  Sure. 1. I haz bizness idea 2. LOL credit cardz 3. ???? 4. OH NOES I'm not being facetious here, really. Lot of businesses get off the ground using bank credit. Kevin Smith famously made Clerks on his credit cards (a film = a startup), won a prize, and sold the IP for a lot of money and further success. But lots of other people have followed the same recipe and failed. Moral: do not assume 'less burdensome regulations' = 'level playing field', especially if you are the needy party.
hristov 17y ago
As it was discussed to death in a previous thread, Dodd's bill does not include any direct increases to the accredited investor standards. So, when AVC says: "Dodd's bill would increase that to $2.3mm and $450k respectively", he is pulling the numbers out of thin air. Dodd's bill says that the SEC shall increase the amount "as the Commission determines is appropriate and in the public interest, in light of price inflation ..." quoted directly from the bill. So the SEC has wide discretion as to how to increase these standards and has to consider the public interest. It is extremely unlikely that the SEC would make the drastic increases this article mentions. It should also be noted that the SEC has had the power to change these numbers at any time since 1982, and has chosen not to do it. So, again it is unlikely that they will now decide to double the numbers. Of course you may think that the bill is still undesirable, because one should not prod the SEC to raise these numbers. But the way the original article worded things was simply not correct.
cakeface 17y ago
Could this hurt startups? Yes. Is this a reasonable compromise when considering the entire financial industry? Yes.

102 points by ankeshk 17y ago

danskil 17y ago

>You have to be a qualified investor. Does this mean that startups can no longer take money from friends and family?

bilbo0s 17y ago
No. See comment from apinstein above.

jcnnghm 17y ago

When writing an article like this you should include the name of the bill, Chris Dodd's Restoring American Financial Stability Bill, and a link to where you would go to contact your senators, http://www.senate.gov/general/contact_information/senators_cfm.cfm http://www.senate.gov/general/contact_information/senators_c.... It's also wise to include a sample letter that people can quickly modify and send. Dear Senator Mikulski, In Senator Dodd's Restoring American Financial Stability Bill, there is currently a provision to change the definition of an accredited investor as defined in Rule 501 of Regulation D of the Securities Act of 1933. At present, an accredited investor is defined as someone with a net worth of over $1mm or net income of over $200k. Dodd's bill would increase that to $2.3mm and $450k respectively. And then index those numbers to inflation. Unfortunately, while these changes may look good on paper, in practice they will severely dampen the flow of money into job creating early-stage technology companies. Many early-stage technology companies are funded by one or more angel investors. Increasing the accreditation requirements will reduce the pool of potential angel investors, reducing the flow of money into the technology industry. Between 1994 and 2004, employment in the technology industry increased by 616,000, a staggering 8% annual growth rate. Through 2014, an additional 453,000 jobs are expected to be created by the industry as a whole. Reducing, and in some cases eliminating, the flow of investment capital into this industry will hamper the job-creation potential while our nation needs it the most. Early-stage technology companies are also responsible for the creation of innovative new products and services that spread throughout the world. Many of these companies are funded with small private investments; some have the potential to go on to become the next Google, Facebook, Twitter, or Apple. Entrepreneurial innovation has been in the character of this nation since its founding. Please oppose the modification of the definition of accredited investors in Senator Dodd's Restoring American Financial Stability Bill. Thank you for your time and consideration of this matter, jcnnghm include your address, telephone number, e-mail address, and congressional voting district (http://www.redistrictingthenation.com/search.aspx http://www.redistrictingthenation.com/search.aspx)

anigbrowl 17y ago
At present, an accredited investor is defined as someone with a net worth of over $1mm or net income of over $200k. Dodd's bill would increase that to $2.3mm and $450k respectively. Untrue. The bill would direct the SEC to review the existing financial thresholds in the light of inflationary changes since 1982 but does not mandate any particular change. The SEC might, for example, choose to leave the limits about where they are at and simply index to inflation from now on. I am not in favor of shrinking the pool of accredited investors unnecessarily. I am, however, in favor of accuracy when discussing the contents of the bill.

URSpider94 17y ago

While I plan on calling my Congresspeople in opposition to this measure, I think it's important to understand WHY it's a part of the banking reform bill. Start-ups aren't the only companies that operate under this exemption. So do hedge funds and folks like Bernie Madoff. A company that only sells shares to accredited investors doesn't have to provide information on its operations to its shareholders or the public, and so has much more opportunity to hide shady business practices. If the limit comes down far enough in real dollars, you open up the opportunity for a "shadow stock market" that essentially skirts the regulations that we voted into place. That said, my inner libertarian ranks the potential damage to legitimate start-ups much more highly than saving millionaires from ill-advised investments.

dantheman 17y ago
If you choose to bear the additional risk hat should be your choice.
- sethg 17y ago
  Two words: counterparty risk. If you borrow from A (or if A invests in you) and lend to B (or invest in B, or, if B is a bank, deposit money in B), then any risk that B might default translates into a risk that A will have trouble getting its money back too. One could, of course, say that every lender is responsible for not only checking out its debtors but also its debtors’ debtors and debtors’ debtors’ debtors and so on, and if a lender finds itself on the end of a chain of defaults, them’s the breaks. However, the experience of the late nineteenth century—never mind the Great Depression or the recent unpleasantness—teaches us that when this idea is implemented as law (perhaps I should say, as absence-of-law), we have periodic crises where the whole engine of credit seizes up, the economy goes into the toilet, and impoverished workers take to the streets. Securities regulations weren’t passed to save you from the capitalist system. They were passed to save the capitalist system from you.

jakarta 17y ago

my comment from AVC: One of the things I really hate is how VCs are lumped with PE and HFs when it comes to financial legislation. I feel like with VCs role in helping create entirely new industries and the level of risk involved in the kinds of ventures they fund VCs should be held at a separate standard that offers more leniency/hands off. I think that one of the best things right now is how you are seeing an increase in angel investing, often by ordinary engineers who are choosing to invest in co-workers that are leaving to start new ventures... and now with this qualified investor rule, the Senate is potentially legislating to reduce that kind of activity.

fnid2 17y ago

This doesn't hurt startups, it hurts investors by making some people who are currently investors unable to invest in certain types of investments. It could help startups. We don't really know what the effect on startups will be. There's no clear evidence that investment in startups by outside forces is actually good for those startups. In fact, it may benefit startups in general by giving more of them a more level playing field for longer. A great startup without investment can compete more effectively against a lesser quality startup with investment, so I'm not convinced that this will really hurt startups. It's no wonder that it is investors who are claiming this law is going to hurt startups. There's lots of evidence that not getting investment can be good for startups, so I'd like to see some evidence that making it hard to invest actually hurts startups. If startups were more focused on generating revenue to keep themselves alive, we'd be less focused on seeking investment and perhaps be more likely to survive.

borism 17y ago
great point
messel 17y ago
I hadn't considered the absence of capital as a potential benefit before. Interesting inverse thesis. I think it depends heavily on the form of startup, and how much investment it takes to become a profitable business entity. By the way your kind of (in)famous on Fred Wilson's blog today. I still never heard back from you (beyond the initial Mark Pincus TC buzz) why you thought Fred was such a villain.

grellas 17y ago

A few observations: 1. Under federal and state securities laws, an issuance of stock can lawfully be done only if the issuance meets SEC registration requirements or if it is exempt from registration. 2. Registration is an elaborate and expensive process and is basically what companies do when they go public (it has many other variations as well). 3. Therefore, startups can realistically issue their stock only if any given offering is "exempt" from securities law registration requirements. 4. SEC registration requirements arise from the Securities Act of 1933. 5. The 1933 Act contains a statutory exemption under Section 4(2) for private placements. 6. Whether something is a private placement or a public offering is a factual question turning on such factors as the size of the offering, the number of purchasers, the use of advertising to induce investors to invest, the sophistication of the investors, etc. This is basically a highly murky area and it is therefore normally somewhat treacherous to structure an offering purely under Section 4(2). 7. Why treacherous? Because if you think your startup is doing an exempt private placement and investors can demonstrate that it was not truly exempt, then it is an illegal offering and investors can rescind and get their money back from the issuer and from its officers and directors. Thus, that great success you thought you had when you raised that $5 million can become a personal judgment against you as a founder who sat on the company's board when the offering was made. 8. In addition to federal law, all U.S. states impose their own forms of securities regulation. Therefore, in issuing stock to investors, a startup must make sure that all shares sold are exempt under both federal and state securities laws. In practice, this means that you need to fit the offering within an applicable exemption for each state in which one of your investors resides. Since state laws of this type are referred to as "blue sky" laws, this is known as blue sky compliance. 8. Regulation D, adopted in 1982, brought tremendous benefits to startups by taking the murky standards of Section 4(2) and blue sky compliance and simplifying them greatly. It did so by setting forth specific criteria that, if met, would ensure the startup that its offering was exempt. No more murkiness. That is why the relevant categories are known as "safe harbors." Regulation D also preempted significant aspects of state regulation, meaning that, if its standards were complied with, the issuer would not need to worry about states trying to impose special regulatory burdens in excess of whatever was required by Regulation D itself. 9. The "accredited investor" concept is an integral part of Regulation D and it lies at the core of its simplification of the offering process. In essence, if an issuer deals only with accredited investors, the process of keeping the offering exempt is highly certain and very easy. 10. In practice, this has meant that, if a startup sells stock to investors, the "securities law compliance" aspects are easy to meet and become pretty much a checklist item that is done by junior attorneys or even by paralegals working under an attorney at very little cost. 11. While the "accredited investor" concept thus worked to bring great rationality to this process, Regulation D itself does not preclude issuing stock to some non-accredited investors even under its own rules and, moreover, Regulation D did not and does not supersede the prior regime under Section 4(2), meaning that any startup can issue stock to any person (accredited or not) in any "private placement." Thus, startups can and do issue stock all the time to persons who are not "accredited investors." This can be done in many cases without problem, including to friends and family investors. The problem is that it is riskier to do, leaving the issuer and its officers and directors at greater potential legal risk whenever they issue stock to non-accredited persons. 12. The Dodd bill would sharply reduce the pool of persons who would qualify as accredited investors and would also require issuers in more situations to meet special regulatory burdens imposed by various states in which their investors reside. Since there have been no big problems in this area, I believe this is a step backward in the world of startup funding, and it will hurt startups in their funding efforts. With the Dodd changes in place, the pool of investors from which to draw will shrink and the process of complying with securities laws will likely go up significantly for many offerings for which formerly accredited investors will need to be treated as non-accredited.

sethg 17y ago

In fact, what we need is to eliminate all accredited investor requirements for small investments of up to $25k. Why does someone have to be a millionaire to invest in a friend's startup? I understand that we don't want someone mortgaging their home, or betting their entire life's savings on a startup. But for a small amount, like $25k, we should not be regulating angel investing. How many non-millionaires would have $25k lying around that they could throw at a friend’s startup without mortgaging their home or doing something equally rash? OK, maybe they wouldn’t have to bet their entire life savings, but cashing in a third of one’s 401(k) to put into a startup isn’t very bright, either.

secret 17y ago
What's funny (well, sad) is that the government considers one an accredited investor by virtue of having money, not actual investment knowledge. You could have a PhD in finance, on the other hand, and be considered by law unsophisticated enough to make an educated investment.
- hga 17y ago
  It's not so much an "educated" investment but one you can afford to lose without significant pain.
  - secret 17y ago
    Good points (you and URSpider), it's just a regulation that really bothers me. Anyway, when I finish my MS in mathemetical finance, I plan to lose money through options instead :). (It's much faster that way lol!)
- URSpider94 17y ago
  This isn't entirely correct. Regulation D also includes requirements that the investor be knowledgeable and experienced enough to evaluate the potential risks and rewards of the investment, and be able to tolerate those risks. However, the net worth/income test is a pre-requisite. Now, in practice, an investor's knowledge and risk tolerance are usually established by signing a piece of paper attesting to such, or at most by having the investor check "YES" in a check-box.

pxlpshr 17y ago

Repeal this bill here: http://gopetition.com/online/32354.html http://gopetition.com/online/32354.html

anigbrowl 17y ago
That'd be a nice trick, considering it hasn't even been debated or brought to a vote yet. Repeal is the process of reversing an existing law. Anyone who doesn't understand this basic concept isn't qualified to have an opinion.
- pxlpshr 17y ago
  next time i'll more carefully monitor my word choice in haste, but then again why bother when I have trolls that auto-check my grammar for me? Maybe you should concern yourself with the proposed legislation, instead of illustrating that you have waaay toooo much time on your hands.

pierrefar 17y ago

Thinking out loud here without being well-versed in the details. If the US moves towards a state-by-state regulatory framework, wouldn't that set up competition between the states to attract investors? To rephrase this, wouldn't it set up a market allowing entrepreneurs and investors to shop around? If California wants to keep Silicon Valley, they're going to have to compete with other nascent and potential tech hubs, and those competitors will be doing their best to attract investors. Let me be clear; I do not like this scenario, but it could be an outcome that makes this item in the bill not as bad as it could have been.

daeken 17y ago
Why is that not a good scenario? If the states are competing with each other to make investments better in their state, how does this do anything but help out investors and startups alike? The only real downside is that you may end up going to Montana to get the best investment, but lots of people already go to the bay for investments as it is, not to mention things like tax incentives for starting datacenters in a given state.
- pierrefar 17y ago
  I don't like this scenario as I think it adds too much hassle rather than promote healthy competition, that it becomes a net negative.
- hga 17y ago
  Problem: as I understand it, the issue is with the state of residence of the investor(s). California today has a critical mass of angels (but how much further can the state decline before enough of them flee???). But let's say I was in Arlington, Virginia (not hard for me to imagine since I was there from 1991 to 2004 :-). My potential investor pool would ideally include residents of D.C. and suburban Maryland. If Dodd passes I've now got to worry about three different sets of state laws, and I'm sure at least one will be insane. As far as moving to Montana to get that great angel investment (hardly out of the question, look at Simplot and Micron in Idaho), well ... how likely are you to be successful there? Recruiting people to come there wouldn't be quite as hard as to Yellowknife in Canada, but, seriously.... There's reasons the SV startup ecosystem is so good, and Boston's is good enough to make it the undisputed #2. Expecting to go just anywhere and replicate the same success strikes me as unrealistic.

ojbyrne 17y ago

Umm, this article quotes the numbers on accredited investors from the Business Week article (http://www.businessweek.com/smallbiz/content/mar2010/sb20100318_367600.htm http://www.businessweek.com/smallbiz/content/mar2010/sb20100...) as fact, when it was clear they were poorly thought out speculation. How do people this stupid actually become VCs? Original discussion here: http://news.ycombinator.com/item?id=1213658 http://news.ycombinator.com/item?id=1213658

davidw 17y ago
Good point, but perhaps you could remove the name calling? Simply stating that he's using bad numbers as if they were facts is plenty.
- ojbyrne 17y ago
  If it was some anonymous blowhard on the internet I was calling stupid, I'm sure few if any people would object. But it's a member of the elite, and therefore we have to be respectful. It's a stupid uncritical piece that reflects poorly on the writer.
  - davidw 17y ago
    Someone being an "elite" has nothing to do with it. I don't care who it is; you should talk as if you're talking to someone's face. This is a guideline that's been here for a while ("Be civil. Don't say things you wouldn't say in a face to face conversation.") because it works well in keeping the discussion focused on the issues, rather than degrading into pissing matches.
skmurphy 17y ago
see http://www.angelcapitalassociation.org/resources/public-policy/federal-policy-issues/highlights/ http://www.angelcapitalassociation.org/resources/public-poli... The Angel Capital association has looked at three sections o Sec 412 (page 380) Adjusting the Accredited Investor Standard for Inflation o Sec 413 (page 381) GAO Study and Report on Accredited Investors o Sec 926 (pages 816-819) Authority of State Regulators Over Regulation D Offerings and concluded "These 3 sections that threaten to reduce the number of accredited angel investors in the United States by about 75 percent and complicate the regulation of Regulation D offerings (which include angel investments) to increase the time needed for entrepreneurs to raise money and make it more difficult to get investors across state lines."

deleted 17y ago

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apinstein 17y ago

> In fact, what we need is to eliminate all accredited investor requirements for small investments of up to $25k. Why does someone have to be a millionaire to invest in a friend's startup? IIRC, you don't have to be an accredited investor to invest in a friend's startup. You only need accredited investors if you're soliciting investment publicly. It's part of "Regulation D" of the SEC code: http://en.wikipedia.org/wiki/Regulation_D http://en.wikipedia.org/wiki/Regulation_D This bill looks like it might have negative side effects on the startup economy, but "friends & family" isn't one of them.

bilbo0s 17y ago
I thought that discrepancy was interesting too. You would think someone like Fred would have known that.
TimothyFitz 17y ago
While it's not illegal to take "friends & family" investment, it adds a lot of legal headache and it's something VCs really don't want to deal with. Startup Lawyer puts it better than I can: http://thestartuplawyer.com/convertible-notes/life-is-too-short-to-deal-with-non-accredited-investors http://thestartuplawyer.com/convertible-notes/life-is-too-sh...

mlinsey 17y ago

Naive question: if as described in point (2) of the OP, the bill would "eliminate federal pre-emption of state regulations of accredited offerings", would this not allow some states to create less burdensome regulations than other states or even than Federal regulations? State governments who wanted a Silicon Valley in their state could then take advantage of this to attract a much better community of investors and startups.

anigbrowl 17y ago
Sure. 1. I haz bizness idea 2. LOL credit cardz 3. ???? 4. OH NOES I'm not being facetious here, really. Lot of businesses get off the ground using bank credit. Kevin Smith famously made Clerks on his credit cards (a film = a startup), won a prize, and sold the IP for a lot of money and further success. But lots of other people have followed the same recipe and failed. Moral: do not assume 'less burdensome regulations' = 'level playing field', especially if you are the needy party.

hristov 17y ago

As it was discussed to death in a previous thread, Dodd's bill does not include any direct increases to the accredited investor standards. So, when AVC says: "Dodd's bill would increase that to $2.3mm and $450k respectively", he is pulling the numbers out of thin air. Dodd's bill says that the SEC shall increase the amount "as the Commission determines is appropriate and in the public interest, in light of price inflation ..." quoted directly from the bill. So the SEC has wide discretion as to how to increase these standards and has to consider the public interest. It is extremely unlikely that the SEC would make the drastic increases this article mentions. It should also be noted that the SEC has had the power to change these numbers at any time since 1982, and has chosen not to do it. So, again it is unlikely that they will now decide to double the numbers. Of course you may think that the bill is still undesirable, because one should not prod the SEC to raise these numbers. But the way the original article worded things was simply not correct.

cakeface 17y ago

Could this hurt startups? Yes. Is this a reasonable compromise when considering the entire financial industry? Yes.