Securities regulators hope a change in the federal definition of accredited investors brings more people into the investor pool for startups and other companies seeking private capital, although it remains unclear whether it will significantly affect the flow of capital.
The U.S. Securities and Exchange Commission’s new rule that takes effect this fall broadens the definition of an accredited investor who can participate in private offerings to include people who hold certain financial professional accreditations or certifications and “knowledgeable” employees at private investment funds.
Rather than rely on an income and wealth threshold in place for nearly four decades, the rule modernizes the definition by opening accredited investor eligibility to people who are financially sophisticated enough to understand the inherent risks of investing in private offerings.
“In terms of raising money and for our clients and for business, people who have these types of credentials should be smart enough to not spend their money unwisely,” said Josie Boucher, executive partner of Warner Norcross + Judd LLP’s Kalamazoo office who chairs the law firm’s Funds and Investments Services Practice Group.
Boucher cites, for example, financial professionals who are licensed by the Financial Industry Regulatory Authority (FINRA), an organization that writes and enforces the rules for registered brokers and broker-dealers in the U.S., as having the sophistication for an accredited investor.
The SEC rules defining an accredited investor are designed “to protect people from themselves,” she said, “and I don’t know how much protection people who are highly qualified need from themselves.”
Growing the pool?
Investment professionals MiBiz contacted for perspectives on the SEC rule change said the updated definition is long overdue, though they wonder how far it can actually grow the investor pool in the U.S. and the availability of private capital.
“While the actual numbers of those affected by this rule change is small in comparison to the investing populace, I do think this signals a small step forward by the SEC in using something other than net worth as an indicator of accreditation. This takes into account personal experience and sophistication and sets it on par with net worth,” said Dale Grogan, managing director at Grand Rapids venture capital firm Michigan Accelerator Fund I.
Skip Simms, managing partner at Michigan Angel Fund in Ann Arbor who has been pushing to grow the pool of angel investors in the state, gave the SEC rule change a “thumbs up.”
The rule change can grow the investor pool, although potential angel investors who may now meet the new accredited investor requirements still need to have accumulated enough wealth to actually invest, Simms said.
“It opens the door a little bit more for more people to invest in private equity, but I’m not confident it will significantly move the needle in terms of making millions of dollars suddenly available for small businesses, startups and various entrepreneurs,” he said in an email. “Allowing financially sophisticated people not yet considered high net worth is good, but without a high net worth they will not have the wherewithal to make significant investments, and they already had the ability to make small investments through crowdfunding platforms. … We’ll know within a year how meaningful these changes will be.”
Perhaps more important to Simms is that the new SEC definition would allow entities such as limited liability companies, family offices and their family clients, rural business investment companies, Native American tribes, and governmental bodies with at least $5 million in assets to become accredited investors. Those entities “could put millions into the private economy quickly,” he said.
“The bigger news that appears to me is the impact of the addition of certain institutional investors,” Simms said. “Angel funds and micro VCs could be big beneficiaries. The funds offer a less cumbersome way for these investors to achieve the diversification they need for high returns without having to allocate a lot of time to source and do the diligence needed for success.”
‘Thoughtful and appropriate’
The present definition of an accredited investor goes back nearly four decades and uses a financial threshold. To become an accredited investor, a person needs an annual income of at least $200,000 or minimum assets of $1 million.
“It was solely tied to wealth,” Boucher said. “If you did not hit those, you could be a fantastic, sophisticated investor, but you could not qualify as an accredited investor.”
Boucher calls the changes by the SEC “thoughtful and appropriate.” Like others, she’s unsure how many new accredited investors could result from the definition change, though “there’s a lot of times people are close, especially at the beginning of their careers, to those thresholds, but haven’t hit them.”
“They would have been unable to participate in these types of offerings because they don’t qualify as an accredited investor,” Boucher said. “Now they would, if they can fall into one of these new categories that were specifically added.”
Tim Parker, president of Grand Rapids-based Grand Angels, also welcomes the updated definition, including the addition of “spousal equivalents.” That change allows, for instance, domestic partners to “pool their finances for the purpose of qualifying as accredited investors,” according to the SEC.
Parker considers the rule changes “one step in the right direction” that brings the accredited investor definition “forward to the 21st century.”
“Certainly, the pool of investors will increase by allowing family offices, financially certified individuals or knowledgeable employees to invest in private offerings. It is also encouraging to finally allow spousal equivalents, rather than simply spouses, to be considered when calculating net worth,” he said in an email.
Lower thresholds for equity
However, Parker wishes the SEC had gone further. A board director at the Center for American Entrepreneurship, Parker hoped to see regulators lower the net worth threshold to enable more people to become involved in angel investing.
“In order to bring in more investor diversity, lowering the net worth requirement as long as investors are working with a professional investment organization will provide a more equitable playing field. This will not only bring in younger investors, but also help us create an investor base that more accurately represents the communities we serve,” Parker said. “The connection to an investment organization will provide education helpful for new investors. New businesses are the lifeblood of our economy and we need to allow more people to participate.”
Even in issuing the new 166-page regulation Aug. 26, the SEC said it was unable to estimate how many more people could become accredited investors, although commissioners “are confident that the final amendments will cause some modest increase in the number of individual accredited investors.”