

Ask HN: Should we reduce the restrictions on who can angel invest? - johnrob
http://johnrob.blogspot.com/2010/02/thoughts-on-accredited-investor.html

======
grellas
Actually, the securities laws do permit investments by non-accredited
investors within limits. For example, California has a so-called limited
offering exemption by which a corporation can issue stock to up to 35 non-
accredited investors in any given round who have a pre-existing relationship
with the company or its founders and who warrant that they are acquiring the
stock as an investment and not for resale (federal law also supports
investment by non-accredited investors, as for example under Rule 504 of
Regulation D). This exemption would generally allow, for example, for a
company sale of stock to the employee who saves up $10K and wants to buy in an
angel round.

Though the law allows limited avenues for such non-accredited investments, the
securities law rules nonetheless operate in practical terms to bar most such
opportunities. VCs, for example, are very hesitant to invest in a company
along with a lot of non-accredited investors. This means that startups will
hesitate to open up such opportunities.

Thus, the essential point of this piece is a good one. Why arbitrarily
restrict the ability of individuals to invest in promising opportunities? The
theory of the securities laws is that investor protection warrants the
restrictions and this impulse, far from being on the decline today, remains
strong (there are, for example, current attempts in Congress to _increase_ the
requirements for what it takes to qualify as an accredited investor). So the
question becomes, in re-evaluating these requirements, should the law take a
more, or a less, paternalistic direction. Protection is fine but it does have
its costs in limiting choice.

While I have not given much thought to how the restrictions might be eased, I
would definitely say that the efforts currently afoot to tighten them would be
a horrible mistake for the startup world, for founders and investors alike.

~~~
portman
The same law that defines "Accredited Investor" (Regulation D) also defines
the situations in which the investor does not need to be accredited. There are
three categories of exemptions:

<http://www.sec.gov/answers/rule504.htm>

<http://www.sec.gov/answers/rule505.htm>

<http://www.sec.gov/answers/rule506.htm>

I encourage everyone on HN to become familiar with these exemptions, because
there is rampant misunderstanding of Regulation D. (For example, I have
personally been downvoted several times on HN because people mistakenly think
that only Accredited Investors can do angel investments.)

~~~
tptacek
I read grellas' comment as pointing out that although there are limited
circumstances in which non-accredited investors can invest, it's not a good
idea to do so because of the impact it has on financing down the road.

------
dschobel
How angel investing is fundamentally more pernicious to personal wealth than
casinos, credit cards or time-shares I'll never understand.

Although you have to admire the tenacity with which our congress tries to
legislate common sense....

~~~
cperciva
_How angel investing is fundamentally more pernicious to personal wealth than
casinos, credit cards or time-shares I'll never understand._

It isn't; and there are no restrictions on who can invest in startups...
subject to one caveat, of course: The company issuing the stock must satisfy
the standard disclosure rules.

Casinos, credit cards, and time shares are all heavily regulated; they don't
have exactly the same regulations as stock offerings have, but overall I'd say
they're similarly burdensome. The current situation vis-a-vis angel investing
isn't an extra regulatory _burden_ ; rather, it's a loophole which allows --
under certain circumstances -- startups to suffer _less_ regulation than other
similarly risky enterprises.

~~~
lisper
> It isn't

It is, for two reasons:

1\. The minimums are higher.

2\. You are not _guaranteed_ to lose in angel investing the way you are in a
casino. That makes angel investing much more difficult to resist than ordinary
gambling.

------
mrshoe
I'm not sure this would fix the problem.

According to the pg quote in the article "There probably aren't more than a
couple hundred serious angels in the whole Valley." There are _tons_ of people
in the Valley who make >$200k/year. Tens if not hundreds of thousands of them.
If only a couple hundred of those people take the risk of angel investing,
what would lead us to believe that a lot of the lower-salaried people would
choose to participate?

I agree that the law seems a bit silly, and probably unnecessary, but I'm not
sure that removing it would have much of an effect.

Which leaves me thinking about other ways we could encourage more angel
investing activity....

~~~
johnrob
The problem is that most people earning over 200K/year in salary are not part
of the startup community (what kind of startup pays that kind of salary?).
They're probably too scared to invest, and rightfully so.

On a side note, your comment made me think of one silver lining in the current
law: if nothing changes, inflation should break down this barrier. I wouldn't
be surprised if in 10 years time, startups pay over 200K.

------
petercooper
Here in the UK there are no restrictions at all (that I'm aware of) over
investing into private companies. There's also a 30% tax break on doing so
through the venture capital trust scheme (with the restrictions that implies)
- <http://en.wikipedia.org/wiki/Venture_Capital_Trust> \- _and_ there's no
capital gains or income tax to be paid on VCT gains! (Note: I am not your
financial advisor!)

Despite this, the UK isn't known as a hotbed of angel investment (at least,
not in tech) and it hasn't "hurt" us.. so why not?

------
coffeemug
It seems to me that creating an open market for angel investment will cause
all the problems the public market went through in the past few hundred years
(bubbles of extraordinary proportions, fraud, etc.) That means the government
would have to establish more and more regulation to prevent abuse, which would
severely limit the ability of startups to operate. Having the market be
restricted to a pool of accredited investors instead makes more sense to me.

~~~
johnrob
The bubbles seem to exist regardless of what we do; the fact that they've been
around for hundreds of years suggests it would take more than a few laws to
suppress them.

~~~
Retric
I got the impression that while bubbles still exist they are smaller relative
to GDP than they used to be.

------
tptacek
I'm not sure this law is in place because of the risks of startup investing.
It seems rather more likely that it's there to protect the public from
outright fraud, "Cash4Gold"-and-"Gold4Cash"-style.

------
aditya
How do friends and family rounds get around this angel investment rule?

~~~
_delirium
Many don't do official rounds at all--- if your dad wants to donate $10k to
you with no strings attached, in return for an informal promise that you'll
fund his retirement if you strike it rich, there's nothing standing in the way
of that.

------
andrewljohnson
In theory, angel investors are limited. In practice, that is not the case.

There are many ways for your Uncle Jimmy to give you $10K without needing to
be accredited. And if it's not your Uncle Jimmy investing, or they want to
give you $100k, they are probably accredited.

The rules around angel investing are a non-issue.

~~~
johnrob
Show up to YC demo day as a non-accredited investor, and tell us how it goes
:)

~~~
andrewljohnson
Show me the Angel that shows up at YC demo day wanting to invest $10K.

~~~
johnrob
Chicken and egg problem - because of the high barrier to angel investing, you
are right that most investments are probably larger. But would they
necessarily be so high, if more people were legal (especially hackers who
could be good contributors/selectors)?

~~~
_delirium
I don't think it's purely that. VC demo days may not be the best place for
someone with modest assets to find something they want to spend $10k on. They
might have better luck talking to their friends, for example, or friends of
their friends. The angel restrictions don't apply to those cases, either: it's
only really official solicitations and funding rounds for which there are
restrictions. If a few people get together and want to put in $10k each to a
business one of their friends is starting, there is no law against that. It
long predates tech startups, too; plenty of restaurants, dry-cleaners, and
other traditional small businesses get their seed funding that way.

------
timcash
Your point seems to pass the test for me. Is there a place for people to group
up and make these types of investments? Say 10 people each want to make a
$2000 investment. Seems like a good idea to me...

------
gojomo
You're allowed to put your money in public stocks that essentially go to zero
(GM, Lehman, Fannie Mae), and you're allowed to gamble all your money away
(and then some via borrowing) on negative-expectation government lotteries or
licensed casinos.

So it's silly and unfair to then prevent regular people from putting a small
portion of their savings in risky -- but possibly positive-expectation --
private investments.

~~~
evgen
The difference is that there is a limit to the number of public stocks and to
the number of regulated casinos and lottery schemes that are out there. This
makes policing the system for fraud and abuse a somewhat tractable problem. If
there were no limits on angel investing then it would, in a heartbeat, become
the preferred mechanism for scammers and fraudsters -- instead of getting
sucked into a pump and dump scheme that the SEC might eventually find the
victims would invest in fraudulent companies that would disappear in a puff of
smoke once the checks clear...

~~~
gojomo
What's there to 'police'? It was legal for GM to go bankrupt wiping out its
stockholders. It's legal for a casino to take all a person's money.

(And even the 'tractable' policing doesn't work so well: see Madoff and many
smaller scams.)

What's more, those people willing and able to 'disappear in a puff of smoke
once the checks clear' can already do so. They don't care so much about the
rules, and if willing to deceive can make their scams appear to fit whatever
rules are in effect.

And if this wave of fraud you predict were to appear, people would learn
quickly. (Are there that many people who'd race to invest in loosely-attached,
no-reputation fraudsters? Moreso than those same marks already gamble or buy
snake oil?) And you could still chase down the biggest fraudsters, using the
same laws and mechanisms that already exists.

If any rule is necessary, a far more sensible rule would cap private-equity
investment at some liberal percentage of net worth -- say 50%. You can easily
lose 50% of your money in public stocks, even the stock market as a whole. So
even the stupidest non-millionaire private investor wouldn't lose everything
before understanding, "Hmm, I may need to do some due diligence on these get-
rich-quick schemes!"

~~~
tptacek
GM was required to disclose huge amounts of information to the public on a
regular basis about its operations and cash flow. The SEC doesn't exist to
reduce the risk of bona fide investing. It's there to reduce the instance of
out-and-out fraud.

------
presty
offtopic:

since when do "ask hn" topics link to a frakkin blogpost?

