There has been a lot of debate over a section of the financial reform bill proposed by Senator Chris Dodd, (aka the Dodd Bill), which has a few provisions that could significantly impact angel investing, and ultimately the secondary markets in a very negative way. Although this has been widely covered, and while it appears as though most of the worst parts will be eliminated, we felt we should discuss how it may ultimately affect the secondary markets.
Currently, most technology startups raise their initial funding from angel investors, which by law must be accredited investors. An “accredited investor” is currently defined as anyone with a net worth of over $1MM or net income of over $200,000 a year. The “Dodd Bill” proposes to increase these to $2.3MM net worth and $450,000 annual income, and then index those numbers to inflation.
The second thing the Dodd Bill proposes is to eliminate the existing federal pre-emption over state regulation of “accredited offerings.” This means that venture and angel financings would be regulated state by state, creating a ton of rules and regulations that each financing would need to be subject to. Each financing would require startups to register with the SEC, which could take up to 120 days to review the filing. This may in itself kill most angel investments, since angels like to react quickly to the market, and most technology investments are clearly time sensitive.
Last year, 259,480 angel investors invested $17.6 billion in 57,225 entrepreneurial ventures. There are over 240 million Americans that reported earnings in 2009, with 2.5 million earning over $200,000. That means only 1% of the U.S. population currently qualifies as an eligible “accredited investor”. The problem with the Dodd Bill is that it could dramatically reduce the total number of eligible angel investors, which is what has everyone in an uproar.
The negative impact will be severe. First, fewer angels will make capital more expensive, fewer startups will be funded, and innovation will be stunted. However, in the short term, this may actually create an even higher demand for shares on the late stage growth startups like Zynga, Facebook, Twitter and more within the secondary markets among the remaining eligible angel investors.
The secondary market will also suffer as there will be fewer “winners” to invest in.
Government is never in equilibrium, and tends to extremes. We were basically on a 30 year de-regulation binge, that with 20/20 hindsight, went to far, and destroyed a lot of wealth. It appears we may now experience the blowback, the new extreme will be too much regulation that will likely destroy even more wealth than the de-regulation binge.