A recent amendment to the federal definition of what it means to be an “accredited investor” could have an impact locally by providing more people the opportunity to engage in venture capital.
The long-awaited amendments, adopted by the U.S Securities and Exchange Commission on Aug. 26, create new categories of individuals and entities that may be certified as an accredited investor with the goal of increasing access to private offerings.
The primary change to the definition is that the SEC now considers an individual’s education as a factor, where a wealth test previously served as the sole barometer for those looking to become accredited.
Area experts say that change could increase the amount of people involved in the local venture capital ecosystem.
Under the previous SEC rules, in order to become an accredited investor, an individual had to have a net worth of at least $1 million, excluding one’s primary residence, and annual income exceeding $200,000 for each of the past two years, or $300,000 combined income with a spouse.
Now the definition has expanded to also include individuals who hold certain professional certifications administered by the Financial Industry Regulatory Authority, Inc., such as the Licensed General Securities Representative (Series 7), Licensed Investment Adviser Representative (Series 65), and Licensed Private Securities Offerings Representative (Series 82).
Regardless of their net worth, individuals holding those licenses who are in good standing with FINRA can become accredited, said C.J. Wauters, attorney at Godfrey and Kahn.
It has always been the case that certain key members of operating companies such as directors and executive officers are considered accredited. But now the definition also extends to private fund executives and employees of private funds who participate in the investment activities of their employer’s fund.
Wauters says this change is particularly meaningful because many funds prefer to have their employees involved since they are responsible for analyzing and generating the investment.
“It gives them the opportunity to participate, align their interests and have some skin in the game and this will allow that to happen,” Wauters said.
Locally, the new definition could have an impact on Brookfield-based Golden Angels Investors. The firm consists of a network of 105 accredited investors, but it also manages a training program called Golden Angel Advisors for young professionals who have an interest in entrepreneurship.
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Tim Keane, director of Golden Angels Investors, started the program because he wanted to help more people become angel investors. He was inspired by the Sequoia Scouts Program, through which startups that have been funded by California venture capital giant Sequoia Capital identify and invest smaller amounts in pre-seed and seed technology startups.
“Now, under these rules, some (Golden Angel Advisors) who work in the financial services industry or have other relevant experience could invest or be accredited,” Keane said.
It might also encourage people interested in venture capital to join angel networks like Golden Angels, which allows its members to invest in smaller quantities, Keane added.
“One of the things that this will do is make those smaller investments more accessible to more people because now the young person who is accredited can raise $2,000 or $4,000 without having to write a check for $20,000,” Keane said.
Another significant change to the accredited investor definition is the addition of “spousal equivalence” when calculating whether individuals meet the criteria based on net worth. Now prospective accredited investors can combine their net worth with a “cohabitant who is occupying a relationship generally equivalent to that of a spouse” for the purposes of becoming accredited, Wauters said.
The new definition also includes an avenue for several entities to become accredited, including state-registered investment advisors, exempt reporting advisors, rural business investment companies, family offices, Indian tribes and governmental bodies.
Although these changes may open new capital avenues, the amended definition could become problematic in some circumstances, Wauters said. For example, employers could lean on their employee to make an investment they would otherwise not feel comfortable making. Also, if an investment goes poorly, the employee could lose not only his or her money, but also their compensation or even their job.
Liquidity is often a concern for startup investors because venture capital investments can take several years to generate return. Investors are typically unable to sell their securities prior to liquidity events.
For this reason, many venture capital firms, including Baird Capital, viewed financial education as an important factor even before the SEC modernized the accredited investor definition.
“With this new limit, (the SEC) is taking more of the financial education into account, or how much you know about the financial markets, which is important,” said Katie Schoen, Baird Capital vice president. “From our perspective, you need both.”
