Startups Get Hit By Shrapnel In The Banking Bill

http://www.avc.com/a_vc/2010/03/startups-get-hit-by-shrapnel-in-the-banking-bill.html

by ankeshk • 16 years ago

102 73 16 years ago

sethg4• 16 years 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.

lrm2422• 16 years ago

It's not the governments place to tell you how to invest your money in the same way they don't tell you how to spend your money. It is an unfortunate artifact of bad legislation that the government feels the need to protect its citizens from foolhardy investments.

jacoblyles• 16 years ago

It is the government's place to tell you how to invest your money when they are backstopping all of society's risk.

anigbrowl9• 16 years ago

Regulation D was not created by Congress, FYI. The SEC created it in 1982 under the Reagan administration, when Donald Regan was treasury secretary.

davidw3• 16 years ago

Ok, but there are plenty of other ways that stupid people find to lose their money, so why not let them? It's not as if they have to invest the full 25K. You could put that money on a horse, invest it in Worldcom and Enron shares, and all kinds of other equally stupid ideas.

dabent• 16 years ago

One of the comments in the article says "If I can mortgage my house and bet it on black at a roulette wheel in Vegas, I can surely invest in a friends startup, regardless of how wealthy I am."

There's a lot of ways to just blow money, but so many restrictions on investing it.

thaumaturgy• 16 years ago

Upper-middle-class family.

noodle• 16 years ago

would you be happier if he said something like $20k or $10k?

sethg4• 16 years ago

Maybe some formula along the lines of “no more than X% of the investor’s net assets or Y% of the investor’s annual income”, and a footnote saying that for the purpose of computing the X%, your primary residence is not considered an asset and your mortgage on it is not considered a liability.

secret2• 16 years 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.

hga2• 16 years ago

It's not so much an "educated" investment but one you can afford to lose without significant pain.

URSpider942• 16 years 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.

krav• 16 years ago

A PhD in finance should automatically deem you unsophisticated enough to make an educated investment. For proof, I give you Wall Street.

anigbrowl9• 16 years ago

Actually, that is only one of the criteria for accreditation. There are multiple ways to qualify as such without meeting the specified financial thresholds.

chime• 16 years ago

I'm 29. I have two non-millionaire friends who are 27-28 years old and have over 100k in savings each. They saved the money over last 5-6 years by being smart with their finances. Both are willing to invest $20k-$30k in me whenever I am ready. Neither expects crazy high returns (10% interest rate will suffice). They also know that if I hit it big, I will reciprocate well beyond 10%. Both trust me enough that no matter what happens in my life, they will at least get their seed money back in a couple of years.

Even though 25% of savings seems like a big bet, if you truly trust a person, it really isn't a risk. I wouldn't trade my friends for any amount of money so cheating them out of a measly $20k during a stage in my life when I really need their support would be pretty stupid of me. I have life insurance and so if I get hit by a truck, they will be compensated well. I don't see why it isn't bright to invest in your friend's startup if you trust them. Sure, money can get in the way of friendship but as long as there is honesty and maturity among all parties involved, investing can only make the bonds stronger.

My friend loaned me about $10k over the course of a year and I fully paid him back once I was able to. This helped strengthen our friendship instead of tearing it apart. So my personal advice is to go ahead and invest in your friend if you trust him/her. You only have one life and if 25% of your savings can change their lives forever, you gotta give it a shot.

alanthonyc• 16 years ago

Plenty.

250 grand in the bank leaves you a long way from being a millionaire, yet still makes 25k a realistic (albeit relatively large) percentage to invest in one asset.

jedberg• 16 years ago

> How many non-millionaires would have $25k lying around

Me?

lsc• 16 years ago

How many people drive luxury cars, paying $25K more than a two year old non-luxury car?

ibsulon• 16 years ago

raises hand

Single people and Dual Income No Kids.

pxlpshr2• 16 years ago

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

anigbrowl9• 16 years 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.

pxlpshr2• 16 years 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.

pierrefar2• 16 years 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• 16 years 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.

pierrefar2• 16 years 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.

hga2• 16 years 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.

agmiklas• 16 years ago

Canada actually uses this system -- we have 13 SEC-like entities: one for each province and territory. The consensus view seems to be that this adds a lot more headache for very little gain.

The federal government has been trying for ages to get the provinces to give up their regulatory authority in exchange for a national regulatory body, but they've never been able to get it done.

anigbrowl9• 16 years ago

I'm not in favor of that, actually. A single set of regulations is much better than 50 different ones. A similar approach was tried when the credit card market was liberalized, and the outcome was that all the CC issuers just set up Delaware corporations because Delaware had no cap on the amount of interest issuers could charge.

(EDIT: it's not quite that simple - besides Delaware, Utah and South Dakota also offered regulatory environments with no 'usury' caps on interest rates. Please read 'Delaware' as shorthand for 'states with lender-friendly regulations' and bear in mind the summary nature of this already-too-long post. Thanks.)

Now, nobody is forced to acquire or maintain a debt with a credit card, but on the other hand it's rather difficult to build up a credit rating without using credit. To build up a good credit rating, you need to demonstrate the ability to take out a lot of credit. Not having a good credit rating, or not using credit at all and thus not having a rating, imposes all kinds of annoying difficulties - leasing an apartment usually requires a credit check, so do many kinds of employment, and so on. You are administratively penalized, with a resulting economic cost, if you do not show a willingness to incur a significant amount of debt. To my mind this is perverse.

But if you accept the fact and participate by opening and maintaining a credit facility, Delaware law gives card issuers a great deal of freedom to change the terms of your credit arrangement by fiat, such as raising or lowering your credit limit on a whim. Quite a number of people with perfectly good credit who made only cautious use of their credit facilities have lately received letters from their card issuers advising them that their limits had been adjusted sharply downward, often to just above the amount of credit outstanding; as a direct result, their credit score has in many cases been simultaneously adjusted downward because they are suddenly using a much higher percentage of their available-but-newly-reduced credit, despite not having spent any extra money. Unsurprisingly, a good many people have inadvertently found themselves exceeding the newly-reduced credit limit, incurring a $35 or more fee each time (which is added to the amount outstanding) and causing their score to be revised downward (in addition to any other downward revision which took place as a result of the limit reduction). And having your credit score go down is typically cited as justification for a lender to increase the rate of interest you must pay. Indeed, many lenders cite such changes on other lenders' credit facilities as justification to adjust their own terms, regardless of an individual's payment history on their own account.

Furthermore, as there are no interest caps under Delaware regulation, many people find themselves saddled with an APR of up to 30%, at a time when the federal funds rate is effectively zero. This isn't illegal but it is massively punitive. It's many times more than the IRS would demand on an outstanding tax debt, for example. Especially so if you were making relatively cautious use of your available credit, only for your card issuer(s) to cut your credit limit in half and jack your rate up from a 'reasonable' 17 or 18% to 29.99%, as described above. Through no fault of the borrower and with no change in their income and expenditure patterns, creditors have had, and freely exercised, the ability to significantly increase a borrower's immediate liability while simultaneously raising their risk of default from probabilities of 0.5 all the way up to 1.

My personal experience in recent years consists of opening a small credit facility after having avoided any debt for years, managing it somewhat poorly (though in mitigation, this occurred after an unforseeable medical emergency requiring surgery), being penalized as a result, and paying off and cutting up the cards later that year. Now I am fairly financially secure again and unsurprisingly being bombarded with more offers than a sailor on shore leave.

A family member with outstanding credit and and an absolutely perfect payment history (ie no rolling balance at all - in the CC industry such people are referred to as 'deadbeats' because they pay off their credit in full every month and thus generate no income for the issuers) saw their limits revised sharply downwards to just above the amount of the balance they typically accumulate during their grace period, presumably in the hope that they'd bump against the newly-lowered ceiling and set off revenue-generating triggers such as overlimit fees.

This is a very long way of saying that if we shift to a competitive regulatory model, the result will very likely be a stampede towards whichever jurisdiction offers the greatest opportunities for unilateral advantage. Startups will find themselves unable to attract investment participation on any other terms, but will have to set up a shell company and issue their PPM in whichever state confers the greatest advantages to investors. In other words, almost nobody will be prepared to cut a check unless the startup is incorporated in XX state whose regulations will be binding upon founders seeking capital. If the experience of the credit industry is any guide, this is a recipe for reverse takeovers and worse, by allowing investors to change the terms of their investment by fiat, file a claim of default or material breach of the investment terms about 30 seconds later, eject the founders and capture the IP.

Sounds apocalyptic, eh? Sure it does, but few people (other than those lobbying for it) foresaw the evolution of the credit industry when interstate barriers were lifted. Well, you say, investors won't be able to buy in if startups refuse to subject themselves to such onerous terms by setting up and issuing their PPM in such jurisdictions. Riiight....like you can tell the bank you'll only accept credit issued under California law (which IIRC does not allow the freedom to set any interest rate the issuer likes) instead of Delaware law. When you need a significant amount of external capital, you have to go where the money is.

Now, I do agree with the poster elsewhere on that thread who said that changes in the law might encourage startups focus more on organic growth than early-stage capital formation. That might indeed be a Good Thing. But sometimes you have to spend money to make money, and choosing the organic growth route comes with an opportunity cost which is an indirect barrier to entry. While you're feeding and watering your green shoots and waiting for your revenue to grow from a trickle to a stream, there's a much greater likelihood of an astute and well-financed competitor spotting the new market you have created and buying up all the surrounding territory without the bother of going through the acquisition process.

ojbyrne2• 16 years ago

Umm, this article quotes the numbers on accredited investors from the Business Week article (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

davidw3• 16 years 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.

ojbyrne2• 16 years 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.

skmurphy2• 16 years ago

see 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."

anigbrowl9• 16 years ago

A valid opinion, but let's not forget that this is a worst-case scenario from an interested party. I might note in contrast that the SEC has considered this change before and decided against it after public consultation.

Now, asking them to review it again in the wake of a serious financial crisis might result in the effects described, but then again it might not. I don't think that the idea of re-examining the regulatory environment is inherently bad. Capital formation is not being singled out, just reviewed as part of a comprehensive regulatory overhaul.

And yes, I do support a comprehensive regulatory overhaul, which is not the same thing as a general increase in complexity or strictness. It might even result in simplification of regulation by clarifying some of the ambiguity in existing regulation (bear in mind that regulation D was itself written in the wake of a severe recession). Our financial system has been at the epicenter of a truly severe crisis and I think it's quite appropriate to re-examine the rules it operates under.

apinstein2• 16 years 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

This bill looks like it might have negative side effects on the startup economy, but "friends & family" isn't one of them.

bilbo0s2• 16 years ago

I thought that discrepancy was interesting too.

You would think someone like Fred would have known that.

TimothyFitz• 16 years 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-sh...

danskil• 16 years ago

>You have to be a qualified investor.

Does this mean that startups can no longer take money from friends and family?

bilbo0s2• 16 years ago

No.

See comment from apinstein above.

jcnnghm• 16 years 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_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)

anigbrowl9• 16 years 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.

URSpider942• 16 years 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• 16 years ago

If you choose to bear the additional risk hat should be your choice.

sethg4• 16 years 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• 16 years 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• 16 years 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• 16 years ago

great point

messel3• 16 years 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.

grellas2• 16 years 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.

messel3• 16 years ago

It appears that Regulation D is a band aid on a shotgun wound. If I can gamble away my wealth on public stocks, or better yet at a casino, I can certainly back my friend who's building a startup.

The act of getting capital from folks that are under the bar shouldn't damn a startup, there's something wrong with this whole process. We shouldn't stop at just nixing the Dodd bill, we should fix the process of angel investing and pooling resources to back those we trust, even if we don't have net worths over an arbitrary line.

Could a group of people who have net worths under the qualified investor line, pool resources and be considered over the line?

grellas2• 16 years ago

If the pool is formed for the purpose of making the investment, it does not help. The law in that case requires that each individual within the pool be evaluated to determine his or her investment status.

In other words, forming a pool does not allow otherwise non-accredited investors to get around the accreditation requirements. It does not take them "over the line," to use your phrase.

hristov3• 16 years ago

Again, it is not true that you cannot back your friend. Investing in a friend's business is most certainly a private offering, so that it is probably exempt under 4.2 as grellas explained above.

However, if the relationship becomes more tenuous, and he is not really your friend but a friend of a friend or a random acquaintance, then it might be judged to be a public offering.

apinstein2• 16 years ago

The reasons for the Reg D restrictions are not to shield people from risk, but rather to shield them from scams.

When buying / selling publicly traded shares, there is enough regulation to reasonably protect people from outright scams.

However, it is not uncommon for someone to "pitch" investment ideas to the public that are simply scams -- anything from straight-up ponzi schemes to simply running off with money never to be found again, etc etc.

anigbrowl9• 16 years ago

12. The Dodd bill would sharply reduce the pool [...]

s/would/could, per this exchange: http://news.ycombinator.com/item?id=1214242

Without disputing grellas' far more experienced explanation, I would like to reiterate that any shrinkage of the investment pool would be an effective rather than an explicit consequence if this bill were to become law; jurisdiction over the terms of admittance to the accredited investor pool remains with the SEC.

I know, Dodd is a Democrat who leads his committee under a Democratic administration, and Democrats are stereotypically in favor of tightening regulations on business rather than loosening them. Concern about the likely outcome is entirely understandable, although I don't believe Democrats lie awake at night dreaming of new ways to inhibit small-scale capital formation.

Also (and for the last time, I promise), AFAIK no changes are proposed to the provisions of Regulation D which confer accreditation status on any prospective investor who accepts a directorship, partnership, or executive office in a business, regardless of their financial wherewithal (although accepting such a position incurs obligations of its own, with corresponding costs of compliance).

hristov3• 16 years ago

This is all correct except for your last point. As we already discussed this in a previous thread, neither you nor I nor anyone knows whether the Dodd bill would sharply reduce the pool or not.

joelhaus2• 16 years ago

11. [...] This can be done in many cases without problem, including to friends and family investors. The problem is that it is riskier to do...

Can this statement be qualified?

Whether a private or public placement, significant risks surely exist. Beyond the specific context of Reg. D, could one be correct in stating that public placements are riskier?

That said, thanks again for your always valuable contributions to this community grellas.

andrewljohnson• 16 years ago

He fully qualified this statement I think... just follow the logic. He's saying that if you borrow from non-accredited investors, you introduce the risk of them reclaiming their money.

"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."

mlinsey• 16 years 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.

anigbrowl9• 16 years 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.

hristov3• 16 years 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• 16 years ago

Could this hurt startups? Yes.

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

Startups Get Hit By Shrapnel In The Banking Bill

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