Ask HN: Should we reduce the restrictions on who can angel invest? | Hacker News Reader

Ask HN: Should we reduce the restrictions on who can angel invest?

johnrob.blogspot.com

17 pointsjohnrob30 comments

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.

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.)

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.

Regarding the employee saving 10K to invest - it's fine for an employee to invest in the company he/she works for. However, since that company already has employees it stands to reason that 10K is probably not going to buy much equity. If the employee wants a bigger piece of a startup, he needs to look for an seed opportunity (one that is probably legally off limits).

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....

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.

> 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.

For some reason people are more willing to invest all there money in a single company than just put it all on black in las vegas. Granted when you don't have a lot of assets it can be the best choice, however if you are close to retirement then it can be devastating.

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....

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.

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?

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.

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.

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

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.

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

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.

Friends and family is one of the exceptions to the SEC rules.

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.

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

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

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)?

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.

I think the law is fine as is. If you have $100,000, then you don't have any business making strategic investments in early stage start-ups. And if you really want to, you can, though not through certain forums.

To some extent, the government absolutely must protect people from their own ignorance. Being a so-called accredited investor is a very low bar, and there are ways around it anyways. Credit cards laws are an excellent example of laws that protect people from themselves, and that should be stricter still.

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...

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.

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...

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!"

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.

offtopic:

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

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