Understanding Angel Investment Regulations

Joe Johnson, Ph.D.
Entrepreneur. Investor. Startup Expert.

Investments in the United States are regulated by the Securities and Exchange Commission (SEC). Their mission, as stated on their website, is “…to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.” The SEC requires public companies to disclose information pertinent to investors so that investors can make informed decisions in their own best interests. In addition to enforcing regulations, the SEC also aims to educate investors.

The SEC is responsible for creating the rules that effectively translate legislation into actionable components. They are tasked with ensuring that the different regulations set forth in the Dodd-Frank Act and the JOBS Act are fashioned into rules that can be followed and enforced. They also work to render political language more readily understandable.

Recently, discussion among investors has focused on potential changes to the ‘accredited investor’ definition. Changes to the investment landscape thanks to the JOBS Act have also led to questions and confusion. This information should help you to better understand the regulations currently in place (as well as possibly upcoming changes):

‘Accredited Investor’ Definition

If you qualify as an accredited investor, it’s not necessary to register your investments with the SEC. The qualification requirements are meant to ensure that those who participate in investment opportunities actually have the means to do so and that they understand the risks associated with investment activities. Under the Dodd-Frank Act, this definition must be reviewed every four years to provide assurance that it’s still valid. The SEC is tasked with investigating whether changes should be made to the definition based on the nation’s prevailing economic landscape. The goal of the investigation (and possible modification of the definition) is to serve as a safeguard that the definition still serves its original purpose: to protect investors.

Adopted in 1982, the ‘accredited investor’ definition had not been altered until passage of the 2010 Dodd-Frank Act, though the investment scene had certainly undergone a revolution. Thanks to the definition remaining static for so many years, ever more individuals qualified as accredited investors. At the same time, the rise of the Internet combined with almost thirty years of financial sector innovation completely altered the financial markets. Simply assuming that the same definition would continue to make sense going forward was no longer an option. In an effort to ensure that the ‘accredited investor’ definition still served to protect potential investors, the Dodd-Frank act altered the definition of ‘net worth’ to exclude an investor’s primary residence and also laid the groundwork for future review of the definition.

Some groups believe that having a large pool of accredited investors makes for a rich startup scene as it permits investment by individuals from more varied backgrounds. They believe that altering the definition to limit investors may curb growth. Regardless, Dodd-Frank requires periodic review until it’s either repealed or amended by further legislation – which is a distinct possibility thanks to H.R. 2187.

In February 2016, the House passed H.R. 2187 which maintains most of the current definition and adds that an accredited investor may also be a person “…whose demonstrable education or job experience qualifies as professional knowledge of a subject related to a particular investment, and whose education or job experience is verified by the FINRA or an equivalent self-regulatory organization.”

The Senate has yet to pass the measure.

Until the measure is passed or rejected, the current ‘accredited investor’ definition, as well as information on how to calculate one’s net worth, can be found on the SEC’s Investor.gov page.

The JOBS Act of 2012

The Jumpstart Our Business Startup (JOBS) Act of 2012 further impacted the relevance of one’s accredited investor status and opened up angel investing opportunities to those who do not meet the accredited investor criteria. According to Angel Capital Association, the JOBS Act serves “…to increase capital available to startups and provide an easier regulatory path for growing companies for successful exits.”

The JOBS Act was enacted after the Great Recession with the hope of sparking an increase in small business activity. An amalgam of resolutions with bipartisan support, the bill covered multiple aspects of small-business fundraising. It relaxed certain regulations for new businesses and eased the transition from private to publicly-traded status.

Advertising Rules

Title II of the JOBS Act – Access to Capital for Job Creators – affects investors in two significant ways:

Firstly, startups are now allowed to advertise to investors. The aim is to enable startups to reach a larger audience and to assist with raising capital. This should also help investors find more opportunities to pursue.

Secondly, while verification of an investor’s accreditation status wasn’t previously required, because startups now have the ability to advertise their opportunities, they must verify that participating investors are, in fact, accredited in compliance with the SEC’s prevailing rules.

Crowdfunding Rules

The Internet has touched almost every aspect of modern life, including investing. Not only does the Internet facilitate network building and information sharing, but the rise of crowdfunding has enabled greater numbers of individuals to become involved in investment activities. Because of its unique ability to enable the participation of people not traditionally considered as accredited investors, crowdfunding also has its own set of regulations.

Title III of the JOBS Act – Crowdfunding – is based on Senate Bill 1970, Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure (CROWDFUND). It expands on investor qualifications and provides startups with access to more potential capital. This part of the JOBS Act only recently went into effect.

As of May 2016, any individual interested in investing (even if they’re not an accredited investor) can purchase securities from a company through a broker or crowdfunding platform. These investments are generally early-stage. Government regulations limit the amount that any one person can invest depending on their income. According to the SEC website Investor.gov:

  • If either your annual income or your net worth is less than $100,000, then during any 12-month period, you can invest up to the greater of either $2,000 or 5% of the lesser of your annual income or net worth.
  • If both your annual income and your net worth are equal to or more than $100,000, then during any 12-month period, you can invest up to 10% of annual income or net worth, whichever is lesser, but not to exceed $100,000.

Businesses which choose to crowdfund are required to follow certain regulations and are limited in the total amount that they’re permitted to raise. For startups that are not in highly-funded sectors, however, this presents a new potential funding stream that may invigorate the entire startup scene.

The investment landscape is constantly changing and it won’t stop anytime soon. With talks of Dodd-Frank changes in the works, angel investors may once again find that the game has been altered. Staying on top of the latest regulations requires a good network and qualified advice from investment professionals.

Sources:

Crowdfunding
https://www.investor.gov/additional-resources/news-alerts/alerts-bulletins/investor-bulletin-crowdfunding-investors

HR 2187
https://www.congress.gov/bill/114th-congress/house-bill/2187

SEC Current Accredited Investor Definition
https://www.investor.gov/additional-resources/news-alerts/alerts-bulletins/investor-bulletin-accredited-investors

Review of the Definition of Accredited Investor
https://www.sec.gov/corpfin/reportspubs/special-studies/review-definition-of-accredited-investor-12-18-2015.pdf

SEC JOBS Act Rules Overview
https://www.sec.gov/spotlight/jobs-act.shtml

Further Reading

The following document is over 600 pages and includes information about Crowdfunding under the JOBS Act and all requirements. https://www.sec.gov/rules/final/2015/33-9974.pdf

About the Author

Dr. Joe Johnson is an entrepreneur, investor, and startup expert. He is the founder and principal of GoodField Investments and the GoodField Foundation (www.GoodField.com).

Joe has a Ph.D. in Entrepreneurial Leadership and an MBA. He is the author of the upcoming book on The Science of Why Most Entrepreneurs Fail and Some Succeed.

Most importantly, he is the incredibly blessed husband of one amazing wife and father of six wonderful children. He resides in Bradenton, Florida. For more information on Dr. Johnson and his work, go to www.JoeJohnson.com.

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