By Tom Still
Imagine this scenari An angel investor hears or reads a pitch from XYZ Software, a local start-up company. He expresses interest in investing in return for a share of the company.
Jane App-head, one of the company’s founders, says her team would be happy to talk…but the federal Securities and Exchange Commission first requires a little paperwork. That includes a mix of the following:
■ A copy of the angel’s tax returns to be kept on file by the company.
■ A letter stating the angel has a “reasonable expectation” of reaching a prescribed income level in the current year.
■ Documents proving that all of the angel’s personal assets and liabilities are disclosed.
■ A third-party letter from a lawyer, accountant or broker affirming the investor is “accredited” under SEC rules…and updated every three months.
Welcome to the SEC’s tortured rule-making process for the federal “Jumpstart Our Business Startups” act. Dubbed the JOBS Act, the legislation was passed by Congress and signed into law by President Barack Obama more than a year ago.
Perhaps the law should be renamed the “Jeopardizing Our Business Startups” act because that’s precisely what the SEC rules will do if the nation’s angel capital industry is buried under a mound of invasive and unnecessary paperwork.
Read this commentary in the Milwaukee Journal Sentinel here.
SEC misses the memo
For decades, the nation’s 200,000 or so angel investors have self-certified as individuals or through organized angel groups that they meet all the legal rules — primarily, income and asset tests — that allow them to risk their own money in a venture that is not a “public offering.” In other words, they are affirming they have enough spare cash to invest in small, privately held firms.
The system works. Those 200,000 angels invested about $23 billion in 2012 in roughly 66,000 start-up companies, from the most complex technology firms to mom-and-pop stores. That $23 billion represents 90% of the equity such start-ups get from sources other than themselves, friends and family.
Given the role of angel investors in the nation’s start-up economy — a phenomenon also evident in Wisconsin — Congress thought it would make sense to end federal prohibitions on the “general solicitation” of capital for privately offered securities. If it became easier to invest and to attract investment dollars, Congress reasoned, more dollars would flow to job-producing start-ups.
Apparently, the SEC rule-makers missed the memo on congressional and presidential intent.
The SEC is proposing to replace self-certification with a general solicitation verification process. It would require most individuals who want to be considered “accredited investors” to provide detailed financial information to entrepreneurs, either directly or through a third party. The rules would take effect Sept. 23, unless blocked or modified.
“The JOBS Act sought to empower the smallest businesses,” wrote the chairmen of two House of Representatives subcommittees in a letter to SEC Chairwoman Mary Jo White. “After violating the legally required implementation deadline for over a year, the commission now proposes to disregard the intent (of the law) by vastly expanding the regulatory burden for (investors).”
In a guest column for the Wall Street Journal, the chairman of the Angel Capital Association predicted early-stage investors “will flee rather than agree to this invasion of their privacy.”
“No angel investor I know would show their finances to an entrepreneur or other issuer of a private security,” wrote David Verrill, chairman of the ACA and founder of Hub Angels in Boston. “Third-party verification also is costly, invasive and burdensome. This financial information in the hands of a (private security) issuer is subject to far more potential for fraud and abuse than could ever emerge from self-certification.”
The potential danger extends to entrepreneurs. Under a proposed SEC rule, entrepreneurs themselves could be subject to more paperwork or risk violating the law. Any start-up that takes part in a public pitch presentation, “demo day” or even some closed events could be sanctioned by the SEC unless they submit certain filings in advance. Those sanctions could come with a Start-up Death Penalty: No fundraising allowed for a year.
Precisely because it’s largely self-regulated and run by people who understand small business, angel investing in the United States works. In Wisconsin alone, angels invested $67million in early stage companies in 2012. Those kinds of investments could evaporate with government overreach. Let’s jump-start more jobs, not jeopardize them.