In the Securities Act of 1933, the definition of the accredited investor came about, which defined who can make investments within high risk securities such as hedge funds, private equity funds, and various other unregulated investments. In essence, it was designed to protect lower income individuals from being preyed upon by upstarts, who can exploit their supposed lack of sophistication. The Act defines those who’s annual income is less than $200,000 ($300,00 with spouse) and at least for private equity funds, they will not allow you to invest unless you have a net worth of at least a million dollars. Technically, if you are starting up a company, you cannot take funding from those who don’t fit the two hundred grand annual income or one million dollar net worth criteria.
I think that the act is definitely important to protect people from being exploited. The problem that I find lies in their determination of a sophisticated investor. As an entrepreneur attempting to get something off the ground, my fund raising to the proof of concept phase could be enhanced by attracting small investments from various friends and family who may not fit the criteria. With Internet companies becoming cheaper and cheaper to fund, a few dollars here and there from friends may be extremely helpful. And at least for my friends, these are people who will undoubtedly be able to fit the criteria outlined by the Securities Act in a couple of years, but technically, I cannot have them involved as investors only today. These are all college educated (some with grad degrees) from top-tier institutions and engage in heavy investing within the secondary markets of the various security exchanges.
I don’t claim to fully understand the Securities Act of 1933, but I think the definition of sophisticated investor should be changed to incorporate the vast amount of information that we now have at our disposal. Blogs, RSS feeds, vertical news shows and the like really have done quite a bit to make the learning curve reasonable for a wide range of people, many who aren’t worth a million dollars. In fact, several grammar schools teach their students about the stock market. I wonder if we’d be better off if there was some sort of standardized exam to get certified as an accredited investor. Does everyone follow this accredited investor rule? No, but as it was preached in my business school courses, I’d love for the Act to be changed to be more current with the times. I think the more people we have investing in start-ups, the more innovation we can expect, and as we all know, it’s the small businesses that move the U.S. economy forward, not the large corporations.