To say the least, there has been mannered criticism of Sen. Dodd’s proposed banking bill as this relates to angel investing. The issue is this: A provision in Sen. Dodd’s proposal resets the definition of “accredited investor” – a necessary qualification in a private financing transaction – to a level of personal wealth that exceeds the previous standard. The vocal opposition bases its argument on the following complaints:
Because entrepreneurs – in order to mitigate resource-draining public listing requirements – typically source startup funding from angels who are accredited investors, the proposed bill will make it more difficult for startups to raise capital by reducing the number of angels qualified to invest. As bad as such a development would be for entrepreneurs, there is a broader economic consequence, in that startup finance is used to create – among other things – jobs.
The counterargument – or rather, the bill itself – is based on the defense of the vulnerable, the less sophisticated, and their capital: Vulnerability determined by an accreditation standard, in turn determined by wealth; defense against the whims and fancies of risk-taking (and implicitly more sophisticated, although less wealthy) entrepreneurs, which whims (and fancies) may lead to loss of capital.
The debate, as far as I can see, is at this point theoretical and built on platitudes. To advance their respective cases, the two sides may want to make it less so. Here is a list of issues that could warrant further analysis if either is to be taken seriously:
- According to certain estimates, the Dodd bill would reduce the number of accredited investors by 77%, a statistic to which the side against has latched. Does this estimate, however, truly signify that the number of angel investors will decline by 77%? Not unless all accredited investors are also angels, which is surely not the case, and perhaps not even close to reality. A more informing calculation, equally plausible to undertake, would be to show how historical startup financings would have been impacted by Sen. Dodd’s redefined accreditation, and if there would have been a material drop-off in investments closed or a material change in syndicate compositions. My suspicion is my own, and hinges on anecdotal observation, but angels in my experience would probably satisfy the new accreditation standard just as they did the old.
- If Sen. Dodd’s intention is to save the less prepared investors, defined as less wealthy by whatever standard, from undue risk and capital erosion, targeting the startup finance asset class may be the proverbial cart before the horse. For starters, it would be interesting to see how angel investing, as a class, has actually fared in comparison to other alternatives. By way of reference, public equity markets lost about 50% of their value in 2008. (I understand that portfolio diversification could complicate the study, but if portfolio theory should factor into the debate, this is a subject that has not even yet been broached.)
- In the macroeconomic case against the new legislation, that startups create jobs and support economic growth, there should be a quantifiable method to show both the number and the types of jobs that startups have created in the past decade of explosive startup growth. Based on personal experience and anecdotal support, once again, startups create jobs when successful. When startups fail, jobs are lost. Most startups fail – by a wide margin – and the “employees” thereof work at low or no pay in the meanwhile. In many cases they are paid in equity, which, when startups fail, is worthless. (By the way, there should be a delineation between “small business,” which statistics show to constitute the majority of employment in our economy, and small businesses that are angel-backed startups. Small businesses such as the local dry cleaner or gas station are not what the angel accreditation rigmarole is currently about.)
