Would More SEC Paperwork Really Scare Away Angel Investors?

[Updated 7/17 with correction, see below.]
Letting startups advertise that they’re raising money is supposed to be a boon for early stage companies. But a big advocate for angel investors says new federal regulations could have the opposite effect.

Those new rules, approved by the SEC last week, could effectively “kill angel investing” by making angels jump through new hoops to show they’re rich enough to risk money in early stage companies, the Angel Capital Association says.

“With thousands fewer angels participating in this market, startups will have far less access to capital, the millions of jobs they create each year will disappear, and the economy will suffer,” Angel Capital Association director Marianne Hudson says in a news release today.

That’s probably the harshest reaction I’ve seen to the new rules, which have been alternately praised and criticized in public discussion by lawyers, investors, and entrepreneurs mulling over how their work has changed. Will the effect on angels really be that dramatic?

The new regulations spring from the federal JOBS Act, which became law early last year. Its aim is to make starting and building a company easier by, among other things, loosening some old restrictions on raising cash from investors. One of those changes is ending the ban on advertising, known as “general solicitation,” by investment funds and startups raising money.

But there’s a tradeoff. In exchange for the ability to tell more people they’re raising money, startups now have to abide by new rules for making sure everything is on the up-and-up.

[Corrects joint income threshold from incorrect figure provided by source.]
That’s where the Angel Capital Association comes in. In order to invest your own money in private-company stock, you have to be rich enough that the law considers you a reasonably unlikely to go broke in the process. That means annual income of more than $200,000 for a single person or $300,000 for a couple, or net worth of more than $1 million (not counting your house).

In the past, companies were essentially allowed to prove that their angel investors met that test by asking, and checking a box on their SEC paperwork. But not any more.

Now, the SEC says entrepreneurs will have to get additional proof that angels meet those income requirements for “accredited” investors.

Hudson says that raises the specter of angels having to fork over their family tax returns just for the ability to write a check to a new startup they want to bankroll. And, she says, that kind of exposure could lead lots of angels to just give up.

There’s a catch in the Angel Capital Association’s argument, though. Investors also can have their accountant or lawyer send in a note that says, in short, “We’ve checked, these guys are rich enough to invest, no problems.” Since you have to assume most angel investors have accountants or lawyers already, what’s the big deal?

Hudson acknowledges those protections. But the association’s bigger point is this: There’s not much evidence of angel investors needing this protection, and any bit of extra legal paperwork will just discourage people from making these risky investments in the first place.

“It costs more money. The accountants have compliance officers, and they’re going to have some legal concerns,” she says. “While that does seem like a better option to me than handing my tax forms over to the entrepreneur, it still just creates expensive hassle.”

This comes at a time when venture capitalists have spent several years climbing down the ladder into earlier-stage deals, competing with angels who typically had small-check-writing mostly to themselves in years past. Big institutional funds, of course, are better equipped to deal with lots of government paperwork and regulation than a single investor, although angel groups could conceivably help shoulder out the load.

But it’s not like VCs are universally thrilled with the idea of more government regulation in their business, either. Influential VC Brad Feld of the Foundry Group writes about some of the new, complex filing requirements still being considered by the SEC, saying that he hopes “the SEC will reject these new proposals, especially in the context of Congress’s mandate to Jumpstart Our Business Startups.”

Disclosure: Some Xconomy investors are members of the Angel Capital Association.

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