Why we have it so good as investors compared to the US
At the start of the year, I saw tweet that I assumed was a piece of fake news.
Made by Steve Burns, the tweet said:
"95% of Americans are not allowed by law to invest in start-ups. Only ‘accredited investors’ are entitled to do so, but you can buy lottery tickets all you want or go to Las Vegas to gamble."
A quick dig around, however, and it soon became apparent it was anything but fake news. Or even remotely inaccurate. For the most part, it proved to be completely and utterly true.
And to someone who's always just assumed investing into early stage startups was something we could all do through the likes of equity crowdfunding, this information as fascinating.
Appreciating our position
‘Make America great again’ was the campaign slogan of Donald Trump and it proved to be a winner – as had a similar phrase for Ronald Reagan.
Both men were making an appeal to Americans’ deeply ingrained image of themselves as a nation of independent, self-reliant, freedom-loving entrepreneurs.
After all, wasn’t the US the home of buccaneering capitalism, where a laissez-faire impatience with the restrictions of regulation and privilege meant that anybody, with a bit of get-up-and-go and hard work, could make money?
This view of the US has been shared by other countries. Even in the UK, we have tended to look enviously across the Pond, wishing that we had more of that swashbuckling freedom and were less handicapped by an overactive nanny state.
These are the stereotypes and, like most clichés, while they contain an element of truth, they also simplify to the point of misleading.
In fact, in the UK, if it weren’t for our own national characteristic of understating our strengths, we would recognise an important truth: when it comes to financial innovation and pioneering ways of financing new business, it’s we who are the true champions of free enterprise.
Making startup investing unnecessarily complex?
In the UK we take it for granted that if you want to invest your own money in a business or enterprise which is engaged in legal activities, then you are perfectly free to do so and this is a right which is not restricted to people who are already wealthy or who have certain qualifications.
Most British people would be astonished to learn that that’s not the case in the US, the Home of the Free.
Under US federal law, a company that seeks to raise capital by selling securities has to register with the Securities and Exchange Commission (SEC), which entails costly and time-consuming procedures.
To be fair, this isn’t terribly different to the situation with our own Stock Exchange, which isn’t usually regarded as being too onerous for a large and established business. However, for start-ups without a trading history or deep pockets but with a need to raise capital quickly, jumping through these hoops can be a major headache.
Sure, US law does provide some exemptions, but they are incredibly tight. Take Rule 506 of Regulation D, to give a flavour of the bureaucracy. This allows a company to sell securities without registering with the authorities to be ‘accredited investors’.
The law’s definition of an accredited investor is almost 2,000 words long, broken down into paragraphs, subparagraphs and explanatory notes. In summary, to be counted as an accredited investor, you have to demonstrate an annual income of US$200,000, or US$300,000 for joint income, for the last two years with expectation of earning the same or higher income in the future. Not only that, but you must have earned income above the thresholds either alone or with a spouse over the last three years.
And if you don’t qualify? Don’t despair - you can also be considered an accredited investor if you have a net worth of at least US$1m, either on your own or jointly with your spouse.
Furhthermore, the SEC considers a person to be an accredited investor if they work at a senior level for the business issuing the registered securities. And an organisation can be an accredited investor if it is a private business development company or an organisation with assets worth more than US$5m.
These regulations – designed to protect the financially uneducated – are highly restrictive. So restrictive in fact that it has been estimated they rule out some 92% of the US public.
Helping US investors
Admittedly, in 2016, there was some relaxation of the rules.
First, Congress modified the definition of an accredited investor to include registered brokers and investment advisors. Also, if a person can demonstrate sufficient education or job experience showing their professional knowledge of unregistered securities, they can also be included in the definition.
More significantly, in May 2016, a new law - Regulation Crowdfunding - made it legal for the general public to invest as little as US$100 in private companies.
However, there are still a number of notable restrictions and bureaucratic hurdles. For instance, the fundraising company has to file a Form C with the SEC, disclose up to two years of accounts, along with other details, which includes number of employees, officers and directors, stakeholders with more than 20% voting power, past fundraising rounds, use of funds. All material risks.
Even then, only US$1,070,000 can be raised from a Regulation Crowdfunding offering each year – for any more a company must turn to accredited investors.
Nor does the federal government confine itself to policing the fundraising company. The investors still have restrictions imposed on them: namely they are limited to investing between 5% and 10% of their income or net worth each year.
Bo Lais, CEO of US-based startup Lula, explained “No matter how you slice or dice it there isn’t an easy way in the USA to raise funds for your startup as an entrepreneur, but at the end of the day, the securities laws are in place to protect average income Americans. The unfortunate by-product of that is that it makes an already challenging task of getting your startup off the ground even harder.”
“We’ve raised $535,000 to date, but only with accredited investors, and we work closely with our attorneys to make sure we comply with the securities laws. That way we won’t have complications when raising later rounds.”
“In many ways it’s a huge shame that this has had to be the case, from a startup point of view, we need to take the route that’s best for us as a company. And we can’t hide the fact that it’s worked for us.”
Supporting the next generation of British businesses
Thankfully, in the UK it’s much easier for small investors to invest in high growth start-ups and therefore for such businesses to raise capital. This has allowed the emergence of innovative and flexible models whereby small investors can co-invest via online platforms alongside professional investors and institutions.
This is important for three reasons.
It allows the UK to make the most of its strength in financial services and a national genius – by no means confined to the City of London – for constantly evolving financial instruments and processes and combining these with advances in digital to keep us at the leading edge of fintech. This will be of increasing importance post Brexit.
Second, it makes it easier for exciting and ambitious high growth businesses to raise the cash they need to fuel their development into the world-beating businesses of tomorrow.
Finally, and most importantly, it’s fairer: it allows everyone to share in the benefits of a capitalist economy.
Since the crash, those with modest savings have seen them eroded as banks have offered interest rates below the rate of inflation. Meanwhile, through quantitative easing, central banks have pumped liquidity into the system. Raising asset prices, for those who hold them this can undoubtedly be a positive - but for those who haven’t had the opportunity to invest, it makes that opportunity even more difficult.
With the US restrictions on who can invest only serving to widen this gap, denying smaller investors a share in those high growth opportunities to which others have access is not a healthy, reasonable or fair situation from my point of view.
And definitely not a situation we share here in the UK.