economics

April 16, 2010

Senate Financial Reform Bill Will Hurt Entrepreneurs

Filed under: Uncategorized — ktetaichinh @ 12:05 am
Tags: , , , ,

There is a bill being debated in the U.S. Senate that has provisions which will make it very hard to raise equity from angel investors.

Called The Restoring American Financial Stability Act of 2009 (Dodd Bill), there are three sections (412, 413, and 926) that were written to prevent the Bernie Maddoff’s of the world from defrauding investors. The trouble is, because of one incidence of fraud, congress is going to make it very difficult for entrepreneurs and small business owners.

The Dodd Bill provisions raise the threshold for who can be an accredited investor. You must be an accredited investor to invest in certain kinds of high risk companies. The bar a current accredited investor must meet is $1 million in net worth or $200,000 in annual income. The threshold for both will double if the legislation passes.

Those small companies that have innovative technology will suffer the most. They typically require several rounds of investment. The first comes from non-accredited investors called friends and family, the second from angel investors who must be accredited, and then the third round of investment typically comes from VCs, Small Business Investment Funds (SBICs), and other funds. If the three sections of the Dodd Bill are passed unchanged there will likely be no more ability to raise equity through friends and family and according to some angel investing groups will make as many as 70% of current angel investors ineligible to invest.

The Dodd Bill will no longer allow state securities departments to allow exemptions from registration and allow investment by non-accredited investors.

Additionally, the Dodd Bill will require any company raising equity to register with the SEC and wait 120 days for approval to

Banks, lending institutions and groups of investors that have formed funds under a corporate umbrella have a different standard and shouldn’t be affected by the Dodd Bill.

The net result of these provisions of this bill will to make it very expensive for entrepreneurial and small companies to raise equity. Imagine a company wanting to raise a relatively small amount of money, say $500,000 spending $25,000 to $50,000 on legal fees, then wait 120 days to be approved, only to be able to seek that money from a very small pool of eligible investors. Not only will the transactional costs go up but so will the percentage of equity given to the angel investor. With less angel investors available they could very easily transform from angels to vultures.

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