Could the Recent Financial Reform Make it Harder for Your Company to Raise Funds

The recently enacted financial reform law (the "Dodd-Frank Wall Street Reform and Consumer Protection Act" for the sticklers out there) impacts a range of financial services and companies in the way they do business.  For startups and small businesses, it may just make it harder for you to raise funds.  That's because the Act changes the definition of "accredited investor" under the federal securities laws. For a bit of background, the securities laws were originally established in the 1930s amidst the Great Depression as a consumer protection initiative against excesses and fraud in the sale of securities.  Under the Securities Act of 1933, any stock or other securities sold by a company have to either be publicly registered or qualify under one of the limited exemptions.  Which means that companies can conduct limited offerings of stock to certain purchasers, and "accredited investors" fall into a special category with fewer requirements.  The logic being that they are more "sophisticated" than an average investor and can make more educated investment decisions (ed. note: this is regardless of what the last couple of years have shown).

For the past three decades, an accredited investor was any individual with a net worth of at least $1,000,000 - including the value of a primary residence - or who earned a personal income of $200,000 in the past two years (or $300,000 with a spouse) and with a reasonable expectation to repeat this year.  While the income test levels remain the same for now under the new law, the net worth test now excludes the value of the investor's primary residence. In addition, the SEC will have the authority - actually, the obligation - to revisit these amounts periodically in the future.

What does this mean for your company? From a practical standpoint, the new law means companies will need to revisit their subscription agreements and investor representations in offering documents to make any necessary changes before making any further offerings.  This should be done with the help of your company's attorney.

But the net effect is to make it harder to qualify as an accredited investor, which means that there will be fewer of them.  Since the income and net worth tests have remained at the same amounts since 1982, the effect of inflation means that many more people would qualify as accredited investors now than when these rules were adopted.  So this new law ameliorates that change to a certain extent.

But at the same time, it cuts down the available pool of potential investors in startups and small businesses.  That is a good thing in order to protect those people that technically meet the requirements but are otherwise unsophisticated investors.  But it could also result in an impediment to companies who need outside investors to grow, but won't or can't tap the more expensive institutional money available.