By: Jim Verdonik
Founder of Innovate Capital Law
Contact me at:
Jim is the author of Crowdfunding Opportunities and Challenges .
(This article incorporates an article originally published in Triangle Business Journal in March 2016)
I recently saw a press release for a Crowdfunding platform that indicated it was "the place for Millennials to invest."
That made total sense.
There is no legally imposed minimum age for investing like there is for driving, voting and drinking, but securities rules that limit investments to "accredited investors" exclude most young investors. Few young investors satisfy accredited investor requirements - net assets of $1 million or more (not including primary residence) or income of $200,000. Most people have to work a couple of decades to achieve that. That's why most angel investors are middle age and older.
Lawyers call this "disparate impact." You primarily hear about "disparate impact" in civil rights cases, but many laws have disparate impacts.
SEC Rule 506 is a good example of disparate impact. More than 90% of private offerings have used Rule 506. What is now Rule 506 (b) permitted issuers to sell to a limited number of unaccredited investors, but imposed such strict disclosure requirements on sales to unaccredited investors that most securities lawyers advised clients not to sell to unaccredited investors. New Rule 506 (c) prohibits sales to any unaccredited investors.
Crowdfunding rules don't explicitly lower the investing age, but state Crowdfunding, Regulation A+ and Section 4 (a) (6) offerings all permit non-accredited investors to invest in offerings in which issuers can make general solicitations.
To see the effects of the disparate impact of securities laws on our economy, let's look at a place where 20-somethings sometimes get rich quick. It's called Silicon Valley. Young tech workers who start or join start-ups sometimes hit the jackpot and skip decades climbing the wealth generation ladder. Many Silicon Valley start-ups raise capital from young investors who meet the accredited investor definition.
Is it just a coincidence that Silicon Valley is a great place for start-up tech companies to raise capital?
Or does creating a younger class of investors promote economic growth?
By changing investor demographics, Crowdfunding may supercharge capital raising and economic growth:
- Younger investors are usually less risk adverse than older investors.
- Younger investors are often early adopters of certain of technologies and products. They will invest because they recognize that they and their friends will be eager customers.
- Social entrepreneurs may also find it easier to raise capital from younger investors, who focus on doing good while investing in socially sustainable businesses.
For these reasons, Crowdfunding is an excellent example of how technical legal restrictions have major unintended consequences.
No one planned to make it harder for technology and social entrepreneurs to raise capital. That was an unintended side effect. So, when we try to forecast the effects of Crowdfunding or other technical legal changes, we should recognize that old laws almost always have unintended side effects. When we change or eliminate old laws, no one can fully predict the impact when old unintended side effects die.
Trying to Protect Unaccredited Investors Often Has the Opposite Effect
Let's talk about another Crowdfunding example. Did you know that both Federal crowdfunding and state crowdfunding laws contain technical restrictions on raising pools of money to invest in other businesses? Did you know these restrictions are creating greater risks for unaccredited investors than for accredited investors in other types of offerings?
You might ask yourself (or your legislator): Why are securities laws protecting accredited investors more than non-accredited investors?
Let me explain how this works. In Rule 506 (c) offerings that are only open to accredited investors, investors are free to invest in a limited liability company or other entity that uses their money to invest in a business. The LLC pools many small investments. Its manager monitors the investment for a fee - usually a percentage of profits. These investment pools or "syndicates" promote:
- Due diligence by the manager.
- Coordinated voting power by the investors.
- Diversification by investors who invest small amounts in many "syndicates."
That sounds pretty useful. Right? Who opposes diversification, due diligence and voting?
Unfortunately, the zeal to protect non-accredited investors from supposedly predatory syndicate managers deprives non-accredited investors of investment tools that accredited investors find very valuable. So, as we eliminate unintended consequences of old securities laws, new securities laws create new unintended consequences.
Future articles will discuss other unintended consequences.
Why can't we design better laws?