Public policy shapes the rules of the game that startups and investors must play by as they begin and grow businesses. Sometimes, policy limits who is allowed to play the game at all. The Securities and Exchange Commission’s (SEC) “accredited investor” definition—one of the primary measures that determines who can participate in private securities offerings—is one of those rules.
The definition was created to protect investors and to prevent unsophisticated individuals from losing all of their assets in illiquid and high-risk investments. In practice, however, it limits the group of people that can invest in private companies like startups, especially investors from historically underrepresented communities. The SEC is considering changes to the definition, which could include raising the accredited investor financial thresholds. Doing so would further restrict, rather than expand, participation in startup investment and stand to keep more would-be startup investors on the sidelines.
The current financial requirements in the accredited investor definition might warrant revision, but based on history, it might be to reduce, rather than increase them. For an individual to meet the financial thresholds, they must have an annual income over $200,000, household income above $300,000, or net worth of $1 million or more. These figures have been the same since they were adopted in the early 80s and are not indexed for inflation. That means, over the years, the number of households meeting the financial requirements has actually increased 11 times those that met them at inception. Despite that significant increase in eligible households, there appears to be no evidence the current rules are failing to protect investors from losing their assets and suffering widespread financial loss. If anything, policymakers should consider expanding the definition to include more investors.
In 2020, the SEC did amend the accredited investor requirements, adding the ability of knowledgeable investors to participate that don’t otherwise qualify based on the financial thresholds if they hold certain financial securities licenses. But those amendments did not change the financial thresholds, which remain a problem for communities that face systemic barriers, including fewer opportunities to build the kind of generational wealth needed to meet the net worth threshold. This partially explains why there are so few investors from these communities. Only 1.3 percent of angel investors are Black, and 2.3 percent are Hispanic. And fewer underrepresented investors means fewer underrepresented founders getting funded.
Capital access is a primary concern for all founders, but particularly for those in underrepresented communities. Research has shown that it is tougher for these founders to raise capital, and the statistics are equally stark. Just 1.7 percent of VC-backed startups have a Black founder and just 1.3 percent have a Latinx founder. Restricting the pool of startup investors—especially in ways that effectively exclude many members of marginalized communities—will only increase these divides.
These concerns were on display at a meeting of the SEC Small Business Capital Formation Advisory Committee—which is made up of individuals from across the startup ecosystem—last month, where the committee heard from Shelly Omilâdè Bell, the Founder and CEO of Black Girl Ventures, and Eli Velasquez, the Founder and Managing Partner of Investors of Color and a Board Member at the Angel Capital Association. Both expressed how the accredited investor framework excluded them, taking particular issue with the financial thresholds. Velasquez pointed out that some of his younger colleagues with access to generational wealth were able to invest while the rules excluded him from “investment opportunities that could have provided potential generational wealth” for his family.
Discussion at the committee meeting did reveal potential motivations behind the potential rule change. The SEC is worried about the risky nature of investing in startups. And startups do fail at high rates—but this is a natural product of the innovation cycle, not securities fraud. Protecting investors from financial loss due to startup failure might seem noble, but doing so using financial thresholds discounts the ability of individuals to make rational decisions and not invest above their means—especially when they can alternatively pile their assets into the latest meme stock or cryptocurrency. As a result, in a poll to gauge their stance on the issue, no member of the advisory committee said they were in favor of restricting startup investment by revising the financial thresholds upwards.
Startups can be risky investments, since the majority of them fail, but it is imperative that the SEC creates avenues for greater participation in startup investment—especially from historically underrepresented communities—to ensure that more people can participate when startups prosper. In its upcoming rulemakings, the SEC must consider ways to increase the number of people that can invest in startups, not further restrict access to those markets and decrease investment in startups.
