Florida Funders, Seedfunders weigh in on new investor rules for startups

Dozens of startups in the Tampa-St. Petersburg area regularly turn to outside investors for early-stage capital.

Amended rules from the Securities and Exchange Commission would expand the pool of investors who could provide that funding, but local investment group leaders are divided over the impact on young companies in the metro area.

The amended rules help democratize the financial system and open the world of startup investing to a new group of participants, said Saxon Baum, vice president of investor relations at Tampa-based Florida Funders. The impact of the amendments will be limited, and a more effective approach would be education about startup risks and rewards for people already allowed to invest, said David Chitester,  co-founder and CEO of Seedfunders, an early stage investment firm in St. Petersburg.

Until now, only “accredited” investors could participate in private offerings or offerings that are exempt from registration with the SEC. Accredited investors historically have been defined by income or net worth. The SEC has adopted amendments to the rules that allow institutional and individual investors with knowledge and expertise, including securities industry professionals, to also qualify as accredited investors.

Greg Yadley

The immediate impact may be modest but it’s a good beginning, said Greg Yadley, a partner at Shumaker Loop & Kendrick in Tampa.

“One of the issues is that new businesses don’t know where to find capital, and investors don’t know the small businesses. While the internet has allowed everyone to make a noise, a ‘match’ usually happens because someone trusts someone who knows someone,” said Yadley, who is a member of the SEC’s Small Business Capital Formation Advisory Committee, which recommended the amendments.

Under the new rule, anyone with a Series 7 license, which allows individual to sell securities, can now invest in a startup, and they can also tell their accredited friends about the deal.

“If your broker personally invested in a private deal, wouldn’t you be more likely to invest? She wouldn’t even need to be your broker, just your friend, since there could be regulatory issues with the broker advising you on an outside deal,” Yadley said.

Closer look: Wealth and expertise

Existing rules define accredited investors as people whose net worth exceeds $1 million, or whose annual income exceeds $200,000 for an individual or $300,000 for an individual and spouse.

The amended rules add individuals who hold Series 7, Series 65 and Series 82 licenses. The SEC says it will consider adding other certification, designations or credentials in the future.

The amended rules also expand accredited investors to knowledgeable employees in a private fund, and add limited liability companies and family offices with $5 million in assets. They also add the term “spousal equivalent” to the accredited investor definition.

The amendments and order become effective 60 days after publication in the Federal Register, the SEC said.

Accreditation was in need of a revamp for a while, Florida Funders’ Baum said. The existing rules have been around since the early 1900s, although the dollar amounts in them had been revised over the years.

Saxon Baum

Accreditation is designed to protect investors from risk, but it has been based off net wealth or income. Adding education and expertise for people in the professional services or asset management allows a new subset of investors at Florida Funders, a hybrid venture capital firm and angel investor network.

“They might be under 30 and they don’t have the net worth or they’re not making $200,000 a year so they’re not considered accredited, but now those individuals have the ability to invest because they have the right education and certification. It opens up our doors, probably not as much for the fund investors, where it’s a much higher investment threshold, but for individual deals, when people can put as little as $5,000 in a deal, it absolutely opens up this world to people who were not able to be in it beforehand,” Baum said.

The biggest impact would be on Florida Funders’ angel network.

“Probably one out of every 10 people I get on the phone with because they’ve come through our system are actually not accredited, and it’s not usually something they were even aware of. Now, I’ll bet a lot of them would be considered accredited, ” he said.

There are risks to startup investing, and companies seeking funding might need to do more education for newly qualified investors, Baum said. “It’s not the company’s job by any means, but they could get in front of some arguments and/or some issues that if the company were to fold or to lose money, that they were very upfront with the investor, letting them know this was a risky investment.”

While the amendments allow more people to participate in early deals, the impact will be inconsequential, said David Chitester, co-founder and CEO of Seedfunders, an early stage investment firm in St. Petersburg.

David Chitester

The amendments currently primarily apply to the registered brokers licensed by FINRA, the Financial Industry Regulatory Authority.

“There are only 625,000 licensed FINRA individuals in the country. If all them, all the licensees, are eligible, that’s only added 625,000. And most of them are accredited anyway. Most of them have $1 million of net worth. So I don’t think it’s adding a whole lot of people to the potential investors,” he said.

Additionally, for those who don’t have $1 million in net worth, Chitester questions if they can really afford to invest.

“What if they have $500,000 in investable assets? Are they going to put $50,000 into a deal? I don’t think so,” he said. “The guideline is usually 3 to 5 percent of your investable assets that you put into these kind of risky deals, these early-stage deals, so that’s $25,000 someone might be able to put into a deal. That’s not a lot of money.”

Many FINRA-licensed individuals likely won’t be eligible to invest in offerings that haven’t been vetted by a FINRA company, Chitester said.

For Chitester, educating the existing pool of potential investors is a more promising way to fund startups.

“The problem is that accredited investors that are out there don’t invest in these deals,” he said. “Only about 3 percent of accredited investors actually invest in these kind of deals, so there’s 97 percent of people who are accredited don’t invest. That’s where the money is that’s not being invested.”

Seedfunders works to reach those accredited investors who aren’t participating in startup deals through education and seminars.

“Part of our mission is to get people to understand that if you put 3 to 5 percent of your investable income into these deals you have a huge upside. Studies show your overall portfolio can grow by as much as 20 percent if you invest 3 to 5 percent in these high-risk deals because some of them are going to be huge hits,” he said. “A lot of them will not. Forty-three percent of them typically will go to zero and you lose all your money. Accredited investors don’t want to take that risk … But overall if you manage a portfolio right and you invest in a lot of deals, typically 10 minimum and more likely 20, you’re going to make money doing this.”

A wider investor pool will help more than just the startups that Florida Funders works with, Baum said. As one example, he cited CrowdStreet, an online crowdfunding platform for real estate investments.

“I think these platforms are going to continue to become more and more accessible and also more and more legitimate. They’ll become the go-to place to be able to get alternatives done, rather than the traditional realm,” Baum said. “I think overall it will continually go in the same trend that we’ve been riding since 2013, this democratization of the financial system.”

Under-represented founders

The SEC’s Small Business Capital Formation Advisory Committee separately has asked the securities agency to take a lead role in making it easier  for women and minority-owned small businesses to get funding for their young companies.

The committee has just finalized its recommendation to the SEC, Yadley said.

“The country is at an inflection point with respect to confronting matters of racial equity and inclusion, and access to capital is a powerful tool to help achieve racial and economic equity,” the Aug. 26 letter to SEC Chairman Jay Clayton said.

“Regulatory action to improve the current capital-raising system – in which minorities and women have been underrepresented and inadequately supported – is critical. The Committee supports regulatory revisions to the capital-raising rules and ecosystem that promote increased opportunities for diverse entrepreneurs and investors, particularly minorities and women, and asks the SEC to take leadership in the area,” the recommendation said.