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Oops, we just killed angel financing...

Finance Blogger: Anthony Harrington Anthony Harrington

It is one of the facts of business life that one of the prime sources of funding—often the only source of funding—for start-ups is that which comes from family and friends and from business “angel” financing. In this context, angels are simply independent people (i.e. not venture capital funds) who decide to risk some capital on a new venture by third parties. It is extremely hard to overstate the importance of angel funding, both in the UK and Europe and in the US. It is no surprise, then, to find that Senate Banking Committee chairman Christopher Dodd’s Finance Bill in the US has put the angel community into an uproar.

For no particular reason other than possibly “completeness,” the Bill, which is designed to address the systemic banking failures responsible for the crash (which no-one pretends had anything to do with angel investing), includes several provisions which, in the eyes of many commentators, would wipe out angel financing. Nice going, Dodd. The Bill has been so watered down that it probably won’t do much to address systemic issues so it may as well dump all over the angel community … which will at least ensure that the 1,300-page Bill will have an impact in the real world, even if not exactly the impact intended by its author.

So what are the new provisions introduced as a “minor addition” to an already highly complex bill. Basically Dodd and, by extension, the Obama Administration would like all new start-ups looking for outside investment to register with the SEC—doubtless part of the new transparency that everyone wants. The second provision looks to raise the bar for “accredited investor” status (rich enough to make your own mind up how you invest your money) from those with $1 million in assets to those with $2.3 million in assets. One imagines that the aim here is to prevent people who by definition can’t afford to lose capital getting sucked into betting on start-up ventures. What’s so wrong with that, you might ask, if you don’t usually move in business angel circles.

What’s wrong with it, as market commentator John Mauldin spells out at some length in his recent Thoughts from the Frontline newsletter entitled “First, kill off the angels” (April 16) is that these provisions are a job and innovation killer.

“In 2007 angel funding in the US accounted for almost as much money invested annually as all venture capital funds combined, US$26 billion versus $30 billion, but it is invested into more than ten times as many companies, 57,000 versus 3,918.”

In the first six months of 2009, total investments by angel investors in the US amounted to $9.1 billion and funded 24,500 new start-ups, according to The Centre for Venture Research at The University of New Hampshire [PDF, 124 KB].

The Dodd Bill hammers both new starts-ups and their funding. By requiring new start-ups to register with the SEC and then wait 120 days for the SEC to review their filings, Dodd is in effect saddling new start-ups with a process that could cost them $100,000 in fees (just for permission to launch) while at the same time imposing a mandatory 120-day delay. This in itself will cause untold numbers of would be entrepreneurs to fold up their tents without getting to first base. Then there is the funding provision. By requiring investors to have assets of $2.3 million or income of more than $450,000, Dodd is cutting the number of potential investors from around 9% of the US population down to about 1%, according to Mauldin.

Why is this being done? “I hear no cry to protect angel investors from themselves,” Mauldin says. Again, we seem to be dealing with a natural law that says that regulation will always seek to expand its remit. Once you set out to protect people, how do you avoid becoming overprotective?

Further reading angel financing

Tags: angel financing , regulation , Senator Chris Dodd , start-ups , transparency , US
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