Part of every startup’s life is raising capital. This will typically involve Angel Investors – high net worth individuals. However, Robert Litan has discovered a potential unintended consequence in Senator Dodd’s Financial Reform Bill:

Under existing law, startup companies can raise money easily and quickly from “accredited investors” — individuals with substantial wealth or income. There is no need for the companies or the investors to gain approval from any state or regulatory official.

All of this would change if Section 926 of the Dodd bill is included in any final reform legislation. That section would require, for the first time, companies seeking angel investment to make a filing with the Securities and Exchange Commission, which would have 120 days to review it. This would both raise the cost of seeking angels and delay the ability of companies to benefit from their funding.

The negative impact of the SEC filing requirement would be aggravated by the proposed doubling of the net worth or income thresholds required for investors to be “accredited.”

It is difficult to know why these provisions are in a much larger bill whose primary aim is to address the fundamental causes of the recent financial crisis. Those causes are now well known and much commented on: excessive subprime mortgage lending combined with excessive leverage throughout the financial system. There is no evidence that angel investment in startup companies played any role whatsoever in events leading up to the financial crisis.

America became prosperous by its risk-taking and by backing their abilities and talents. It is such a shame that politicians should want to get in the way of two parties voluntarily agreeing on a deal. If this bill gets up it will only mean less deals, less wealth-creation, less innovation and more startup failure rates. Timothy Lee from Cato sums it up well:

It’s hard to overstate how important a favorable regulatory climate is to the success of startups. Some of the most important startups have been founded by 20-somethings without the resources to hire lawyers or navigate regulatory bureaucracies. And startups frequently find themselves within weeks of insolvency before they have a big breakthrough. Having a crucial round of funding delayed by four months can be the difference between success and failure. If this description of the bill is accurate (and I have no reason to doubt that it is), this provision would be very bad for the future of high-tech innovation in the United States.

UPDATE: Senate amends bill:

The changes included removing a 120-day waiting period for state regulators to review an investment after a deal has been made and allowing federal regulations to govern angel investments, as opposed to a hodgepodge of state regulations.

Although the amendment preserved annual income and net-worth requirements for angel investors to be accredited, it removed requirements that the levels rise with inflation. Instead, the Securities and Exchange Commission would review the requirements every four years to see if they needed to be changed.