According to Jiajie Xu, assistant professor of finance, the rule change asserted that angel investors could no longer count the value of their house as an asset to be accredited by the SEC. They made this change in 2011 with the intention of protecting marginal angel investors after the “Great Recession” of 2008 and 2009 when many lost their primary residence.
 

Xu said the agency’s assumption was that angel investors were not very sophisticated and needed regulators to look out for them. But she said the agency’s rule change ignores the fact that most angel investment happens in the investor’s immediate geographical area, so they know the neighborhood well and have enough information to know if a business is likely to succeed or fail.
 

“They’re actually sophisticated investors,” she said. “If they weren’t, they’d have a history of investing in bad firms or dead firms—and they don’t. They know the local community and the local demand for a business very well.”
 

Xu said angel investors play an important role in venture funding, as they’re often the initial source of cash to help a founder get their startup off the ground. Most invest small amounts in any single business—she said the typical size is about $10,000, though some can reach into the hundreds of thousands of dollars.

Real world impacts

• The number of potential angel investors decreased by 20% and led to an 11% decrease in the amount of angel investments in the most affected cities.
• The greatest effect has been seen in smaller cities away from the coasts, places that most need angel investors because they’re generally ignored by venture capitalists and investment funds.
• The number of patents issued to companies based in the most affected cities dropped in the decade after the rule change, as did retail sales and number of jobs at angel investor-supported businesses.
• Founders have been forced to rely more on SBA loans and second mortgages to finance their startups.

Hot Tip
Looking for startup funding for your new venture? Go to your next college class reunion. A recent study by Professor Jon Garfinkel has found that investors and entrepreneurs are statistically more apt to connect and work together if they share a collegiate alma mater. Watch a webinar about it here!

This article appeared in the 2024 issue of Exchange magazine.