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The U.S. Senate finally began debate on the Restoring American Financial Stability Act of 2010 last week, and groups that assist start-up companies are working behind the scenes to address provisions of that bill they say could slam the door on a significant source of investment funding for entrepreneurial ventures.

Under one provision of the financial reform legislation, the criteria for “accredited investors” would be revised in a way that could eliminate about three-quarters of potential angel investors available to invest in start-up companies. The proposal would raise the net worth requirement for such investors from the current $1 million to an inflation-adjusted figure of approximately $2.3 million.

Another proviso in the bill would impose a waiting period of 120 days on angel investments, requiring the funds to be held in escrow while the transaction is reviewed by regulators. That would change the funding timeline for start-ups from weeks to months, jeopardizing time-sensitive deals. Such changes would be catastrophic for start-up companies if enacted, say industry experts in Iowa.

“Right now, we know that (angel investors) are being more circumspect with their dollars because of the nature of the market,” said John LaMarche, a principal with VentureNet Iowa, a statewide entrepreneurial organization that connects start-up companies in the state with capital and expertise. “Part of the result is that there are less angel investor dollars than there were a few years ago, so this would further dampen the market from our perspective.”

Though the bill’s primary sponsor, Sen. Christopher Dodd (D-Conn.) recently assured organizations representing angel investor groups that he would offer amendments that would be less damaging to angel investments, much uncertainty still surrounds the issue as the controversial legislation is debated.

The asset minimum for accredited investors has been $1 million since 1982; the reform legislation would adjust that level for inflation. The accredited investor rules were created in an effort to quantify and provide a “bright-line test” of who is considered to be a sophisticated investor who could afford to lose their entire investment.

“We understand the rationale for it,” LaMarche said. “But making a course correction all at once – maybe it was overdue, but it’s probably anti-stimulus on the face of it. So at this time it seems to be inconsistent with other public efforts to stimulate the economy. It seems like the timing of this is not very good, even though it may be necessary.”

If enacted as originally proposed, the changes would significantly impede economic development efforts in Iowa, said Adam Claypool, managing director of the investment banking division of DeWaay Capital Management in Clive.

“This at the end of the day is about job creation and potentially stifling innovation,” he said. “If you’re not independently wealthy and don’t have the capital, how are these businesses going to get off the ground?”

Claypool said he was surprised at how few people, even within the investment industry, were aware of the proposals affecting angel investors.

“We are letting our co-investment partners know; we are letting other angel investors know; we are letting other investment firms know; and we’re letting economic development organizations know,” he said. “And we’re letting venture firms know, because they’re getting their deal flow from the investors that bootstrapped these companies and matured the companies to the point where they can get venture capital.”

Smaller investments

Nationwide, angel investments in 2009 totaled an estimated $17.6 billion, a decrease of 8.3 percent from 2008. A total of 57,225 entrepreneurial ventures received angel funding in 2009, or about 3 percent more than in 2008, according to an annual market analysis conducted by the Center for Venture Research at the University of New Hampshire. The average size of each deal decreased by 11.1 percent last year, an indication that investors were committing fewer dollars.

“The recession definitely has had in impact on angel investment,” said Marianne Hudson, executive director of the Angel Capital Association (ACA), a trade association based in Kansas City, Mo., representing 160 angel investment groups across the country. “With a drop in net worth of 28 percent last year, people are making smaller investments, fewer investments, and they’re keeping their investments limited to companies they had already invested in.”

Hudson’s organization, along with the National Venture Capital Association, has lobbied for changes to the provisions concerning angel investments since March. On April 21 the ACA announced that Dodd planned to introduce amendments that would:

• keep the threshold for accredited investor status at $1 million, but exclude the value of the investor’s primary residence;

• disqualify investors identified as “bad actors” from making Regulation D 506 private filings, rather than requiring a 120-day waiting period for all investors.

In a telephone interview, Hudson said she believes the amendments will have bipartisan support.

“I know there’s a lot of negotiation to do on a very large bill,” she said. “But from our members talking with (senators), it does sound like a bipartisan issue.”

As part of the amendments, the Securities and Exchange Commission would review the accredited investor income and net worth thresholds at least every four years in relation to “public interest and the state of the economy,” but that would not require the agency to necessarily change those limits, Hudson said.

More than capital

In Iowa, angel investors provide an important source of private capital, said J.D. Geneser, a senior partner with LWBJ Capital Advisers. “We work with a lot of entrepreneurs, and a lot of the state-assisted funds (such as the Iowa Demonstration Fund) require matching funds, and those funds come from angel investors,” he said.

Having a 120-day waiting period would be extremely detrimental to these entrepreneurial companies, Geneser said.

“From our perspective, angels bring a lot more to the table than just capital,” he said. “They provide advisory services, mentoring, possibly strategic relationships as well. So there’s a lot more going into these deals than just money going into these start-ups, so if there’s a delay in that, that alone can cripple the entrepreneur from not having that mentorship in place.”

Dave Sengpiel, senior investment manager for the Iowa Farm Bureau Federation, said it’s difficult to comment on the legislation “because there are so many unknowns at this point.”

“The way it was originally written would have been catastrophic,” said Sengpiel, who serves as general manager for two statewide investment funds focusing on start-up companies in rural communities. One of those funds, the Rural Vitality Fund, has invested approximately $13.5 million in 10 start-up companies over the past three years.

Though the majority of Rural Vitality’s money has come from three partner institutions – the Iowa Agricultural Finance Corp., Central Iowa Power Cooperative and Wellmark Blue Cross and Blue Shield – “all of (the start-ups) have been impacted by angel investors,” he said. Those angel investments have come more from pooled groups of angels rather than individuals, and have averaged about $250,000 per company, he said.

Meanwhile, as is the case nationally, the recession has slowed the Rural Vitality Fund’s pace of new investments, Sengpiel said. “We’re doing follow-on investments in our current companies, and kind of waiting it out.” However, “I think things are starting to move,” he said. “The horizon seems to be looking a little sunnier, let’s put it that way.”

Regardless of the direction the federal legislation takes, investors can always benefit from assistance to better evaluate deals, LaMarche said.

“We always say that starting a business is a social enterprise, and drawing upon people with a deeper understanding of the marketplace and to be able to share that with someone looking at the investment, that’s an important facet of the equation,” he said. “We would like to see (potential changes) encourage more use of experts to help investors to essentially handicap the risk. It’s still a risk-reward proposition.”