Australia’s ’20/12 Rule’ Stifles Angel Investments and Any Chances of Younger Generations Supporting Startups
When the topic of regulations that need to change to increase angel investment in Australia, an excuse that comes up often is:
“Individual investors are not prevented from investing in startups, there is the 20/12 rule! “
Well, let me tell you why this is largely unnecessary.
I recently spoke with someone who told me they were looking to start a union to help young people invest in startups.
Himself less than 30 years old, he had already invested in more than 10 companies to date alongside Sequoia, a16z, Y Combinator, Elon Musk and SoftBank.
He told me that he started early and that he wanted to create a syndicate structure to allow other new investors to have access to transactions with him and, most importantly, to learn more about it. angel investing.
It wasn’t just random moms and dads he wanted to bring in, they were people who were already interested and involved in the startup ecosystem.
Fantastic idea, isn’t it? Encourage the next generation of angel investors to invest early, while providing a relatively safe vehicle and the education needed to build confidence.
The biggest hurdle, he said, was that most of these people would not be considered sophisticated investors and they lack the ability or appetite to invest directly.
He asked me:
“The problem is, these investors want the benefits of investing collectively with their contacts – to pool capital and meet the minimum check amount set by the startup or to diversify their investment portfolio by making smaller investments. Can we get a lawyer to create a trust to make this happen? “
My answer for him is this:
Yes, a lot of angel investors pool their money and expertise to form unions like this for exactly these reasons.
Barriers to investment syndicates
However, the legal landscape for doing this comes with some pretty important (and unfortunate) caveats:
- You cannot promote or recommend your trust as an investment to other people (ie, you cannot provide “financial product advice”).
- Investment decisions and trust should be controlled by all investors (i.e. you do not run an investment service for them).
- You cannot take any fees or cost recovery for your role in the investment (i.e. you are not the head of an investment firm).
If you can work your confidence by these rules (and others), then great!
If not, then each participant should be considered a “wholesale investor” and the 20/12 rule does not apply (and you may also need to obtain an AFSL to support your trust. investment).
It might sound crazy, but the bottom line is that retail investors may be able to invest directly under the 20/12 rule (if they invest the minimum startup check size), but it can be really difficult for they manage the risk by pooling their investments. with others.
Let’s see how it works in practice. Let’s say you and 9 friends decide to pool your money.
If you each put in $ 50,000 a year, that’s $ 500,000. It could go a long way, say 20 investments of $ 25,000 each. It’s a very good portfolio! If, however, you each put only $ 5,000, that would add up to a total of $ 50,000 to invest per year, which means only 2 startups at $ 25,000, maybe 4 if you’re sophisticated and stretch it. .
Assuming you want to invest in at least 10 startups to diversify your returns (and increase your chances of sustaining a big exit), you may need to pool at least $ 250,000 ($ 25,000 from 10 investors).
Unfortunately, this is where everything changes.
What you need to do to comply
If you need 10 people to put in at least $ 25,000 each to get at least $ 250,000 to be able to do at least 10 investments create a diversified portfolio; you would probably want to get their commitments in advance to make sure the capital will be there when you call them… and you would probably need a contract in place with fee terms to cover the costs…. and you may need to share the details of your investment mandate with potential investors to make sure they are comfortable … and if this happens, it could be considered to provide advice on financial products to the retail investors.
Or if you’ve decided to go low-doc, and not put any deals in place until a startup is identified, and instead just ‘mention’ the deal to them every time, then something share after the 3rd or 4th “occasional” mention of this “startup in which I invest” to all your 9 friends…. your little club is starting to look a lot like an “arrangement” to invest in financial products.
The sad truth about our federal financial system is that the system just doesn’t work on a grand scale. The rules push retail investors to make fewer, larger, and riskier investments themselves, rather than allowing them to reduce risk by working with others. It wasn’t an oversight, they designed it that way on purpose.
They are terrified that this angel investor who has experience and early access is going to swindle their 12 friends out of their hard-earned money, and they would much prefer the money to go to places with more certain results. (like cryptocurrency).
This is why the 20/12 rule is largely unnecessary in bringing smart money to early stage startups and creating a strong support system for them.
It totally misses the business reality of investing in startups, and angels’ natural tendency to manage risk and invest in groups.
My question to all of you is, why exactly are we preventing the next generation of angel investors from entering the market?