My venture partners and I are raising money for new venture funds at the moment and there’s an awkward moment every time I have an initial conversation with anyone who’s considering investing in VC for the first time: the moment when I have to raise the question of holding a sophisticated investor certificate.
When I ask, “Do you currently hold a valid sophisticated investor certificate?” most of the time they’ll say something like, “I’ve never heard of that before, what is it?”
If we’re getting along well and I think we might become friends, I’ll tell them what I really think.
A sophisticated investor certificate is an annoying, exclusionary, discriminatory and ineffective requirement for investing in alternative investments like angel syndicates and venture funds.
It was a clumsy legislative kludge by the Howard government back in 2001 designed to make it look like the government was doing something to protect inexperienced investors from dodgy investment scams and it’s still a kludge two decades later.
It’s annoying because nothing will have changed about you as an investor before and after gaining a sophisticated investor certificate from your accountant in terms of your knowledge, skills or experience as an investor.
It’s exclusionary because it’s a wealth and income-based evaluation — about as useful as asking if you went to a ‘good’ private school or a ‘sandstone’ university without asking what you studied there and what your grades were.
And in order to qualify as a sophisticated investor you need to show you earn at least $250,000 income a year or own at least $2.5M in assets, which is probably something you were hoping to achieve by investing in a venture fund, rather than a prerequisite.
Discriminating for the rich
It’s discriminatory because it’s a test of prior wealth and income, not a test of investment knowledge, skills or experience — being wealthy doesn’t make you smarter — and since there’s no cap on how much money they can invest in a year, it doesn’t even protect wealthy investors from being misled, being overly-optimistic, making a stupid mistake and losing it all.
More importantly, it’s discriminatory because we know only about 16% of the Australian population satisfy the sophisticated investor wealth or income requirement and those people are overwhelmingly white middle-aged men of privilege, and much less likely to be women, people of colour, people from non-English speaking backgrounds, young people or LGBTIQ+ people.
As if that’s not enough, the current ALP government (the kind which is meant to be looking out for the rights of the underprivileged) has announced it wants to make the legislation even more exclusionary and discriminatory by raising the wealth and income requirements to $4.5M in assets and $450,000 per year and potentially exclude your most valuable asset — your home — from the test, which would mean that only about 2% of Australians could qualify, no matter how knowledgeable, skilled or experienced they are as an investor.
In short, the sophisticated investor certificate is a thing that doesn’t work, but if you have to ask what it is, you probably can’t get one.
In fact, if the proposed changes make it into legislation, I won’t be the only person wondering if I’m one market downturn away from managing a venture fund that I’m excluded from personally investing in.
I’ve seen some modelling to suggest that perhaps as much as a third of the individuals currently actively investing in Australian startups would be excluded from doing so under the new requirements.
Startup investment is different
However, I’m from the startup industry, and two things make us different: we have a low tolerance for bad solutions, and we work to replace them with better solutions. So please allow me to suggest some ideas for how the federal government could redesign the sophisticated investor test, for better outcomes for investors, for startups, and for the innovation industry we know is the next potential engine of our nation’s economy.
The wealth and income requirements of being a sophisticated investor are commonly referred to as the “sophisticated investor test” and there’s an important clue there, in the word “test”, which suggests, say, an exam.
If we’re seeking to ensure someone has sufficient knowledge and skill as an investor to be able to make their own investment decisions, it would seem obvious that asking people to study and sit for an online exam, rather than have the butler count all the gold bullion piled in the swimming pool.
In startups, when we see an idea already in use in other places, we call this “market validation” and it’s a good thing.
So I’m pleased to report that in the more advanced and successful startup industries of Singapore, the UK and US, they use an exam process to determine if someone should be allowed to invest in startups. A similar exam in Australia wouldn’t be a risky, untested solution.
And we know this for sure, because the way we determine whether a financial adviser is qualified to give you financial advice in Australia is through an educational curriculum you must study, assessed by making you sit an exam.
If it’s good enough for finance professionals, surely it’s good enough for finance amateurs.
I can also think of at least two ways we could design, implement and administer such an exam, but before I do, I want to rule out using Australia’s universities: they have morphed over the decades to become profit-driven revenue machines, and they would be unable to resist the temptation to price the majority of Australians out of any sophisticated investor qualification they were designated to deliver.
Option one would be to use the Australian Securities and Investments Commission (ASIC) which is responsible for administering and policing our investment industry, and which currently administers the education system and exams that financial advisors must complete.
They have the experts, the educators, the curriculum designers and an online evaluation system — it all just needs to be funded and resourced to do so.
Option two would be to use the Technical And Further Education (TAFE) infrastructure Australia already uses to teach and assess adults in non-degree level vocational training (clue: it’s literally in the name). As you probably know, TAFE is chronically under-funded and resourced, but Labor governments past and present talk a good game about supporting TAFE, and unlike ASIC, TAFE also has the capacity to deliver in-classroom training nationwide.
I can’t see Labor voters criticising the government for putting more money into TAFE to ensure more Australians from all walks of life can learn how to invest safely in a broader range of investment classes.
As anyone who’s watched much reality television will know, wealth is not an accurate indicator of knowledge, skills, experience, or, for that matter, intelligence. If we need a sophisticated investor test, let’s make it an actual test, with the goal of making sure anyone who studies hard and passes the exams is allowed to invest in the innovation industry.
Imagine the economic afterburner we could create if we stopped making the wealthy 1% wealthier, and turned a nation of gamblers into a nation of informed, successful investors.