Why the federal government's plan to increase the sophisticated investor threshold is terrible news for Australia's startups

Federal Labor’s recent suggestion of increasing the income and assets tests for the sophisticated investor exemption is one of the most infuriating examples of trying to fit a round peg in a square hole I’ve seen in a while.

Currently, to qualify as a sophisticated investor, you need at least $2.5 million in assets or earning more than $250,000 a year for two years.

Since 2002, the number of people who fall into that bracket as risen from less than 2% to 16% now.

So the federal government wants to change the definition.

Simply increasing the numbers to ‘account for inflation’ does not take into account the many, many factors of our economy and the dynamics that have affected how and where people invest over the last 20 years.

To be clear, I understand there is a valid problem of retirees being targeted for complex investment schemes that likely aren’t suitable.

However, as has been pointed out, these are people who qualify simply because of the asset value of their home.

For this, there is a simple solution: Exclude the value of the primary residence from the assets test.

This is the case in the US, and I wholeheartedly agree with this. The family home should be excluded from the calculation.

Regulators are worried that ~2% of individuals qualified in 2002 and ~16% qualify now. This large increase is almost entirely driven by primary residence appreciation.

Individuals making a gross income of $250,000 or more make up 2-3% of the Australian population. So if they were to exclude primary residence, that could actually be pretty close to where they are aiming.

The problem lies with the suggestion of possibly increasing the annual income threshold from $250k, to $450k.

An increase, especially one of this size, would be incredibly problematic for Australia.

Only around 0.4% of the Australian population makes $450,000 or more. There are many problematic outcomes to point out, but I’ll cover the top 3, in my opinion.’

A huge hit

For one, the early-stage investment landscape would take a huge hit. Angel investors are often called the life-blood of a startup ecosystem.

Based on wholesale investor data from Aussie Angels (a platform that supports early-stage tech investing via syndicates and funds), approximately 9 out of 10 investors who qualify, do so based on income not assets.

With an increased threshold, a huge number (by my estimate somewhere between 70-90%) would no longer qualify, and these investors would have far less options available to them for investing in early-stage tech.

Not only that but the remaining options would likely be more time-consuming and have higher barriers to entry (such as larger minimum cheque size). With less options and more barriers, we would likely see a mass exodus of angel investors, simply no longer willing or able to invest in Australia.

Second, we would likely see a widening of wealth inequality across the country over the years following this kind of change.

Wholesale investors gain access to private placements, and other high-risk investments that are not available to the general public. They can diversify their portfolios by investing in alternative assets, such as private equity, hedge funds, and venture capital.

These investment opportunities often have the potential for higher returns compared to traditional retail investment vehicles. Limiting high-return assets to only the ultra rich would see further consolidation of wealth at the topmost brackets.

Impact on women

Thirdly, this change would undoubtedly have a larger negative impact on women. The current sophisticated investor income/assets tests are already less favourable to women (for example no exceptions or hold based on maternity leave). Men dominate the higher-paying jobs.

ATO tax data shows that a mere 27% of those in the top tax bracket ($180,000+) are women. As evidenced by countless stats outlined from ATO tax data, the gender pay gap across the entire economy is real. This means that overall women in particular would be more disadvantaged by a change in the income threshold.

It’s also worth noting that this change would put Australia vastly out of whack with our overseas counterparts such as the US & UK.

In the United States, for example, the Securities and Exchange Commission (SEC) requires an individual to have:

An annual income exceeding USD$200,000 (~AUD$300k) or USD$300,000 (~AUD$450k) for joint income, for the past two years, with the expectation of earning the same or higher in the current year, or
A net worth exceeding USD$1 million (~AUD$1.5m), either individually or jointly with a spouse, excluding the value of their primary residence.

In the UK, for example, 4% of the population meet the income threshold.

A certified high net worth individual must:

have an annual income in excess of £100K (~AUD$190k), or
have net assets in excess of £250K (~AUD$475k) beyond your pension fund assets and your primary residence

Furthermore, both the US and the UK have clear pathways for experienced and knowledgeable investors who don’t meet the income or assets test to still qualify.

The US & UK are so unconcerned about the specific number or percentage of people who qualify (via any valid pathway) that I couldn’t even find the exact numbers (by my estimates somewhere in the range of 15-30% of the population).

Australia will struggle to stay competitive for tech and innovation, if we were to jump so far out of range on the income and assets test that very few investors still qualify.

If the goal is to protect vulnerable people from unsuitable investments, Australia should take note and be less concerned about the proportion of the population, and more concerned about who is actually included or not.

The TLDR here is this: Do not under any circumstances increase the income threshold. Do exclude the primary residence from the assets test.

And in a perfect world, ideally Australian regulators would create a more robust pathway to wholesale status through education and/or experience, such as what the US has done with the Professional Designation pathway to Accredited Investor status, or the UK’s sophisticated investor pathway.