Education − the solution to investor protection

There is concern in the private capital sector that the federal government might accept a recommendation by the Financial Services Council (FSC) to increase the wholesale investor net asset threshold from the current $2.5 million to $4.5 million.

This would seriously damage raising of investment capital for early-stage technology businesses.

Startmate chief executive Michael Batko says 98% of the accelerator’s angel investors would no longer qualify as sophisticated investors if the threshold was lifted to $4.5 million.

Batko argues that this would put innovation back 20 years.

There is now a strong push to make the federal government aware of how such a change would affect the start-up sector.  

This is fine but I believe we need a wider strategy to protect from unintended consequences if the government does decide to act on the FSC’s recommendation. Simply highlighting potential damage to the start-up sector is inadequate, particularly as it might be seen solely as acting in self-interest.

It is important to consider precisely who the FSC is seeking to protect, and from what, and then to work out a strategy that would allow for those protections to be achieved while not preventing individuals who really want to do so from investing in early-stage businesses.

In its proposal, the FSC says: “When thresholds were first introduced in 2001, only 1.5% of households were captured under the current $2.5 million threshold. Today it’s increased to 11.7%.

“If the threshold is left unchanged, these trends are set to continue, so that by 2033, more than one in five mum-and-dad investors could cease to have access to the consumer protections that are inherent when you are defined as a ‘retail investor’, and instead be treated as a sophisticated ‘wholesale investor’ regardless of whether they understand the more complex financial products they can be offered.”

The FSC says its proposal would bring the proportion of households qualifying as sophisticated investors under the net worth threshold “back down to 3.1%”. So why 3.1%?  Is this an arbitrary figure or is there some reason for setting this proportion?

The reference to ‘mum-and-dad’ investors is also interesting. Presumably this is an indication of the type of investors the FSC is seeking to protect. To me it suggests people who don’t have intellectual interest in investing but are simply looking for somewhere to park their money where it will be reasonably safe but will earn more than in a bank term deposit.

I don’t know of any such ‘mum-and-dad’ investors who have invested in early-stage businesses. In my experience, most individual investors in the start-up sector are ‘friends and family’, people with an interest in the tech space, or people who are intentionally seeking high risk/ high potential reward investments. Many would not qualify as sophisticated investors under the proposed new regime.

But I am aware that many ‘mum-and-dad’ investors have, despite current protections for retail investors, lost large sums of money by investing in risky property development schemes. Images of attractive properties such as Gold Coast high-rise apartments and references to the security of real estate have persuaded many unsophisticated investors not to pay much attention to fine print.  

So, I believe we should oppose the increase of the investor net-worth threshold but should also seek to ensure that, if it is to be increased, there will be an improved facility for well-informed individual investors to opt out of the retail investor protection.

This would require changes to Section 708 of the Corporations Act.

Section 708(10) allows for professional and experienced investors to be regarded as sophisticated investors if they are vouched for by a professional adviser. Understandably, advisers may be reticent to open themselves up to liability by doing so.

Perhaps requiring a specified level of formal financial education would be a better restriction.

This would be an opportunity to seek government support for programs to increase financial literacy across the community to which the private capital sector could provide expertise.

Adrian Herbert

Managing Editor, Australian Private Equity & Venture Capital Journal.