High-profile startup figures have urged the federal government to reconsider proposed changes to the sophisticated investor test that they say will “significantly constrain” the sector.

The sophisticated investor test is used to determine who is able to access investments deemed to be high-risk, such as private equity, venture capital, and seed rounds for startups. In qualifying as “sophisticated”, an investor then forgoes protections such as financial advice free from conflicts and the right to complain to a government dispute resolution body.

Currently, to qualify as a sophisticated investor, an Australian must have net assets of $2.5 million or have an annual income of $250,000 in two consecutive years.

These thresholds have not increased since 2001, and more than 15 per cent of Australians now qualify as sophisticated investors.

Through a review of the regulatory framework for managed investment schemes, the federal government is mulling changes to this scheme to make it harder to be a sophisticated investor, in an effort to limit exposure to highly risky ventures.

According to the Australian Financial Review, the government is considering increasing the test to $4.5 million in net assets or $450,000 in annual income.

The sophisticated investor scheme is “critical” to the tech sector, ACS Innovation Labs director Pauline Fetaui told Information Age.

“If the threshold changes, that is going to wipe out a considerable portion of what’s existing and stifle future pools of sophisticated investors – that effect will be felt for years,” Fetaui said.

“It’s a contradiction. There’s no point releasing an AI paper to say how we’ll govern AI but at the same time removing seed funding or restricting seed funding for emerging tech companies and AI ones.”

These reports sent fear across the Australian startup sector, which commonly relies on sophisticated investors, known as angel investors, to pitch in money to early-stage companies to get them off the ground.

Startups push back against the changes

A petition launched by the Regional Angel Investor Network calling on the government to rethink the proposal has now garnered more than 400 signatures, including from a number of significant figures in the Australian startup sector.

“Australian founders, especially those who don’t have access to the wealth of family and friends, are most reliant on private investors to back their innovations,” the petition said.

“Without this early-stage catalyst funding, the Australian startup ecosystem will be significantly constrained.”

Upping the sophisticated investor test “risks severely limiting access to investment opportunities in startups and innovation in Australia” and will “significantly limit the pool of potential investors in Australia”, it said.

“[They will] further exclude knowledgeable individuals, exacerbate gender and geographic disparity in investing and concentrate investment power in a smaller, wealthier segment of the population.”

The review of the regulatory framework for managed investment schemes was announced by the Labor government in the October 2022-23 budget to examine whether the scheme was fit-for-purpose.

The review received nearly 60 submissions but none from tech or startup bodies or companies, with the sector seemingly caught off guard by the changes to the important scheme.

Stifling innovation

The federal government is mulling the reforms to reduce the risk of retirees losing life savings in schemes they do not understand, and for the financial thresholds to keep pace with inflation.

The thresholds have not been upped in more than two decades.

In 2001, less than two per cent of Australians qualified as sophisticated investors, but this number has exploded across the last 20 years, with 16 per cent of Australians now passing the test.

But the changes may lead to tech companies leaving Australia to seek investment overseas, Fetaui said.

“It’s already extremely competitive – we already have companies going to the US, Asia and Europe for investment,” she said.

“The government in Australia is constantly complaining about that yet they are looking to completely stifle investment in a critical phase of starting up.

“The UK is throwing money and incentives for investors and companies to migrate over there, and now we’re constraining them.”

The changes will also hamper efforts to improve diversity in the tech sector, she said.

“We have an issue where women do not have enough super and assets on their own to qualify as sophisticated investors as it is,” Fataui said.

“Diverse groups are coming out to try to focus on funds for minority groups – what’s going to happen to them? Seed funding is already a problem and now we’re restricting it further and going backwards.”

Many in the startup sector are pushing instead for a certification process to be run by ASIC based on education and expertise rather than financial information.

“This approach aims to balance the need for investor protection with fostering a diverse and dynamic ecosystem for startups, essential for Australia’s economic growth and technological advancement,” the petition said.

Disclaimer: ACS is the owner of the ACS Innovation Labs.