Early-stage companies could be impacted by changes to Australia’s sophisticated investor definition

Unless an exemption applies, companies looking to raise funds in Australia need to issue a disclosure document such as a prospectus, which can be expensive and time consuming. One common exemption is for offers to ‘sophisticated investors’. Currently, a person is a sophisticated investor if they have AU$2.5 million in net assets (net asset test) or if they have earned more than AU$250,000 for each of the last two financial years (annual income test), or if they pay a minimum of AU$500,000 for the investment.

The sophisticated investor exemption allows companies, particularly start-ups and earlier stage businesses, to raise capital from a range of investors without needing to deal with burdensome disclosure document requirements. From an investor perspective, falling into the ‘sophisticated investor’ definition gives access to a wider variety of investment opportunities, including private equity and seed financing rounds.

Proposed changes

The Australian government has indicated that these thresholds may increase, largely because the test thresholds have remained static since 2001. Critically, the net asset test includes the primary place of residence and given the continuing rise in property values, this has naturally expanded the scope of those deemed ‘sophisticated investors’ beyond what the government at the time anticipated.

Whilst no decision has been made, commentary has suggested that the net asset test may rise from AU$2.5 million to between AU$4.5 million and AU$5.0 million, whilst the annual income test may rise from AU$250,000 to AU$450,000.

If implemented, the change is likely to see a significant drop in the number of investors who currently qualify as ‘sophisticated investors’, thereby reducing the potential capital available for companies in Australia.

FSC recommendations

The Financial Services Council, an Australian peak body which develops policy in the financial services sector, released their recommendations on 15 January 2024, recommending that the net asset test threshold either remains at AU$2.5 million, provided that the family home is exempted or increases to AU$5 million if the family home is included. The exclusion of the family home mirrors the sophisticated investor threshold test used in the UK.

Moreover, the FSC recommended that there should be no change to the annual income test, noting that this threshold is well above the highest marginal tax rate and only a limited number of Australians satisfy this.

Venture capital and early stage

Figures in the venture capital and start up community have expressed concerns with increasing the thresholds. A change to either the net asset test or the annual income test would be likely to diminish the ability for early stage companies to raise funds, without extensive disclosure, as the number of people currently considered ‘sophisticated investors’ reduces. In an already tight capital market, it remains to be seen what effect limiting the potential investor universe will have.

Early stage companies in particular are watching this space with interest. While early stage companies in Australia have a lot going for them - entrepreneurial talent, access to a large and stable domestic market and close proximity to the growing economies of Asia - one of the challenges is always access to capital. With other countries in the region also looking to attract talent, striking the right balance between investor protection and allowing businesses to access willing capital is fundamental to Australia’s start-up scene continuing to thrive.

Singapore is considered a regional hub for entrepreneurial activity, with an economic system that supports investment. In contrast to the Australian system, although the threshold tests between the jurisdictions are currently fairly similar, the ‘opt-in’ and ‘opt-out’ regime implemented by the Singaporean government, whereby individuals who meet the relevant threshold must consent or may decline to being treated as accredited investors, arguably demonstrates a more pragmatic approach and provides further flexibility by leaving the decision of whether to elect for accredited investor status in the hands of the investors.

Co-written by Tom Walsh of Pinsent Masons