Bvlletpoint

Treasurer Stephen Jones’ move to raise the sophisticated investor threshold to $4.5 million in assets (as reported by AFR on January 12, 2024) may have been crafted with good intentions yet its impact on Australia’s innovation ecosystem will be significant. The use of a deeply flawed asset test which does not truly measure an investor’s financial sophistication, and gating high growth assets behind this test has caused significant distortion this market.

Wealth a poor proxy for sophistication

The existing asset test for determining financial sophistication is a poor proxy, especially in the Australian context where property makes up a disproportionate share of personal wealth. Wealth amassed through inheritance, the appreciation of real estate, or lucrative roles outside the financial sector, like those in mining, may anoint individuals as ‘Sophisticated Investors’ despite a lack of genuine financial literacy. Ironically, one could possess a doctorate in advanced finance and yet not meet the sophisticated investor criteria under the current regime.

Moreover, the present model incentivises a perverse outcome. Since wealth accumulation tends to favour the older demographics, safeguarding high-risk investments with an arbitrary wealth benchmark means that those best positioned to take on high risk assets are also the most vulnerable to potential losses. Meanwhile, younger investors, with ample time to recoup losses, are barred from these investment opportunities.

There are also dubious ethical grounds to justify walling off investments of this nature behind a Sophisticated Investor requirement. Other high-risk assets such as options trading, unregulated assets such as cryptocurrencies—not to mention the government-sanctioned gambling industry—remain accessible while innovative business investment opportunities are gatekept.

Stifling Homegrown Innovation

According to Start-up Blink (a research organization), Australia has slumped to 9th place in global start-up ecosystems, trailing behind Sweden, Singapore, Germany, and France. This is a startling underachievement for a nation with a well-educated and affluent populace. A tangle of government meddling and a lack of domestic financial market sophistication have left Australia lagging its international peers, despite government programs like the Early Stage Innovation Company (ESIC) Tax Incentives.

While the Sophisticated investor test originally permitted only 2% of Australians to invest in these assets, the slow creep of house prices has increased this number to 16%, and with it grown the pool of local capital available for start-ups to draw form. As the proposed legislative changes aim to reduce the number of sophisticated investors back to 2%, the pool of local capital available for start-ups will also shrink dramatically.

The ramifications are severe: Aussie start-ups may be compelled to seek foreign capital, risking that those who benefit from next wave of innovation—personified by successes like Canva or Atlassian—may be overseas investors, rather than Australian.

Worse still, the domestic shortfall in investment could precipitate a ‘brain drain’, as innovative Australian start-ups feel pressure to migrate closer to their overseas investor base.

A simple solution for sophistication

The most obvious solution would be to change the basis of sophisticated investor status to one based on educational qualifications and a proficiency test. Potential investors could then validate their understanding of portfolio construction, alternative assets, and financial strategy. Educational initiatives, such as UNSW’s “Angel Investors Program” or UQ’s “Qualified Early Stage Investor Course”, could form the backbone of this new criterion, expanding as necessary to meet governmental mandates.

This approach would both safeguard inexperienced investors while opening the doors for younger investors to support the nation’s entrepreneurs and innovators. It would not only promote a more informed investor community but also support the freedom of Australians to choose what they invest in.

The simple change to the sophisticated investor test to reflect true financial literacy would not lead to unfettered risk-taking by the Australian public, but it could be the spark needed to reinvigorate Australia’s innovation landscape.