What is a Sophisticated Investor?

Those not familiar with the definition of a sophisticated investor may think of such people as those with a superior intellect to the masses. Or maybe as that guy you see reading the Financial Review at breakfast on a Saturday morning.

A quick check on some local stock forums indicates more confusion. One member defines a sophisticated investor as adviser speak for “I cant be bothered explaining the concept to you, if you dont understand the investment then this isnt for you” or “I dont know how it works so rather than embarrass myself I’ll have you believe this isn’t for you”. Another made comment that it “Can also mean HIGH RISK–best avoided” and “To become involved in Sophisticated Investments may I suggest wearing your best attire. I noticed a mass of sophisticated investors at the Melbourne Cup!”.

One forum participant “got serious” and stated that sophisticated investors are “Investment savvy” and “generally have a sound knowledge of the investments they are involved in. I guess to become one of these people you would gain as much knowledge and then a track record in an investment field or fields”.

The sophists

I can tell you now that the correct definition of a sophisticated investor is “none of the above”. The bloke reading the Fin Review may well be a sophisticated investor but it’s not because he reads the Fin. ‘Sophisticated Investor’ actually has a statutory definition under Chapter 6D of the Corporations Act. A sophisticated investor is defined where:

• the minimum amount payable for securities is at least $500,000; or
  
• a qualified accountant certifies the total net assets of an individual as more than $2.5 million or whose gross income for each of the last two financial years is at least $250,000 per annum.
  
  

Section 708(8) lists a sophisticated investor as being exempt from the requirement to be issued a disclosure document. This, combined with the conditions above, implies that certain individuals are able to protect their own investment interests without regulatory protection based on a measure of net worth or how much they earn.

At the same time, you can also see that a sophisticated investor is not exactly an investor who is sophisticated. I’ve known some pretty whacky marketing and business development execs earning a lot more than $250k per anumm. These people I would never give a single dollar of my savings to manage though. Certain AFL footballers also come to mind.

So why does an exemption exist for a sophisticated investor?

If a full disclosure document was required for every offering of equity/debt funding in private and listed companies then our biggest companies would be law firms, not banks. In fact, some in this category actively discourage regulation and consider any legislative disclosure to be an unwanted cost and a pain in the proverbial all together.

There are a lot of savvy individual investors who actively participate in capital raising’s for private companies without protection from the Corporations Act. This works in your favour as an entrepreneur or SME business owner that is trying to raise capital. That’s not to say it makes in any easier. It just means that you might not have to put together a lengthy and detailed disclosure document and it may be the case that you find investment via a series of private discussions. It can also mean you are getting more than a cheque – think knowledge, industry contacts, partnerships, etc.

To say that finding these people is ‘never easy’ would be an understatement. If you have a viable product or service though then it becomes much easier. In fact a sophisticated investor will probably find you first. If you are a Pty Ltd company trying to raise capital for your business then your only option is to comply with the 20/12 rule or to raise capital from sophisticated investors. So it is imperative that you take note of this group of investors as they might be the difference between global or local, exceptional or mediocre, new or old. Happy networking.