When start-ups raise money, the question inevitably comes up whether the proposed investor is “accredited” or not. One question is simply who is and who is not accredited. Another question is why should you care.
To begin with the second question: The way the SEC regulates sales of securities is to begin with the principle that all transactions in securities must be registered with the SEC, unless there is a specified exemption from registration. (For those of you not familiar with registration, one example of it is the process that companies go through in their initial public offering. It can be expensive, time consuming and a real hassle, although there are streamlined versions of the process.) In any event, the SEC has exemptions for all sorts of transactions in securities, including trades on exchanges and the like. One exemption that the SEC has is for private transactions: so-called private placements. There are many forms of private placement, but almost all investments in venture financed companies fit this exemption. Having said that, if you make offers to too many people, its public – not private. If you advertise (maybe mail to the Harvard Business School class of 1999) it is public – not private. Anyway, you get the idea. It is not always clear what is qualifies a public and what qualifies as private. As a result of the ambiguities that have arisen in this area, the SEC adopted Regulation D. Regulation D is a so-called safe harbor. It has a set of objective requirements. If your transaction meets these requirements, then it qualifies as an exempt private placement.
Among the requirements of Regulation D is that if you make offers to sell securities to persons who are not accredited, you must make disclosures essentially equivalent to those made by public companies in their SEC filings. These requirements are onerous. They include delivery of all sorts of information that may not be readily available to a start up. In any event it will be expensive and time consuming to pull together. Not a desirable, or easy to meet, requirement for an early stage company. If you restrict your offers to “accredited investors”, as defined in the rule, the disclosure requirements are much much lower. As practical matter, the only applicable disclosure requirement is that you not commit fraud. The reason for this is that the SEC deems accredited investors to be able to fend for themselves. So, offerings that are restricted to accredited investors are faster, easier and cheaper.
So, what is an accredited investor? It is someone (or some entity) that meets one of the criteria described below. Actually, there are other categories of accredited investor, but I have just listed the ones that apply to natural persons (lawyer speak for people). Needless to say, complexity can creep into the definition, so you must get professional advice to make sure you are compliant. But, below is the gist of it.
Accredited investor means any person who comes within any of the following categories:
Any natural person whose individual net worth, or joint net worth with that person's spouse, at the time of his purchase exceeds $1,000,000;
Any natural person who had an individual income in excess of $200,000 in each of the two most recent years or joint income with that person's spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year;
Any trust, with total assets in excess of $5,000,000, not formed for the specific purpose of acquiring the securities offered, whose purchase is directed by a sophisticated person as described in Rule 506(b)(2)(ii) and
Any entity in which all of the equity owners are accredited investors.
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