By: James Graves
The Significance of Accredited Investors vs. Non-Accredited Investors
The unfortunate reality of United States securities law is that your company cannot take investment money from just anyone.
One of the most important distinctions in the world of fundraising and securities law is “accredited” versus “non-accredited” investors.
An “accredited investor” is generally an individual with at least $1,000,000 in net worth excluding the equity in their primary residence, or at least $200,000 in income in the last two years and the expectation of the same in the year the investment takes place, or $300,000 with their spouse. A non-accredited investor is essentially everyone besides that. And securities law draws a hard line between the two.
The two easiest and cheapest ways to raise money for startups are Rule 506(b) and Rule 506(c) under Reg D. Under Rule 506(c), non-accredited investors are completely forbidden in the offering. Under Rule 506(b), if you take investment money from only accredited investors, in terms of filings and paperwork, you need only file the Form D. There are no Private Place Memorandums, no additional disclosures, no nothing.
Under Rule 506(b), you can also take investment money from up to 35 non-accredited investors. But here is the problem.
In a Rule 506(b) offering, if you want to take funds from even one non-accredited investor, your disclosure obligations do not scale—they skyrocket. You walk off a legal expense and disclosure obligations cliff. You go from essentially observing the the anti-fraud rules, to public offering (e.g., IPO) level disclosure by taking investment money from even just one non- accredited investor.
Putting forth that amount of money and time just to raise a small amount of funds from a small amount of non-accredited investors is just not worth it.
Securities law assumes accredited investors with the financial means set forth in the law are sophisticated, knowledgeable parties that do not require any additional disclosures. On the flip side, securities law requires a myriad of disclosures to non-accredited investors to “make up” for this apparent lack of sophistication and knowledge. Whether this is actually true or not is besides the point until securities laws changes.
Conclusion
We do not agree with the current framework and have written the SEC (and were later quoted by it in its response) asking it to change it. We hope that they heed our comments and the rest of the legal community’s in doing so.
Until then, make sure you are fundraising pragmatically and within your economic limitations.
Note: if you are set on taking investment funds from non-accredited investors, the best way to go about it is Title III of the JOBS Act, the federal equity crowdfunding rules. We have written extensively on this exemption here and here.
If you have any questions about the above, please feel free to contact me.
Disclaimer: this post is for informational and educational purposes only. It is not intended to provide any legal advice.