Corporate & Transactional
Receiving Money From Non-Accredited Investors
While there are numerous ways to raise capital for a business endeavor, many companies may turn to non-accredited investors. Before receiving money from non-accredited investors, there are several legal and financial matters to consider. Generally, non-accredited investors do not meet the income or net worth requirement from the Securities and Exchange Commission (SEC). Find out what you need to know about these types of non-accredited investors, and if using them as a financial source makes sense for your company.
What Is the Difference Between an Accredited and Non-Accredited Investor?
An accredited investor must meet specific financial criteria the Securities and Exchange Commission sets. Often, these investors tend to be more experienced in investing, meaning the SEC understands that they have the financial means and knowledge to take more considerable losses. Along with that, these types of investors can make riskier investment decisions. Many high-risk investments that target accredited investors have the potential for higher returns and can include hedge funds, venture capital, and private equity. These types of funds provide less information to their investors. Currently, an accredited investor is defined as an individual with the following:
- A net worth of at least $1 million
- An annual income of over $200,000 ($300,000 combined income with a spouse)
On the other hand, non-accredited investors are defined as having less than $1 million in assets and an annual income below $200,000. The SEC restricts potential investors to protect against harmful financial situations. While the restrictions can limit some investment opportunities, non-accredited investors can participate in private investment if they can meet specific requirements.
Offering Opportunities To a Non-Accredited Investor
In the United States, companies must register the sale of shares with the Securities and Exchange Commission. However, some companies can meet certain exemptions to exclude them from official registration. It is challenging for these smaller or early-stage companies to go through the public registration process. As a result, they will typically rely on exemptions. Each state has its own set of rules regarding exemptions. The SEC has provided a way to override these state requirements if the stock sale meets specific criteria, such as restricting the offering to accredited investors. If the opportunities open to non-accredited investors, the company must comply by meeting additional information requirements. In many situations, this usually includes creating detailed and thorough disclosure documents for their investors.
These disclosures can be costly for startups to prepare. Still, the SEC has provided an alternative for companies that have less than $1 million in finance offerings, allowing non-accredited investors to participate without the full offering-style disclosure. However, these offerings must still comply with state securities laws, also known as blue sky laws. It is important to note that these laws apply to the state of residence of the investors, not the company. It is often necessary to conduct legal research to determine the requirements in each potential state for every non-accredited investor. Additionally, it is important to note that all documents provided to potential investors must be accurate and not deceptive, as companies are subject to the anti-fraud provisions of the Exchange Act of 1934. Unfortunately, many companies find it cost-prohibitive to incur the professional fees associated with raising money from non-accredited investors. With that, it is common for early-stage companies to exclude non-accredited investors from fundraising efforts.
What Are Rules 505 and 506?
When receiving money from non-accredited investors, companies must follow established rules and regulations from the SEC. Within Rules 505 and 506, there is a special provision known as Regulation D. According to the Securities Act of 1933, Regulation D states that the securities must be registered with the SEC or exempted. Within Rule 505, certain businesses are exempt if they:
- Offer and sell no more than $5 million of its securities in any 12 months
- Sell to an unlimited number of accredited investors and up to 35 other individuals who are not required to meet the wealth standards of other exemptions
- Inform purchasers that they are receiving restricted securities, meaning that they cannot be sold for at least six months without registering them
- Not use general advertising to sell the securities.
Determining the Feasibility of Funding from Non-Accredited Investors
Rule 505 allows companies to determine what information to provide to accredited investors, providing it does not violate the anti-fraud provisions of federal securities laws. If a company raises capital from non-accredited investors in Rule 505 or Rule 506 registration-exempted financing, it must provide important information about the company. With that, it can lead to increased legal and accounting costs. It may not be practical for a startup short on capital to offer investment opportunities to non-accredited investors.
In addition, non-accredited investors tend to be more emotionally invested in the company and may be more likely to file a lawsuit if things do not go as planned. Also, it may be more difficult for a company to be acquired after completing a financing round with non-accredited investors due to additional rules that may be triggered and the possibility of requiring a buyout of these investors before the acquisition can take place. For that reason, many early-stage businesses and small companies that need to raise money to avoid receiving funds from non-accredited investors. These investors could create several challenges during and after the financing process.
Learn More About What Type of Funding Is Right For Your Business
Many companies avoid receiving money from non-accredited investors during their initial fundraising stages. The added cost of fees can often outweigh the amount of funding that can be raised from these types of investors. This can be challenging for early-stage companies, which may have limited resources and want to minimize expenses. By excluding non-accredited investors, these companies can focus on raising funding from other sources without incurring additional costs.