Who Is an Accredited Investor?

Business owners and managers searching for investors to boost their business with capital should understand the Securities Act of 1933 and its influence on capital-raising avenues. As mentioned in our previous article, this Act initially banned general solicitation for advertising securities, a restriction that the JOBS Act of 2012 subsequently removed. Yet, this allowance came with a significant exception: businesses could now engage in general solicitation to attract investors but must ensure the stakeholders are accredited. In this blog, you will learn the concept of accredited investors and how to confirm the status of your potential financiers. Keep reading below.

The Securities Act of 1933 Impact on Early-Stage Companies

As outlined in our previous article, while the measures outlined in the Securities Act of 1933 are vital for protecting investors and maintaining the integrity of the market, they can also pose challenges for smaller companies in terms of capital formation. The costs and complexities associated with compliance can be significant. Furthermore, the obligation to disclose sensitive business information publicly can inadvertently benefit competitors.

However, within this regulatory framework, Regulation D specifies conditions that allow companies to offer unregistered securities to investors. Notably, Rules 506(b) and 506(c) outline strategies for companies to leverage exemptions from SEC security registration requirements.

Rule 506(b) permits the issuance of unregistered securities through private placements, albeit without general solicitation, which could still hinder capital formation. On the other hand, Rule 506(c), introduced by the JOBS Act of 2012, permits general solicitation in marketing securities, with the stipulation that sales are limited to accredited investors.

Understanding the Accredited Investor

In essence, this term refers to individuals recognized by the SEC as being sufficiently knowledgeable and financially robust to engage in investments involving complex or sophisticated securities. Such investors are deemed capable of navigating these waters without the protective guardrails of the disclosure mandates established by the Securities Act of 1933.

Many early-stage companies turn to Rules 506(b) and 506(c) of the Securities Act of 1933 to issue unregistered securities directly to these investors. This approach allows these businesses to sidestep the extensive costs and compliance challenges associated with the Act's disclosure obligations.

Given the inherently risky nature of such securities, it is crucial for the government to ensure that only those investors who are financially secure and sufficiently savvy about investment intricacies participate. This safeguard aims to ensure that accredited investors fully comprehend the potential implications and risks of where they are allocating their funds.

The Criteria for Individual Accredited Investors

To qualify as an accredited investor, individuals must meet one or more of the following criteria set by the SEC:

• Possess a net worth exceeding $1 million, either individually or jointly with a spouse, not including the value of their primary residence.
• Have an annual income of at least $200,000 individually, or $300,000 together with a spouse, for the past two years, with the expectation of earning the same or a higher income in the current year.
• Hold a key position such as a general partner, executive officer, or director in the company that is issuing the unregistered securities.
• Be a family client of a family office that qualifies as an accredited investor.

Entities can attain the status of an accredited investor, a distinction that comes with its own set of qualifications. While a detailed discussion of these qualifications falls beyond the ambit of this article, we encourage you to check this resource for a comprehensive list of the requirements.

Verification

Under Rule 506(c), the SEC mandates that you take reasonable steps to ensure that your investors meet the accredited status. Here are some of the common methods you can use:

• Income Verification: Investors need to provide tax returns, W-2 forms, 1099 forms, and other official documents to demonstrate that their income levels meet the established criteria.
• Net Worth Verification: Investors may also present documentation such as bank statements, brokerage statements, and other securities holdings statements to verify their net worth.
• Written Confirmation from Professionals: Acquire written assurances from registered broker-dealers, RIAs (Registered Investment Advisors), and licensed attorneys confirming they have taken reasonable steps within the last three months to verify an investor’s accredited status.

Conclusion

In summary, an accredited investor is someone the SEC recognizes as having the financial acumen necessary to understand the risks associated with sophisticated, unregistered securities that companies issue under Rules 506(b) and 506(c) of Regulation the Securities Act of 1933. For business owners, the value of accredited investors cannot be overstated. They have the unique ability to purchase these unregistered securities from your company, enabling you to bypass the stringent compliance and disclosure requirements imposed by the SEC. This, in turn, allows you to access the vital capital needed to drive your company's growth.

Are you wondering about any of the issues mentioned above? Please email us at info@wilkinsonlawllc.com or call (732) 410-7595 for assistance.

At Wilkinson Law, we give business owners the documents and advice they desperately need to fund, grow, protect and sell their businesses. We are trustworthy business advisors keeping your business on TRACK: Trustworthy. Reliable. Available. Caring. Knowledgeable.®