Accredited Investor Requirements: What Startup Founders and Investors Need to Know Before a Private Offering
Raising capital from private investors can provide startups and growing businesses with access to funding without pursuing a traditional public securities offering. However, founders often encounter an important securities-law concept early in the fundraising process: the accredited investor.
Understanding who qualifies as an accredited investor, why that designation matters, and how investor status affects a private securities offering can help founders structure fundraising efforts more effectively. Investors likewise benefit from understanding the qualification standards before participating in private placements, venture financings, private funds, and other investment opportunities that may rely on exemptions from federal securities registration.
This article examines the accredited investor framework, its significance under federal securities laws, and practical considerations for companies and investors participating in private capital transactions.
What Is an Accredited Investor?
An accredited investor is a person or entity that satisfies certain financial, professional, or institutional criteria established under federal securities regulations.
The concept is particularly important under Regulation D of the Securities Act of 1933, which provides exemptions that companies frequently rely upon when offering securities without registering the offering with the Securities and Exchange Commission ("SEC").
Accredited investor status does not mean that the SEC has approved an investor, certified the investor's sophistication, or endorsed a particular investment. Instead, it is a regulatory classification used in determining who may participate in certain securities offerings and what requirements apply to those offerings.
Why Does Accredited Investor Status Matter?
Federal securities law generally requires securities offered or sold in the United States to be registered with the SEC unless an exemption applies.
Registration can involve substantial disclosure, compliance, accounting, and legal obligations. Private companies therefore commonly structure capital raises under exemptions from registration.
Two frequently discussed exemptions under Regulation D are Rule 506(b) and Rule 506(c).
Rule 506(b) Offerings
Rule 506(b) generally permits an issuer to raise an unlimited amount of capital from accredited investors and, subject to additional requirements, up to 35 non-accredited investors who possess sufficient financial knowledge and experience to evaluate the investment.
One significant feature of Rule 506(b) is that issuers generally cannot engage in general solicitation or advertising in connection with the offering.
Consequently, startups relying on Rule 506(b) must carefully consider how prospective investors are identified and approached.
Rule 506(c) Offerings
Rule 506(c) takes a different approach.
An issuer relying on Rule 506(c) may generally solicit and advertise the offering publicly, provided that purchasers are accredited investors and the issuer takes reasonable steps to verify their accredited investor status.
This distinction can be particularly important for companies considering online fundraising campaigns, investor events, public announcements, social media promotion, or other broadly distributed communications concerning an investment opportunity.
Who Qualifies as an Accredited Investor?
Rule 501(a) of Regulation D identifies multiple categories of accredited investors. Qualification is not limited to wealthy individuals.
Depending on the circumstances, individuals may qualify based on income, net worth, professional credentials, or certain relationships with the issuer. Entities may qualify under separate standards.
Individual Net-Worth Qualification
One commonly used qualification method involves an individual's net worth.
Generally, an individual may qualify if the person's individual net worth, or joint net worth with a spouse or qualifying equivalent, exceeds $1 million at the relevant time, excluding the value of the person's primary residence, subject to specific rules governing related liabilities.
The exclusion of a primary residence is important because simply owning a valuable home does not necessarily cause an individual to satisfy the accredited investor net-worth standard.
Calculating net worth for securities-law purposes can also be more complicated than subtracting ordinary liabilities from assets. Certain indebtedness associated with a primary residence can affect the calculation.
Individual Income Qualification
An individual may also qualify based on income.
Generally, an individual can satisfy the income standard with income exceeding $200,000 in each of the two most recent years, together with a reasonable expectation of reaching the same income level during the current year.
For joint income with a spouse or qualifying equivalent, the applicable threshold is generally $300,000 under the corresponding requirements.
Because qualification involves multiple periods, earning above the threshold during only one year does not necessarily establish accredited investor status under this test.
Professional Certifications and Accredited Investor Status
Accredited investor status is no longer based exclusively on wealth or income.
Certain individuals holding professional certifications, designations, or credentials recognized by the SEC may qualify as accredited investors even if they do not independently satisfy the traditional income or net-worth thresholds.
This expansion reflects the principle that financial sophistication may sometimes be demonstrated through professional qualifications rather than wealth alone.
Investors relying on a professional credential should confirm that their credential is currently recognized for purposes of the applicable SEC rules.
Knowledgeable Employees of Private Funds
Certain "knowledgeable employees" of private funds may also qualify as accredited investors for investments involving those funds.
This category can be relevant to investment professionals, executives, and other qualifying personnel working within private equity, venture capital, hedge fund, and similar investment structures.
Whether an employee qualifies depends on the applicable regulatory definition and the person's responsibilities rather than simply employment by an investment organization.
Can Companies and Other Entities Be Accredited Investors?
Yes.
The accredited investor definition includes numerous categories of entities, potentially including corporations, limited liability companies, partnerships, trusts, banks, insurance companies, registered investment companies, certain employee benefit plans, family offices, and other qualifying organizations.
Some entities may qualify based on having more than $5 million in assets, subject to additional requirements applicable to the particular category.
Other entities can qualify when all of their equity owners are themselves accredited investors.
Because the analysis varies depending on the type, ownership, assets, and purpose of the entity, founders should not assume that an investment company, LLC, or investment vehicle automatically qualifies merely because it is a business entity.
Accredited Investors and Startup Fundraising
For startup founders, accredited investor status is more than an investor-side concern. It can affect how an offering is structured, marketed, documented, and conducted.
Before accepting investment capital, founders should determine which securities exemption the company intends to rely upon.
That decision can influence matters including:
Whether non-accredited investors may participate;
Whether the company can publicly advertise the offering;
What disclosures may be required;
How accredited investor status must be established;
What federal and state filings may be necessary; and
What representations should appear in subscription and investment documents.
Founders should therefore address securities-law compliance before broadly marketing an investment opportunity or accepting funds.
Self-Certification Versus Verification
An important distinction exists between obtaining an investor's representation concerning accredited status and independently verifying that status.
In a Rule 506(b) transaction, issuers commonly obtain representations regarding an investor's accredited status through questionnaires, subscription agreements, or related offering documents.
Rule 506(c), however, requires the issuer to take reasonable steps to verify that purchasers are accredited investors.
Depending on the circumstances and the qualification method involved, verification procedures may involve reviewing financial documentation or obtaining written confirmation from certain qualified third parties.
The appropriate procedure depends on the exemption, investor category, and facts surrounding the transaction.
Does Being Accredited Mean an Investment Is Safe?
No.
Accredited investor status should not be confused with regulatory approval or investment quality.
Private securities can involve significant risks, including limited liquidity, restricted resale opportunities, uncertain valuations, limited operating histories, dilution, business failure, and the possible loss of the investor's entire investment.
Private offerings also may provide investors with different information than would ordinarily be available in a registered public offering.
Investors should therefore conduct appropriate legal, financial, tax, and business due diligence rather than treating accredited status as an indication that a particular investment is suitable.
Common Mistakes Founders Should Avoid
Companies conducting private offerings can create unnecessary securities-law risk by treating accredited investor qualification as a simple administrative checkbox.
Common issues can include publicly promoting an offering before determining whether general solicitation is permissible, accepting funds before establishing the applicable exemption, relying on incomplete investor questionnaires, confusing Rule 506(b) procedures with Rule 506(c) verification requirements, or failing to address required federal and state securities filings.
Another potential problem arises when founders focus exclusively on accredited investor status while overlooking the broader securities-law analysis.
An offering does not necessarily become compliant merely because every purchaser is accredited. The issuer still needs an applicable exemption and must comply with the conditions associated with that exemption, as well as applicable anti-fraud and other securities-law requirements.
When Should a Startup Consult Securities Counsel?
Ideally, securities counsel should become involved before the company begins actively soliciting investors.
Early legal planning can help founders determine the appropriate offering structure, prepare investment documentation, evaluate solicitation restrictions, establish investor qualification procedures, and address federal and state filing requirements.
This can be particularly important when a startup intends to raise capital through SAFEs, convertible notes, preferred equity, membership interests, private investment rounds, or other instruments that may constitute securities.
Addressing these questions before fundraising begins can be considerably more efficient than attempting to correct compliance problems after investors have already been solicited or funds accepted.
Plan Accredited Investor Compliance Before Raising Capital
Accredited investor status is a central component of many private securities offerings, but it represents only one part of the broader regulatory framework governing startup fundraising.
Founders should understand which investors qualify, which securities exemption the company intends to rely upon, whether general solicitation is permitted, and what verification, disclosure, documentation, and filing requirements may apply. Investors should similarly understand that accredited status provides access to certain private investment opportunities but does not constitute regulatory approval or eliminate investment risk.
Because securities offerings can create significant federal and state compliance obligations, businesses contemplating a private capital raise should consider obtaining legal guidance before approaching investors or accepting investment funds.
Contact the firm at 786.461.1617 for a consultation to explore your options and discuss how accredited investor requirements and private offering regulations may apply to your proposed capital raise or investment transaction.
