By Fernando Berrocal

When it comes to raising funds, you must know what defines an “accredited investor” and who is eligible to be called one. The distinction between an “accredited investor” and "everyone else" is crucial. Due to disclosure rules, raising cash from non-accredited investors can be expensive. It can also add to your administrative workload as you deal with a various number of small investors. On the other hand, accredited investors can be the lifeblood of your early funding rounds for your startup.

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What is an Accredited Investor? According to the U.S. Security and Exchanges Commissions (SEC), an accredited investor is a person or entity that’s "sophisticated" enough to undertake potentially high-risk investment decisions, such as investing in a startup. In terms of financial worth and regular income, an accredited investor must meet specific requirements.

How to become an Accredited Investor? You don’t have to apply for a particular certificate or pass any examinations to become an accredited investor. If you're soliciting money from authorized investors, it's your responsibility to do your research and make sure they're legitimate.

Why should Accredited Investors be important? Most early-stage enterprises are unable to register their securities on the market. As a result, entrepreneurs opt for exemptions that allow them to issue shares without having to register. Every state has its exemption laws, but if you fulfill the SEC's standards and make a Regulation D Rule 506(b) offering. Your business can issue shares to authorized investors without having to register public securities if you take advantage of this exemption. 

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However, you can issue up to 35 non-accredited investors shares under Rule 506(b), but only if you fulfill specific disclosure criteria. Those standards are so rigorous that completing them isn't worth it for most startups. As a result, if your startup is just getting off the ground, you'll most likely need to rely on accredited investors to generate funds.

What is the SEC's interest in Accredited Investors? In summary, the SEC is concerned with how "smart" investors are because it wants to protect ordinary people from losing all they own through dangerous investments.

Millions lost their money when the stock market crashed in 1929. Many of the businesses were inexperienced and unstable. Following that, the SEC was established to safeguard investors. One method they use is requiring investors in early-stage (and high-risk) businesses to have a stable income in case the venture fails.

What does it take to become an Accredited Investor? To be considered one, you must fulfill at least one of these requirements:

• Your net worth exceeds $1 million, excluding your main residence.
• Your income was above $200,000 in each of the previous two years, and you might fairly predict a similar income this year.
• For the last two years, your aggregate income has exceeded $300,000, and you may fairly assume a similar income this year.

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An organization qualifies as an accredited investor if:

• It's a trust with more than $5 million in assets, and the investment is being planned by someone with adequate business expertise to appropriately assess the transaction's risks and benefits.
• Its stock owners all meet the requirements for individual accredited investors.
• It's a charitable organization, partnership, or corporation with assets worth more than $5 million in this year's income.

Is it worthwhile to raise funds from Non-Accredited Investors? In short, no. While Rule 506(b) allows you to bring on up to 35 non-accredited investors without having to make public financial reports, most startups don't think it's worth it. There are a few strong arguments for this:

• Disclosure is inconvenient: You may be required to furnish a non-accredited investor with a balance sheet, income statements, statements of shareholder equity, and associated financial statements, all of which must be audited and go back two years, depending on the kind of offering. 

• It's not cheap: Disclosure to non-accredited investors could easily approach $50,000. Given how little money you're going to get from them, that's a significant amount to pay.

• You're not going to raise a lot of money:  When compared to an infinite number of authorized investors, each with a net worth of over $1 million and an annual income of over $200,000, the amount you're likely to raise from 35 or fewer non-accredited investors who don't meet these requirements will be minimal.

Accredited Investors and Crowdfunding: Businesses can offer shares to a large number of small investors through “Equity Crowdfunding”. Many investors who would not normally be eligible are now able to participate, although there are a few caveats.  These equity crowdfunding requirements are:

• The size of the offering: Over a year, you can't raise more than $5 million.
• Investor expectations:  While accredited investors are not required, they must fulfill certain net worth standards.
• Resale: The buyer of crowdfunding equity cannot sell it until one year has passed following the acquisition.
• Eligibility: If you are not a US business and file reports under the Securities Exchange Act of 1934, or if you fall under specific types of investment businesses, you cannot use equity crowdfunding.
• Portals on the internet: The offering must be made through an SEC-registered online broker or a Financial Industry Regulatory Authority-monitored crowdfunding platform.

Furthermore, crowdfunding may jeopardize your privacy. Online crowdfunding sites make your organization's information visible. When you're attempting to stay under the radar, this might bring unwelcome attention. Furthermore, if your round underperforms, it will be made public, potentially harming your reputation.

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Ready to bring your startup to the next level? Apply to MassLight’s next batch. MassLight supplies capital and a dedicated tech team. We take equity in return. Have questions? Refer to our FAQ page.

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