Thursday, February 04, 2016
The Persistent Importance of the Accredited Investor Definition
By: William Carleton, Counselor @ Law, and volunteer chair of ACA Public Policy Advisory Council
Yes, there's Title III under the JOBS Act, promising equity crowdfunding (think Kickstarter or IndieGoGo, just not restricted to awards or products, but instead offering ownership in the company); yes, there's Reg A+, also bequeathed by the JOBS Act; and there are a plethora, now, of state crowdfunding laws that lower the bar to who may invest in private companies.
So the accredited investor definition - that old standard under Regulation D - it should be diminishing in importance, right? As the doors to investing in private companies open, it shouldn't matter as much whether people qualify as "accredited investors," typically entailing that they have a million dollars in net worth (not including the principal residence) or a persistent $200,000+ annual income - right?
In fact, the accredited investor definition has become more important than ever. And this is not in spite of the many reforms under the 2012 JOBS Act, but instead largely because of those reforms and subsequent legal developments.
Biggest example: online platforms for angel investing. The best of them hold themselves out as restricting either access to or participation in deals to accredited investors. Test this out for yourself: go to AngelList, FundersClub, and CircleUp (there are others but these are among the leaders).
Here's a sampling of what these online sites have to say about who is allowed to invest:
"If you aren’t an Entrepreneur looking for advice and an introduction to potential investors or you don’t think that you are both an Accredited Investor and sophisticated enough to protect your own interests, then you should not try to create an account on this site." (AngelList)
FundersClub takes the question up a level, not restricting the answer to online angel activity but to investing in startups, broadly speaking:
"Q: Do I need to be an accredited investor to invest in startups?"
"A: Most startups that raise funding rely on legal frameworks and financing documents that restrict investing to only accredited investors. This minimizes the legal and regulatory burden and cost for startups. While there are some legal ways for non-accredited investors to invest in startups as of June 2015, given the legal frameworks in place, in practice startups will usually only allow accredited investors."
The reasons are complicated, and the nuance of variations within Regulation D can be hard to parse, but think of it this way: when Congress gave its okay, under the JOBS Act, for angel investing to go online, it doubled down on the importance of the accredited investor definition and simply made it a requirement. In fact, it's fair to say that the rules tighten when an offering is made publicly, whether online, through social media, or at public pitch events: not only must all purchasers be accredited, but the company conducting the offering must meet a higher standard than before in ensuring that all of its investors are accredited investors.
Where does this leave crowdfunding for people who are not rich? Opinions widely vary, but I think anyone looking at a private deal that is NOT limited to accredited investors should ask: did you have problems raising money from accredited investors, and why?
There are proposals afoot to expand the accredited investor definition, some which might allow people to "test in" and satisfy the standard regardless of wealth. (The real standard should be sophistication, and many lawyers I know, but won't name, have long observed that wealth correlates poorly with sophistication!) Some of these proposals are described in a recent report issued by staff at the Securities and Exchange Commission. But don't hold your breath. The definition today, at least for individuals, focuses on net worth or annual income. Forming an LLC with a group and investing that way, that's not a work around, either: to qualify as an accredited investor, that LLC you form will generally have to be owned only by members who individually qualify as accredited investors.
I'll leave you with this news about a private securities law reform contained in a transportation bill passed by Congress and signed into law by the President at the end of 2015: It's a reform should make it easier for investors to resell stock in private companies, without having to first wait out a holding period. No question that, like the reform under the JOBS Act making it easier to conduct angel investing online, this new private resale exemption is meant to promote investing in startups. If investors have more avenues to liquidity in private stock, and not always have to wait for the company to go public or be sold, they should invest more readily. But guess what one of the conditions is, for qualifying for this private resale exemption? You guessed it: the person buying from you must be an accredited investor!