So, today's topic is A for accredited investor. Many startups take investment money from friends and family during their initial period of operating. This makes sense. Usually in the beginning there's nothing more than an idea, and that idea turns into a product with a small market before hopefully growing over time into something major. In these early stages before there is traction and revenue, it's difficult to attract investors unless you have a proven track record of hitting nothing but home runs in the startup world.
A lot of people turn to friends and family - literally their friends and their family members to invest money in the idea. Generally, the people doing the investing aren't professional investors like a venture capital firm, or even an angel investor who has a large net worth and spends their time investing in early stage startups that have some traction. No, friends and family are usually the folks who believe in you and are investing in YOU with the belief that you have something special that will make you successful. While they have some money, they may or may not be wealthy folks like millionaire angel investors who have already made their money. Now, the process for someone investing in your company - like the actual process of "you give me money and I give you equity" is pretty simple. We decide how much potential equity your money will buy you, we sign some paperwork like a SAFE note or a convertible note (to be covered in a later episode), and then you wire the money into the company's account. But one step that is often overlooked is the step of confirming the person is an accredited investor.
The Securities and Exchange Commission regulates the sale of securities - stock. Equity. This means they decide when a transaction is between people who are sophisticated enough to know what they're getting into. The SEC has a safe haven that startups utilize called Regulation D.
Reg D as people call it, allows startups to avoid having to file paperwork with the SEC if certain conditions are met. One of those conditions is the amount being raised. Another is whether the solicitation for investment was public or private. And the one we care about today is if the investor is an accredited investor. An accredited investor is either a company or trust that has a certain net worth or a person who has a certain net worth, an officer of the company taking the investment, or someone who earns a certain amount per year. Without going down the whole list, when it comes to actual human beings (i.e. your buddy Josh from B school) they need to either have a net worth of $1m generally not including their home as an asset, plus some other criteria. Or they need to have an annual income of more than $200k single or $300k married for the last two years. If this is true, then the person may qualify as an accredited investor and it changes the process from a complicated drawn out matter with the SEC to simply filing a form saying "we raised some money, here's how much, and we're protected by this section of the law because she's an accredited investor". There's some work your lawyer will need to do in order to vet the person as fitting the category, but this doesn't get filed. Now, some startups avoid filing this form because they don't want to tip the world off to how much they're raising and these forms are public for the world to see.
One final point to take note of is that when a company is raising less than $1M, they fall within a safe harbor rule from the SEC that exempts the burdensome reporting requirements that come with taking an investment from a non-accredited investor. However, you'll still need to comply with the "Blue Sky Laws" (state specific securities laws) for the state(s) where each investor resides.
But that is a topic for another day.