New businesses or companies that are just getting started must understand investor classifications before they seek investment capital. Which class of investors cannot and which investors can participate in private offerings? Regulation D put forth by the Securities and Exchange Commission, states that in order to raise funds, the private offering of stock may be issued by an organization without the organization registering officially to “go public”. (A detailed explanation of Regulation D offerings can be found by clicking here.)
All of the various types of market investors come into play here, as only certain types are more encouraged than others by the SEC to participate in Regulation D offerings. And again, some kinds of investors aren’t allowed to take part at all. Below is a listing and brief description of approved investor types.
The Sophisticated Investor
An investor who is non-accredited and has superior knowledge in financial matters and business is known as a sophisticated investor. As further explanation, this could include a banker, business owner, accountant, CPA, CFO, or other professionals in the financial business. The offering company still has some wiggle room for interpretation thanks to this definition. Exactly what is meant by “sophisticated” must additionally be defined. The offering company must determine that meaning and be able to back it up should the SEC inquire as to why the company viewed this specific investor as “sophisticated”.
Investors Who Are Non-Accredited
This is an all encompassing term which includes any and all investors that are simply not accredited. For example, if you are starting a company and have family and friends who, even though they are non-accredited, want to offer their support through investment, your startup business may accept investments from them because they are technically referred to as non-accredited investors. Though this type of investment is forbidden outright by Rule 506(c), Rule 506(b) within Regulation D does allow investment that is non-credited if the investors are sophisticated and the company that is starting up and looking for investments has fewer than 35 of these investors making and participating in these offerings.
Investors Who Are Accredited
Individuals having made in excess of $199,999 per year for two out of the last three years, and who are probably going to make the same amount again in the current year, are referred to as accredited. Should an investor not meet this income threshold, they may still be viewed as accredited if, excluding their primary residence, they have a net worth in excess of $1 million. And under most circumstances, the investor merely has to self-certify that they qualify as accredited. The investor, however, may be called upon to be certified by a qualified third-party or by the issuing company in the case of an offering which can be described as private using Rule 506(c).
Why Should Start-Up Businesses Comprehend These Definitions?
An understanding is critical because there are a number of rules under which your private offering can be issued, under Regulation D. When you’re trying to raise capital through private offerings, you are required in some cases (but at the very least encouraged) by the SEC, to do so with investors who are accredited. But, as long as you meet disclosure requirements, a certain number of investors who are non-accredited can participate. This is spelled out in the rules. As mentioned previously, any investor who is non-accredited must also be a sophisticated investor, according to Rule 506. And, also mentioned earlier, the company seeking investment may be asked to define why they view the investor as sophisticated.
A magnificent source of capital, these private offerings, as long as you make sure that guidelines are followed explicitly. When in doubt, a legal professional can assist you in staying within any and all compliance. An attorney who is experienced in start-up businesses and small businesses will be able to expertly manage your investment rounds.