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Faces of Modern CFO's

Psst…You Don’t Need to be an Accredited Investor

Chris McConnell


April 10, 2019

The traditional accredited investor paradigm has shifted as the SEC has opened up more opportunities for non-accredited investors.

Good news! The SEC is offering more and more ways for non-accredited investors to participate in high-altitude investing.  After all, the accredited investor paradigm is old, stodgy, and just plain arbitrary.  

It’s basically a short-cut for the SEC to use as a crutch.  It says, “Hey, if you’re worth a ton of money, you should know better, so we’re not going to protect you.”  That’s neat and clean for them.  It’s also unfair for us.

As SEC Commissioner Hester Peirce says, “Wait a minute, you’re telling me I have to be rich in order to get rich?”  That makes no sense.

The reality is that non-accredited investors already can participate in many “restricted” investment opportunities.  Certainly, companies can invite almost anyone to invest, no question.  Here’s how.

The SEC has several offering rules that allow non-accredited investor participation.  Perhaps the simplest, and most commonly used, is the Reg D Rule 506(b) private offering.  Here, issuers can allow up to 35 “sophisticated investors.”  That’s you and me!  We just need to have a relationship with the company (for example, know the founder), and have “sufficient knowledge and experience in financial and business matters” to be capable of evaluating the investment.  We don’t have to be rich, or make a zillion dollars.  That said, we should be cautious, and assume that we can lose our entire investment.  Private investing is not for the faint of heart!

Other SEC “safe harbor” offerings include Reg D Rule 504 (offerings up to $5M, not exempt from state blue sky laws), and Reg CF (crowdfunding offerings up to $1M).  Rule 504 and Reg CF have certain advantages and disadvantages; however, neither is as robust as Rule 506(b).  Another option is Reg A (in effect a mini-IPO) which requires companies to meet annual SEC filing requirements.  Hmm, that’s no fun.

On the flip side, there are plenty of investments that simply do not cater to non-accredited investors.  The most famous one is Reg D Rule 506(c) which fueled the ICO (Initial Coin Offering) craze.  Unlike its cousins, Rule 506(c) permits advertising; however, it also requires that the issuer verify that all participants are accredited investors.  But wait.  If you managed to side-step the ICO craze, be happy.  While a few shady characters (and some of their investors) got rich, lots of folks lost tons of money.

Switching gears a bit, many large institutional funds (PE, VC, real estate, etc.) purposely limit their offerings to accredited investors.  Some funds set an even higher bar: they only welcome qualified purchasers ($5M+ net worth).  These limits are not so much about SEC rules, but more about the preferences of the fund managers.  To keep their lives simple (and earn high fees), they only want big chunks from heavy investors.  Nobody can force these funds to accept small investors.

One of the most misunderstood areas of private investing is the resale of private securities, when an investor decides to sell to another investor.  Usually, this will be at least six months after the initial investment, so the SEC does not think that the original investor is a broker/dealer.  There are two SEC statutes covering the secondary sale of private securities.  Section 4(a)(7) is newer, and (here we go) a perfect example of the SEC short-cut.  You guessed it, the buyer must be an accredited investor.  Fortunately, the more traditional statute, Section 4(a)(1½), has no such restriction.  It does require that the buyer be sophisticated (see above) and have sufficient information about the company (officer/director bios and basic financial statements) to make an informed judgment.  So, don’t let anyone tell you that to buy private company shares you need to be an accredited investor.  You don’t.  Period.

Over the years there has been so much angst over the notion of accredited investors that many of us assume that, unless we are rich, we can’t play with the big dogs.  While it’s true we won’t be invited to every party, absolutely we can play.  And here’s an interesting statistic: while there are 3,700 public companies in the US, there are over 7 million private companies.  Whoa.  That means that for every one public company in the US, there are some 2,000 private companies.  That’s huge!

Here’s the bottom line: the opportunity to invest in private companies couldn’t be riper, and it’s perfectly available to you and me.

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