A Few Reasons Why Being an Accredited Investor Matters

Let’s face it: The Securities and Exchange Commission (SEC) requires registration for most offerings. The registration process can be costly and time-consuming, leading to a steep barrier to entry for companies who need to raise capital. Fortunately, Regulation D of the Securities Act contains some important exemptions to this registration requirement. For example, Rule 506(c) of Regulation D permits general solicitation and advertising to anyone as long as eventual sales are made only to accredited investors. Therefore, accredited investor status DOES matter to both investors and issuers of private placement offerings.

What Is an Accredited Investor?

According to Rule 501 of Regulation D, natural persons generally need to meet one of two criteria to be an accredited investor. First, either alone or jointly with their spouse, they must possess over $1 million in net worth, excluding the value of their primary residence. Alternatively, they must earn up to $200,000 (or $300,000 with a spouse) for the two previous years and should reasonably anticipate the same level of income in the current year. Entities must meet separate criteria to be accredited. Such entities may include certain financial institutions, trusts, and companies whose equity owners are accredited investors.

What If You Are Not an Accredited Investor?

An alternative exemption, Rule 506(b) of Regulation D, allows “sophisticated,” unaccredited investors to also participate in a syndicated deal along with accredited investors, but it’s rarely used.  There are other exemptions that also allow companies to raise capital from non-accredited investors, but they come with extra burdens and costs. Registration is always an option as well, but it’s expensive and time-consuming.

For Rule 506(b), the law defines a “sophisticated person” as “someone who has sufficient knowledge and experience in financial and business matters and that he or she is capable of evaluating the merits and risks of the prospective investment, or the issuer reasonably believes immediately prior to making any sale that such purchaser comes within this description.”

That being said, you should keep in mind that there are some major drawbacks for Rule 506(b). For instance, the maximum number of these sophisticated persons but non-accredited investors is only 35 per deal. Furthermore, one of the requirements for the sophisticated person is a pre-existing relationship with the issuer. Capital-raising companies who conduct 506(b) offerings may not advertise or solicit investors generally, so the number of available 506(b) investment opportunities for non-accredited investors is more limited in the private placement market.

Rule 506(c), in contrast, offers a myriad of solicitation opportunities for private placement issuers, making more deals available to accredited investors with no pre-existing relationship with the issuer. Rule 506(c) offerings differ from pure crowdfunding opportunities because they offer increased flexibility to both issuers and investors. For instance, unlike all the other securities exemptions commonly used for crowdfunding, Rule 506(c) does not limit the amount of investment capital a company may raise. Investors also have an opportunity to learn about Rule 506(c) deals on social media and other platforms, and not only on the requisite funding portal under Title III, Regulation CF.

Another advantage of Rule 506(c) is that it does not extend certain obligations to issuers. To clarify, while there is no legal disclosure requirement for Rule 506(c), issuers will still need to disclose anything material. According to 17 CFR 240.12b-2, a statement is material if there is "a substantial likelihood that a reasonable investor would attach importance in determining whether to buy or sell the securities registered." If any material disclosures of a Rule 506(c) offering are untrue or omitted, then the disclosure can be liable under Rule 10b-5. Section 12(a)(2) of the Securities Act of 1933 creates additional liability for a material misstatement or omission, unless the purchaser is aware of the misstatement at the time of purchase.  

Based on the current market trend, we believe there will be an increased number of Rule 506(c) offerings, and an increased reliance on accredited investors in general. Since the rule does not require SEC registration and permits general solicitation for increased market exposure, accredited investor verification is more important than ever for many issuers. For easier, more straightforward accredited investor verification, contact support@verifyinvestor.com.

Updated 4/6/2023

Bottom line is, being an accredited investor matters for investors and issuers of private placement offerings. Rule 506(c) of Regulation D permits general solicitation and advertising to anyone as long as eventual sales are made only to accredited investors. This offers increased flexibility to both issuers and investors, making more deals available to accredited investors with no pre-existing relationship with the issuer. Unlike other securities exemptions commonly used for crowdfunding, Rule 506(c) does not limit the amount of investment capital a company may raise. It also does not extend certain obligations to issuers, while still requiring material disclosure.

As a result, we believe there will be an increased number of Rule 506(c) offerings and an increased reliance on accredited investors in general. Accredited investor verification is more important than ever for many issuers since the rule permits general solicitation for increased market exposure and does not require SEC registration. While there are alternative exemptions that also allow companies to raise capital from non-accredited investors, they come with extra burdens and costs. Therefore, being an accredited investor provides more investment opportunities and may offer greater returns for investors, while also allowing issuers to raise capital more easily and efficiently.