Open-Sourcing the Start-up: Unaccredited Investors

One subject that often comes up in start-up financing is the issue of unaccredited investors. An unaccredited investor is someone who the government has deemed as possibly less sophisticated and therefore more in need of protection than a more sophisticated “accredited” investor. For a listing of the ways an investor qualifies as accredited you can check Rule 501 of Regulation D here. The two most likely qualifications are probably this one:

a natural person who has individual net worth, or joint net worth with the person’s spouse, that exceeds $1 million at the time of the purchase;

and this one:

# a natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year; or

So what happens if you have someone who wants to invest who doesn’t fit any of the criteria for accreditation? Can they still invest? Some people have written that they can’t, or at least shouldn’t. For example, check out blog posts from Jeff Clavier and Brad Feld on the subject. Reading through these makes it seem pretty scary to take money from unaccredited investors. But it’s not necessarily always a terrible idea.

DISCLAIMER: I AM NOT A LAWYER. PLEASE USE THE FOLLOWING ONLY AS A LEAD-IN TO A CONVERSATION OVER COFFEE WITH YOUR ATTORNEY. THIS ISN’T LEGAL ADVICE.

OK, so what happens when your Uncle Bob wants to invest and you’d really like to have him invested in your company despite the fact he’s not a miliionaire? Well, first you have to be really, really careful. You definitely can’t exceed 35 Uncle Bob-type investors in your company. And if you want to be super-safe you really need to get a Private Placement Memo drafted and provide financial statements to these investors. However, the cost of that is often prohibitive which would again seem to exclude unaccredited investors from investing.

However, it’s not necessarily true that have a few unaccredited investors is an absolute no-no. Case law has generally held that so long as the number of unaccredited investors is kept reasonably low and there isn’t other general shadiness going on (e.g., fraudulent activity, etc.) then you probably aren’t in violation of securities laws. However, this is where it starts to get complex (and where you need to make that call to your lawyer). You see each state has its own laws on this so if you are receiving investment from multiple states then it’s possible that one of your unaccredited investments might be perfectly fine while another one might cause an issue (such as the investor having the right to ask for a refund of their investment). It also could be a problem to have a large number of unaccredited investors if you end up getting acquired.

At the end of the day, there are two things I’d emphasize. First, this is a complex topic that you definitely want to have good legal representation for. Second, while it is possible to take money from unaccredited investors you need to be careful when you do and should be well-aware of the risks involved.

This entry was posted on Monday, December 3rd, 2007 at 4:27 pm and is filed under Uncategorized. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.