The Securities and Exchange Commission (SEC) has an important job: to protect investors. Investing comes with risk. And some assets carry more risk than others. So regulators developed certain financial requirements to try to protect less wealthy and “less sophisticated” investors who may not be aware of the risks of a particular investment or may not have a cushion to fall back on if they lose their money on an investment.
To that end, the SEC created two classes of investors: accredited and non-accredited.
What Is an Accredited Investor?
Accredited investors are deemed to be wealthy enough OR financially sophisticated enough to handle the risks of most investment opportunities. They are qualified to invest in a wide range of offerings, including unregistered securities, hedge funds, venture capital, startups and deals involving complex and higher-risk investments and instruments. They get access to investments that are more high-risk, high-reward than most publicly available investments. Many times, this access comes with significantly less information than the SEC requires companies provide to non-accredited investors. And accredited investors make up a small subset of the population. According to the SEC, just 10% of households in the U.S. qualify as accredited.
The SEC typically uses income to determine whether an investor qualifies as accredited. To become an accredited investor, a person must have earned more than $200,000 (or more than $300,000 with a spouse) in income in each of the prior two years and is expected to meet the same bar for the current year. Alternatively, they must have a net worth of more than $1 million, excluding their primary residence. (This may be achieved either alone or together with a spouse.) In very rare cases, an investor that doesn’t meet the financial requirement can become an accredited investor by proving their financial “sophistication.” That proof usually includes significant education in or job experience with unregistered securities. But by and large, income is the usual determining factor.
Entities — including banks, partnerships, corporations, nonprofit organizations, or trusts — can also qualify as accredited investors. To qualify as accredited, an entity’s assets must exceed $5 million or consist of equity owners who are accredited investors.
What Is a Non-Accredited Investor?
The vast majority of American investors are non-accredited. Non-accredited investors (often called retail investors) don’t meet the income requirements to qualify as accredited investors. And their investment opportunities are much more limited. They can invest in public stocks, certain types of bonds, real estate, equities, precious metals, startups and some other assets.
Non-accredited investors don’t have the same access to certain private startup deals as accredited investors do. But thanks to the Jumpstart Our Business Startups (JOBS) Act, which was passed in 2012, non-accredited investors are allowed to invest in startups through crowdfunding (raising money online from a large community of individual investors). Thousands of startups turn to crowdfunding every year. So non-accredited investors do have some optionality there.
Where Do Startups Fit Into This?
As we noted earlier, both accredited and non-accredited investors can invest in startups. But the rules are different. Many startups directly offer securities to accredited investors through Rule 506 of Regulation D (Reg D). This allows startups to be exempt from registering securities with the SEC, which can save them a lot of money. (And that’s very helpful for any startup trying to get off the ground.) This type of offering (called a private placement) tends to carry a lot of risk – which is why they’re only available to accredited investors. Accredited investors can also invest in crowdfunding startups.
Non-accredited investors can invest in some private placement deals, though there are fewer opportunities available for them. Rule 506 allows a company to sell its securities to an unlimited number of accredited investors and up to 35 other purchasers, who can be non-accredited. The non-accredited investors still must demonstrate that they have sufficient knowledge and experience in business and finance to prove they’re capable of evaluating the investment risk.
For the most part, though, non-accredited investors are limited to crowdfunding startups. These include startups raising under Regulation Crowdfunding (Reg CF) and Regulation A (Reg A). Reg CF startups can raise up to $5 million from investors while Reg A startups can raise up to $20 million or $75 million. Investing in these startups still carries considerable risk. But the minimum investment levels are typically smaller than Reg D offerings. And the SEC typically requires companies offering through Reg CF or Reg A to disclose more information than is required in a Reg D offering.