Differences Between Accredited Investors & Sophisticated Investors

The Securities and Exchange Commission regulated Regulation D, an exemption from registration.  Regulation D allows organization to issue a private offering to raise debt or equity without officially registering the offering to “go public”.  This exemption reduces the amount of paperwork required, lessening the time and money it takes to actually raise capital.

Under Reg D there are several rules where your private offering can be issued under.  These include Rule 504, Rule 505, and Rule 506.  Overall, the SEC encourages or requires companies to work with accredited investors when raising capital through a private offering.  However, the rules give room for a certain number of non-accredited investors to participate so long as disclosure requirements are met. In Rule 506 any non-accredited investor must be a Sophisticated Investors.  Many companies, or their representatives, don’t understand the difference between the three types of investors.  We break them down for you here.

Accredited Investor

This commonly used term is defined as an individual that has made $200,000 or more on an annual basis for the past two out of three years and is likely to make that same amount this year.  If it is a couple qualifying together that amount is raised to $300,000.  If they do not meet the income requirements, they can qualify using a net worth of over $1 million excluding their primary residence.  If you issue an offering using Rule 504, Rule 505, or Rule 506 (b) the investor can “self-certify” that they are accredited.  If you issue a private offering using Rule 506 (c) they must be certified by the issuing company or qualified third party.

Sophisticated Investors

If you issue an offering under Rule 506 (b) you can accept investment dollars from non-accredited investors if they are Sophisticated Investors.  This is the only exception to the accreditation rule.  A sophisticated investor is defined as someone that has superior knowledge of business and financial matters.  This definition leaves room for interpretation but it is important to define what that means to you and be able to back up your own personal definition.  For example, it could be a CFO, CPA, accountant, business owner, banker etc. If they SEC were to ask why you thought this person was sophisticated you should be able to point to an internal set of standards so you can prove that caution was taken when making these decisions.

Non-Accredited Investor

A non-accredited investor is simply everyone else.  These may be people that make a good living but are under the SEC’s income requirements.  Many start up companies will receive investor dollars from friends and family that are interested in supporting the individual owners, as much as the company itself.  These investors are often non-accredited but still want to participate.  Make sure that you review the specific guidelines under the rule you are using to raise capital before accepting funds from non-accredited investors.  Rule 506 (c) forbids it outright.  Rule 506 (b) says it is okay as long as they are sophisticated and you have no more than 35 of them investing in the round.

More money is raised through private offerings than on the stock market every year.  This is an excellent source of capital but make sure you are following the guidelines carefully so that you can stay within compliance.

Source: { https://www.sec.gov/fast-answers/answers-rule506htm.html }

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