How to Angel Invest: What is an Accredited Investor?
August 20, 2018 | By Vela Wood
Who can play the game
Angel Investors are individuals who provide seed or startup financing to entrepreneurs. If you give your little brother a few hundred dollars to start a business, technically, you’re an angel investor. However, the more intricate transactions and deal flow are reserved for accredited investors.
Qualifying as an Accredited Investor: Easy as 1,2,3
As defined by the Securities Act of 1933, an accredited investor meets one of the following criteria:
- A net-worth of at least $1,000,000 (excluding their primary residence);
- Income of at least $200,000 in the past 2 years (with a reasonable expectation to make this amount in the next year); or
- $300,000 joint income with their spouse (with a reasonable expectation to make this amount in the next year).
Impact of these requirements
Federal and state securities laws aim to protect individuals from losing significant sums of money through investing. By verifying investors’ incomes or their awareness of the risks associated with investing, the government hopes to ensure investors will avoid financial distress by making intelligent investments in light of the associated risks.
In addition, to ensure investors are informed, these laws require public disclosures whenever there is a sale of a security (i.e. when an institutional investor is raising money for a fund). However, investment funds may be exempt from these disclosure requirements if all of their investors are accredited. Thus, certain investment funds may only accept investments from accredited investors to avoid the burdensome federal disclosure requirements that would diminish the confidentiality of their investing strategy and add additional time and costs to the investing process.
What if I don’t make or have that much money?
There are a few ways to still invest in early-stage companies without being accredited. Pursuant to certain exemptions, the SEC allows for up to 35 non-accredited investors to invest in a company without requiring additional disclosures. Many states also have the non-accredited investors capped at this number.
In addition, crowdfunding is also an option. Under Title III of the Jumpstart Our Business Startups (JOBS) Act of 2012, companies can raise up to $1,000,000 from non-accredited investors (the crowd). There are many platforms, such as Wefunder, Seedinvest, and Crowdfunder, where non-accredited investors may take part in crowdfunding early-stage startups without risking substantial capital.
Alternatively, as suggested in this Harlem Capital interview, you could also offer your services in exchange for equity in the company. However, this arrangement is highly unlikely because you would in effect be acting as an employee and not an investor. Thus, founders and the company’s counsel would likely prefer that you commit to providing these services long term, and that your equity vest over a certain period of time (typically 4 years). Nonetheless, we have recently drafted a subscription agreement where PR services were exchanged for equity.
Finally, if you and a few of your friends are eager to invest in startups, yet none of you are accredited investors, then you all could pool your money together to invest in a fund. Keep in mind that every fund won’t be open to this arrangement, and funds are not always raising money. But don’t worry, the next blog in this series will show you how to meet these fund managers and entrepreneurs.
Special thanks to Vela Wood law clerk, Ikenna Okoro, for his assistance with this series.