When raising capital, one of the most critical decisions founders face is whether to target accredited or non-accredited investors. This choice can significantly impact your fundraising strategy, regulatory requirements, and the long-term trajectory of your business.
Here’s a comprehensive guide to understanding the key differences between accredited and non-accredited investors, their implications for fundraising, and what founders should consider when making this decision.
What Are Accredited and Non-Accredited Investors?
Accredited Investors
Accredited investors are individuals or entities that meet specific financial criteria established by the SEC. These criteria are designed to ensure that accredited investors have the financial sophistication and ability to bear the risks associated with private investments.
Individual Criteria:
Income: Earned at least $200,000 annually ($300,000 for married couples) in the last two years, with the expectation of maintaining that income level.
Net Worth: Net worth exceeds $1 million, excluding the primary residence.
Entity Criteria:
Entities with at least $5 million in assets.
Entities in which all equity owners are accredited investors.
Non-Accredited Investors
Non-accredited investors are individuals or entities that do not meet the financial criteria for accreditation. They represent the majority of the population and have limited access to private investment opportunities due to the associated risks and regulatory requirements.
Key Considerations for Founders
1. Legal and Regulatory Compliance
Regulation D Rules
Rule 506(b): Allows up to 35 non-accredited investors but prohibits general solicitation. Requires extensive disclosures if non-accredited investors participate.
Rule 506(c): Allows general solicitation but limits participation to accredited investors, who must undergo verification of their accredited status.
Challenges with Non-Accredited Investors
Accepting non-accredited investors often requires preparing a private placement memorandum (PPM) with detailed disclosures about risks and financial data, adding complexity and cost.
Non-accredited investors may be more likely to file complaints or lawsuits in the event of investment losses.
2. Fundraising Costs and Efficiency
Targeting accredited investors simplifies compliance and reduces costs. Without the need for detailed disclosures or investor education, raising funds from accredited investors is generally faster and more efficient.
Key Insight: Companies raising under Rule 506(b) who include non-accredited investors typically incur $10,000 to $20,000 in additional legal and administrative expenses compared to those exclusively targeting accredited investors.
3. Investor Expectations and Engagement
Accredited investors are typically:
Sophisticated: They have experience evaluating investments and understanding risk.
Low Maintenance: They generally require fewer updates and less communication.
Strategic: Many bring valuable expertise, industry insights, or networks to the table.
Non-accredited investors, on the other hand, may:
Require more frequent updates and explanations.
Have a lower risk tolerance, leading to potential dissatisfaction if investments don’t perform.
Lack the financial experience to evaluate complex opportunities.
4. Long-Term Impact on the Cap Table
A cap table populated with numerous small, non-accredited investors can complicate future fundraising efforts. Institutional investors and venture capitalists may see this as a red flag, as managing these investors can be challenging and time-consuming.
Key Insight: A clean cap table with experienced, accredited investors signals professionalism and scalability to future backers.
Benefits of Targeting Accredited Investors
Streamlined Compliance: Avoid the costly disclosures required for non-accredited investors.
Strategic Value: Accredited investors often bring more than capital—they bring connections, mentorship, and market knowledge.
Future Fundraising: A professional cap table makes it easier to attract institutional capital.
Reduced Risk: Accredited investors are less likely to file complaints or lawsuits.
When Might Non-Accredited Investors Make Sense?
While targeting accredited investors is often the preferred route, there are scenarios where non-accredited investors can add value:
Community Engagement: Companies with strong local ties may want to involve loyal customers or supporters, even if they don’t meet accreditation criteria.
Crowdfunding Campaigns: Regulation Crowdfunding (Reg CF) allows startups to raise small amounts from many non-accredited investors while remaining compliant with securities laws.
Friends and Family Rounds: Early-stage startups often rely on personal networks, which may include non-accredited investors.
Conclusion
Choosing between accredited and non-accredited investors is a pivotal decision for any founder. While accredited investors often provide a more streamlined and strategic path to capital, there are circumstances where non-accredited investors can play a meaningful role. By understanding the implications of each option and seeking professional guidance, founders can structure their fundraising efforts to align with their goals and set their companies up for long-term success.
Ready to navigate your fundraising strategy with confidence? Contact us to ensure your capital raise is compliant and optimized for growth.
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