United States Securities Law, specifically the Securities Act of 1933, (15 U.S.C. §77a et seq.) provides that an offering of securities to someone in the United States must normally be treated as a “public offering” and that as such, certain things must be done. For example, an offering prospectus must be prepared and various filings made. Further requirements are imposed under state “blue sky” laws. The legal cost of following these procedures can be substantial, typically in the range of hundreds of thousands of dollars.
To avoid such costs, the SEC rules define a class of persons as “accredited investors,” i.e., people who for various reasons are regarded as sophisticated enough to look after themselves. Such accredited investors can buy securities in a private placement under “Regulation D” (17 CFR §§ 230.501-230.508). Accredited investors are usually institutional investors, venture capital funds, directors, and executive officers of the company and high net worth individuals. At the time of writing, high net worth individuals are persons (and their spouses, or joint income with a spouse in excess of $300,000) with a net worth of $1 million or annual income in excess of $200,000.
A detailed definition of accredited investor is published by the SEC, with numerous explanatory examples, and should be consulted by any small company selling shares or securities to persons domiciled in the United States—it is available from the SEC Web site. A company can have an unlimited number of “accredited investors” but is limited to only 35 other investors, who must usually be financially sophisticated. Although early stage capital in technology companies is usually sourced from accredited investors, there are draw-backs. In particular, liquidity is limited by the need to find another accredited investor to which to sell any stake, pre-IPO.