If you are looking to grow your small business and take it to the next level, you are probably ready to seek funding from an outside source. The catch, though, is that raising money usually requires compliance with federal and state securities laws, which can be burdensome and costly. Luckily, there is a (legal) way around these securities laws, and that’s where accredited investors come in.
Here, we discuss what an accredited investor is, how accredited investors can help your small business grow, and some ways a business formation attorney can assist you with vetting and procuring accredited investors.
Do I need to register my transaction with the SEC?
First of all, it is key to note the default rule: generally, offered investments or securities must be registered with the U.S. Securities and Exchange Commission (SEC) and your relevant state securities commission. However, there are exemptions to this rule, including if the investment is offered only to investors that qualify as “accredited investors.”
What does it mean for an investor to be “accredited”?
An “accredited” investor is a legal entity or a person that fits certain criteria. Legal entities that might be accredited investors include banks, broker-dealers, and trusts with assets over $5 million.
An individual accredited investor is someone who:
- Earned more than $200,000 (or $300,000, jointly with a spouse) in each of the previous two years and who expects to earn the same or more for the current year; or
- Has a net worth (individually or with their spouse) of over $1million (not including a primary residence).
Accredited investors are allowed to invest in securities that are not registered with the SEC. The SEC created this exemption to allow sophisticated investors to weigh the risks as to whether to invest. Normally, a registered offering requires a company to make burdensome disclosures and provide information to investors. In theory, this is to protect someone from investing in a business in an industry unfamiliar to the investor.
Because the SEC believes accredited investors are sophisticated enough to handle their own financial analysis, they are provided less protection. In other words, a company does not have to follow the rigid SEC disclosure guidelines to offer the investment.
Does it matter whether an investor is accredited?
A small business owner needs to know whether a potential investor is accredited. While non-accredited investors can still make certain investments, only accredited investors can participate in non-registered securities offerings. If you are offering your investment to more than one investor, all investors must be accredited to fall under the SEC’s exemption from registration.
What are some smart ways to vet an investor?
If your small business is interested in selling investments to an accredited investor, you must vet every potential investor. The burden is on you, the small business, to take the necessary “reasonable steps” (according to the SEC) to verify that all of your investors are accredited. If you do not, you might be out of compliance with the securities regulations and could face fines and other penalties from the SEC, so it is important that you carefully do so.
This begs the question: how can a small business vet potential investors?
While you can do this on your own, a small business attorney will help the process immensely by:
- Preparing an accredited investor questionnaire, which will ask your potential investors for personal and financial information; and
- Reviewing the financial documents provided by investors, including their W-2s, tax returns, bank statements, and anything else that will prove their income and/or net worth.
Because the onus is on the small business to ensure that the investors are accredited, this determination should be handled with care. Your business attorney can assist you throughout the entire process to ensure things run smoothly and that only the proper investors take part in your offering.
Can a business formation attorney help me find accredited investors?
To find accredited investors, small businesses should look to their peers for referrals, consider joining investment clubs or search crowdfunding sites that may provide leads. Do not count out family and friends, either, as, depending on their income and net worth, they may qualify as accredited investors themselves and could also invest in your small business.
The best way a business formation attorney can help during this investment process is through vetting your investors, confirming they are accredited, and preparing the necessary legal documentation. While there are few SEC requirements for investments offered to accredited investors, any investor interested in providing your small business with funding will want to review documentation about the business so that they can gain a full picture of what your company is about. A business formation attorney can help prepare these documents.
If you are interested in seeking capital from accredited investors for your small business, reach out to a business attorney to discuss your options and begin the funding process.
Contact Our Experienced Business Law Attorneys
Starting a business is thrilling. However, failing to abide by the proper legal and corporate formalities can land you in trouble, especially when it comes to financing. At Wilson Ratledge, we assist business founders in taking steps that help their businesses thrive, from their initial founding throughout their first few rounds of funding and beyond. For assistance setting up your business or navigating a relationship with an investor, or for questions regarding your entity, contact one of our experienced North Carolina business attorneys today at 919-787-7711 or via our contact form below.