The Securities and Exchange Commission recently announced a rule change to expand the definition of “accredited investor” ultimately allowing more participation in private offerings. The rule amends one of the principal eligibility tests to include financially sophisticated investors whose income or net worth is below former requirements.
Since Congress first established the definition of “accredited investor” in 1982, the income and net worth requirements—more than $200,000 and over $1 million, respectively—haven't changed. Despite some rare exceptions, that bypassed the income and net worth requirements, investors were required to have a high level of financial expertise and professional knowledge such as experience working in the private equity sector, or have select certifications.
691,000 New Accredited Investors
With the passing of the SEC's new rule earlier this month, holders in good standing of a much broader range of certifications, including the Series 7, 65, and 82 licenses will now qualify as accredited investors. In total, the new rule is projected to grow the pool of investors in the private market by about 691,000.
In addition to the amendments discussed above, further updates to the definition of accredited investor are as follows:
• “Knowledgeable employees” of an investment fund are now eligible.
• Limited liability companies (LLCs) with $5 million or more in assets may be included.
• SEC and state-registered advisers and exempt reporting advisers may qualify.
• The term “spousal equivalent” is added to the definition of an accredited investor, permitting the investor to qualify by pooling their finances with spousal equivalents.
Qualified Institutional Buyer
The definition of “qualified institutional buyer” was also updated to include rural business investment companies and LLCs, as long as they meet the requirement of $100 million in securities owned and invested.
The recent SEC amendments acknowledge that there is a large pool of sophisticated investors who aren't necessarily classified as high-net-worth, but who have sufficient knowledge to participate in private market opportunities. It also broadens private market access for institutional investors with substantial assets.
Impact on Entrepreneurs
The bottom line is that the pool of investors available for simple private placements of securities has increased substantially. Founders can avoid the high cost of registered offerings and most of the often cumbersome requirements of State securities laws by adhering to the requirements of Rule 506 under the Federal Securities Act of 1933. This approach also provides a more streamlined and generally faster pathway to acquiring funds without limitation on the amount, as is the case for some other Federal exemptions.
Importantly, this approach allows the Founders to perform “due diligence” on prospective investors. Having investors with the right mindset can aid in building the business. Having investors who are overly rigid or more interested in their own returns as opposed to the success of the business can be a real headache.
Read the SEC's full release here.
Please contact me at 908-336-0795 if you have questions regarding how the SEC's amendment to the definition of “Accredited Investor” impacts the financing of your business.