Are startups founders automatically “accredited investors”?
We have debated on the Venture In The South podcast whether startup founders are “accredited investors.”
My answer, which might surprise you, is “probably.” Here are some ways founders could be. Number three will shock you, as all good clickbait says.
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First, obviously if a founder meets one of the “regular” accreditation criteria — net worth, annual income, or holding a Series 7, 65, or 82 license, as outlined by the SEC — the founder is accredited like anyone else.
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Second, for your own company or investment fund, you are accredited. The SEC says that “Directors, executive officers, or general partners (GP) of the company selling the securities (or of a GP of that company)” are accredited. So, if you are a director or the CEO (or other executive officer) of the company, you are accredited and therefore can buy shares in your own company.
That matters for several reasons. One overlooked reason in South Carolina is that your investment could be eligible for the South Carolina Angel Investor Tax Credit. Invest $10,000 in your own startup? If you did it correctly, you might be able to get $3,500 back in a state income tax credit. Follow the rules here. Few people know this.
Similarly, for investments in a private fund, “knowledgeable employees” of the fund (even if you are not part of the GP) are accredited. You are “knowledgeable” if, in connection with your regular duties, you participate in the investment activities of the fund, and have (at your company or a similar prior one) for at least a year. So, for example, our head of diligence, Molly Vinkler, and head of portfolio management Alex Biermann, would be “knowledgeable” because they are actively involved in diligence and deal execution. (They also know a lot, of course, but that’s irrelevant here!)
This only applies to your company (or fund) — not to others. And it doesn’t apply to regular employees — only to the most senior members of the management team (or general partner), not to everyone.
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Not accredited yet? There’s a third possible approach. This may come as a surprise but there is a decent chance a founder that has already raised capital is accredited. How?
Equity in privately-held companies counts towards the net worth definition in the first section above, because equity is an asset (like cash in your bank account or your car).
If you raised even a modest equity round, the implied value of your shares could be enough to make you accredited. Take this example. The CEO and CTO of this company created the company at a 75/25 split, and then raised a $1M pre-seed round at a $3M pre-money valuation. Here’s the math:
$1M on $3M pre-money valuation sells 25% of the company. That left the CEO with 56.3% and the CTO with 18.8% of the company worth a $4M post-money valuation.
The value of the CEO’s stake is therefore $2.25M and the CTO’s stake is now $750K. Ignoring all their other assets and liabilities — and assuming all these shares are vested — the CEO is accredited on this alone. The CTO is not.
Obviously your company’s details and cap tables are different. Convertible notes and SAFEs don’t count; unvested shares don’t count; and different classes of shares have different fair market values. (If our CEO held common stock and investors held preferred stock, the CEO might instead rely on an independent appraisal to determine the fair market value of the common stock — something that most companies already do in connection with their incentive stock option plans and is called a 409A valuation.
But hopefully you see there’s a chance the CEO is accredited — for all companies, not just the CEO’s own. Here’s another source for this idea.
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Of course, that doesn’t change that early stage investing is risky, and even if you are accredited it is not a great idea to invest money you can’t afford to lose. All the usual warnings (risky, illiquid, diversification required, etc.) apply.
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Lastly, if the Equal Opportunities for All Investors Act of 2023 becomes law, anyone — including founders — capable of passing the test would be accredited. Hopefully more to come on that!
