Is SEC Opening the Door to More Capital for Private Companies?

Companies seeking investor funding are required to register with the SEC (which is costly and time consuming), unless they raise funds in a manner that is exempt from SEC filing requirements.

One of the most utilized exemptions is to seek funding exclusively from “accredited investors”. Accredited investors are individuals who have an annual income of over $200,000 or a net worth of over $1,000,000 (for married couples, the combined annual income is $300,000). The logic is that these investors are more sophisticated, and, even if they are not, they can weather a loss of their investment.

The SEC is proposing amending the definition of accredited investor.

Will this provide more access to capital? It might.

Adding Licensed Professionals and Certain Entities

The income limits outlined above will not change. However, the proposed rule will allow certain individuals who don’t meet the income or net worth thresholds to qualify as an accredited investor based on their level of financial sophistication. This would be limited to those individuals who hold certain professional certifications or designations as the SEC may designate from time to time; the credentials that would satisfy the SEC will be posted on the SEC website. At a minimum, the amended definition would include individuals licensed under Series 7, Series 65 or Series 82 (FINRA administered exams securities professionals must pass to become a registered advisor). The overall goal of this change is to allow those individuals who are deemed sophisticated enough to understand the risk of an investment, but may not meet the income or net worth thresholds, the ability to participate in such investments.

The SEC proposal also includes in the definition of accredited investor registered investment advisors, Rural Business Investment Companies, limited liability companies with assets over $5 million, and a catch-all category of any entity owning investments in excess of $5 million that is not formed for the specific purpose of acquiring the securities being offered. This would include governmental bodies and indigenous tribes. The SEC believes an investment test is a more accurate method of determining whether an entity in this category requires the protections afforded by a registered investment.

Family offices with at least $5 million in assets under management and family clients of family offices will also qualify as accredited investors.

Spousal Equivalent

The SEC is also proposing a clarification to the spousal net worth requirement to make it clear that, for purposes of determining whether a person is an accredited investor, an individual can aggregate their net worth with their spouse’s, but aggregating the net worth to determine whether one is an accredited investor does not require that the securities be jointly purchased.

The proposed rule change also expands the combined income limited to not just spouses, but also “spousal equivalents”. This would allow cohabitants “occupying a relationship generally equivalent to that of a spouse” to be treated the same as spouses for purposes of using joint income to determine whether the potential investor meets the definition of an accredited investor.

The proposal contains several other amendments, and a wide variety of questions on which the SEC would like to receive input. For example, the SEC has asked whether the definition of accredited investor should be expanded further (i.e., any person with an MBA degree), and whether anyone advised by a registered investment advisor or broker-dealer should be considered an accredited investor.

If you would like to read the proposed rule and/or submit a comment, you can visit the SEC’s website at this link: https://www.sec.gov/news/press-release/2019-265