By Frank Camp / Guest Column
You’ve finally got some money laying around that needs to start earning its keep. Your wife’s uncle’s brother-in-law tells you that you really should diversify your investments. Those mutual funds you’ve got are fine, but they’re boring. You see some local companies opening around you, and you wonder if one of them could be the next [insert your favorite, wildly inflated, internet- disrupting startup here]. How do you begin?
You can always just hand your wife’s uncle’s brother-in-law a pile of cash and hope for the best, but private startups are famously risky and more likely to fail than succeed. Or, you could take a more organized approach and build an angel investment portfolio of seed and early-stage companies through a commonsense process of disclosure, review and analysis known as “due diligence.”
Organized angel investing can take two basic forms these days: regulated crowdfunding and accredited investor offerings. (Actually there are three – Regulation A+ is sort of a mini-IPO for later stage companies, but that’s beyond the scope of this article.) Since 2016, many regulated portals have started offering equity crowdfunding under the 2012 JOBS Act. See, for example, MicroVentures, SeedInvest or WeFunder, among many others. Regulated crowdfunding has opened many small Tier 1 offerings to people with a little money to invest.
Larger, accredited investor offerings are often made under Tier 2 of the crowdfunding regulation or pursuant to an exemption from registration under the Securities Act, known as Rule 506 of Regulation D. Under this exemption, the startup can only offer and sell its securities to people who qualify as “accredited investors.” Such people are deemed to have the knowledge and capability to assess the risks of the investment and the means by which to sustain a loss, should that happen.
For many equity crowdfunding investors, accreditation is a problem. Though nonaccredited investors can participate in smaller Tier 1 equity crowdfunding campaigns with few limitations, many equity crowdfunding platforms and other private deals remain closed to the general public.
The SEC defines accredited investors as individuals who consistently earn more than $200,000 per year, coupled with consistent combined income of more than $300,000 per year and individuals whose net worth (excluding primary residence) is at least $1 million.
How do you become an accredited investor?
You can self-report in many instances to start getting basic information, but to make an investment there will likely be additional steps required.
As of September 2013, the SEC requires companies that publicly discuss their financing to take steps to verify that investors are accredited. This involves providing documentation that shows you meet one of the accredited investor thresholds. Each company’s attorney’s requirements may be slightly different, but usually the process comes down to this:
- If you are accredited based on income, you will need to provide documentation of income for the past two years. This is usually the fastest way to get accredited.
- If you are accredited based on assets, you can provide recent brokerage, bank account or similar statements clearly showing your name, the date and the value of your account(s). Be aware, however that the company may also want to pull your credit report and deduct any non-mortgage debts shown from the value of your assets to arrive at net assets.
- You can also provide a recent letter from a third-party verifier like a licensed CPA, attorney, investment advisor or investment broker. It’s a good idea to check in with those folks before you start your angel investing program to be sure they are comfortable helping with the verification. Some startups may not want to actually look at your tax returns and brokerage statements, so this might be the only option in that case.
Of course, then the real work begins. Learn as much as you can about the companies and their industries, and start your personal due diligence file. Angel investing can be rewarding in a number of ways, but think about investing in a portfolio of startups rather than just one or two, plan for the long run and don’t get in over your head.
Frank Camp is NewBoCo’s general counsel and helps manage Corridor Angel Investors.
