Regulatory Update: SEC change in definition of accredited investor

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Securities and Exchange Commission Gives Investors Like You More Ways to Invest in Private Companies 

 Private Companies Also Gain More Ways to Attract Investors

 

The Securities and Exchange Commission (SEC) has adopted enhancements to its rules which go into effect in early November 2020 that will bring more opportunities to investors on Netcapital and broaden the reach that companies raising capital on Netcapital have to access more eligible investors.

The SEC has updated the definition of “accredited investors”.  This definition, largely unchanged from when it was first adopted in 1982, has mostly focused on whether an investor’s income or net worth, alone or together with his or her spouse, was high enough to meet the definition. This bar has been used exclusively to determine the eligibility of individual investors (other than investors who are officers or directors of the issuer seeking to raise capital) to invest in the private capital markets.

This action by the SEC is part of its initiatives to simplify, harmonize, and improve the exempt offering framework under the Securities Act of 1933 (which is the framework under which Netcapital brings investment and capital raising opportunities to its investors and issuers, respectively).  These initiatives seek to promote capital formation and expand investment opportunities while maintaining and enhancing appropriate investor protections.

Private securities markets have grown significantly in recent years and capital raising in these markets has eclipsed registered offerings.  For example, based on SEC data, in 2019 registered offerings accounted for $1.2 trillion (30.8 percent) of new capital, compared to approximately $2.7 trillion (69.2 percent) that was raised through exempt offerings like those available through Netcapital.

The SEC expanded and clarified existing categories of accredited investors and added new categories of individual and entity investors who meet the accredited investor definition. Among the categories that now may qualify as accredited are:

·   Individual investors with certain professional certifications and designations.

·   The combined income or net worth of an individual investor and his or her spousal equivalent.

·   Limited Liability Corporations (LLCs) that have total assets in excess of $5 million, or entities owning investments in excess of $5 million, that were not formed for the specific purpose of acquiring the securities being offered.

·   Certain SEC and state registered investment advisers.

·   Certain family office advisers and family clients, as defined under the Investment Advisers Act of 1940.

·   Rural Business Investment Companies, approved by the U.S. Secretary of Agriculture.

For more detail on these categories, see Footnote 1 below.

 

Why does being an Accredited Investor Matter?

It can matter to you in three important ways that give you the new or increased ability to:

1.    Invest in an amount above the current limits imposed by Section 4(a)(6) of the Securities Act of 1933, added by the JOBS Act;

2.    Meet the eligibility requirement to invest in a 506(c) offering on Netcapital; and

3.    Purchase on Netcapital System’s secondary transfer platform.
What does this mean for Netcapital investors?

In short, these enhancements put more investors under the accredited investor “tent” which in turn gives an investor meeting the new definition more investment options and flexibility.  These changes will broaden your investment opportunity set that can potentially improve the risk-return characteristics of your portfolios.

In a separate regulatory development, the SEC has also proposed to exclude accredited investors from the investment limits under Section 4(a)(6).  If adopted, the value of being an accredited investor will increase because it will let you invest in these Reg CF offerings without being subject to any limitation on the amount of your investments in these offerings.

What does this mean for Netcapital companies?

You will be able to reach more investors.  Generally, accredited investors, and in particular, institutional accredited investors, supply the vast majority of capital raised in exempt offerings and are vital to the capital raising needs of issuers conducting these offerings.  These amendments will expand the pool of accredited investors and may lead to an increase in the aggregate potential supply of capital available for exempt offerings.

Expanding the pool of accredited investors may have a positive impact on capital formation in certain circumstances, such as in offerings by issuers that are small, in development stages, or in geographic areas that currently have lower concentrations of accredited investors.

Certain issuers, such as issuers that are smaller or in early stages of development, will need to compete less intensively and may incur fewer costs to access accredited investors under these new rules.

These changes should also benefit issuers by potentially increasing the efficiency of the process of raising capital in unregistered offerings by simplifying the process to verify the accredited status of an investor.

What happens next on Netcapital?
We are working to update our site and our documentation to support the expanded definition of accredited investors when it goes into effect in early November.

 

Footnote 1:

Below is more detail on categories of investors that may now qualify as accredited under SEC rules:

1.     Individual Investors:

Professional Certifications and Designations or Other Credentials
A person who has certain professional certifications, designations or other credentials issued by an accredited educational institution, which the SEC may designate from time to time by order.  For example, investors holding a Series 7, 63 or 85 FINRA exam are now accredited investors.  The SEC estimates that this may add over 700,000 new eligible accredited investors.

Spousal Equivalents
The income or net worth of an investor’s spousal equivalent can now be factored into the test.

2.          Entity Investors:

Qualifying limited liability companies (LLCs)   
LLCs that (i) have total assets in excess of $5 million and (ii) were not formed for the specific purpose of acquiring the securities being offered.

Entities owning investments totaling in excess of $5 million
This is a new catch-all category to the accredited investor definition that includes any entity that (i) owns “investments,” as that term is defined under the Investment Company Act of 1940, in excess of $5 million and (ii) is not formed for the specific purpose of acquiring the securities being offered.

Look Through Entities
An entity qualifies as an accredited investor if all of the equity owners of that entity are accredited investors. In some instances, an equity owner of an entity is another entity, not an individual investor. It is now permissible to look through various forms of equity ownership to individual investors in those cases where an equity owner of an entity is itself an entity, but that owner-entity does not qualify on its own merits as an accredited investor (e.g., if the owner-entity is an LLC that does not meet the $5 million in assets test).

SEC and state-registered investment advisers and SEC exempt reporting advisers
Investment advisers registered with either the SEC or any state securities administrator and (ii) exempt reporting advisers relying on either the venture capital fund adviser exemption or t

Certain family offices and family clients 
A “family office” as defined under the Advisers Act, provided that such family office: (i) has at least $5 million in assets under management; (ii) was not formed for the specific purpose of acquiring the securities offered; and (iii) has its prospective investment directed by a “sophisticated” person as defined under the Securities Act of 1933.

Rural Business Investment Companies (RBICs) 
RBICs generally include certain companies that are approved by the U.S. Secretary of Agriculture and that have entered into a participation agreement with the Secretary.

The private fund adviser exemption in the Investment Advisers Act of 1940 (Advisers Act).  There are over 45,000 such SEC and state-registered investment advisers.

Any further questions can be addressed at the following SEC link at https://www.sec.gov/news/press-release/2020-191

 

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