Accredited Investor Status: How to Verify Under Rule 506(c)

TL;DR: Raising funds using general solicitation under Rule 506(c)? You must verify that each investor is an accredited investor under SEC regulations. This verification process includes verifying an investor’s income, net worth or getting third-party confirmation. Once you begin soliciting and publicizing your financing, you’re locked into strict rules, so plan carefully and document everything.

If you’re raising capital under Rule 506(c) of Regulation D, you will need to stay on top of verifying that all of your investors are actually accredited investors under SEC regulations. Unlike relying on Rule 506(b), your company is required to take reasonable steps to verify each investor’s status as an accredited investor.

The advantage of relying on Rule 506(c) is that founders may publicly promote and generally solicit the terms of the company’s capital raise. Whether this be through a page on a company’s website, a mass email blast, a blog post, etc., founders have the ability to reach for a wider audience than their traditional friends and family. However, founders should first weigh the administrative burden of verifying accredited investor status before going down this path.

In this blog post, we break down the requirements of verifying investor status when raising capital and relying on Rule 506(c) of Regulation D.

Want to Raise Capital? Know the Legal Path First

The first key decision that you will need to make early in the financing process is determining how broadly you will offer your company’s securities to potential investors.

Under Rule 506 of Regulation D, there are two main pathways:

1. Old Way – Your company cannot raise money by offering its securities through general solicitation or general advertising (i.e., no website postings, no social media, no email blasts, no newsletters, no radio or tv spots, etc., regarding the proposed offering); and
2. New Way – Your company can use general solicitation and general advertising to seek potential investors, which then will trigger additional legal requirements as you cast a wider net with your financing outreach efforts. Using public platforms for outreach means you must perform accredited investor verification to confirm each participant’s eligibility

More legal requirements mean more complexity and cost, so it is important to weigh the pros and cons of each alternative given your financing goals, investor contacts, etc.

Accredited Investor Status Under Rule 506

In making this decision, you will need to pay particular attention to the type of investors that legally can participate in the financing. Because of the strong temptation that many founders have to use general solicitation and general advertising when raising money, we will focus on the critical verification requirement when using the “new way” or general solicitation method and relying on Rule 506(c).

This modern approach to fundraising lets your company publicly promote its offering, but there’s a major catch: only verified accredited investors may participate. Whether a high-net-worth individual or a qualifying legal entity, the investor must meet specific criteria set by SEC regulations.

Simply put, if your company intends to cast a wide net for investors, it can only sell its securities to high-net-worth or sophisticated investors.

Accredited Investor Verification – A Non-Negotiable Process

With the general solicitation method, your company must take “reasonable steps” to verify that each purchaser is an Accredited Investor, which is not as easy as it sounds.

Accredited Investor verifications create additional complexity and costs in the fundraising process and could push away potential investors given the extra steps and intrusiveness into their personal finances.

Even if all of the purchasers are Accredited Investors, your company will fail to meet SEC regulations if it does not take reasonable steps to verify that each purchaser is an accredited investor, it is not enough to assume someone is accredited. Therefore, your company must verify Accredited Investor status before a purchaser invests money in the financing.

How to Verify Accredited Investor Status

The current rules do not outline specific verification procedures, and what is “reasonable” depends on the particular facts and circumstances of the offering.

Three factors to consider are:

1. who the purchaser is and how it claims to be an Accredited Investor;
2. the specific information that your company has about the purchaser (i.e., easier to verify if information from public sources); and
3. the offering structure and mechanics (i.e., more verification is required if broad solicitation, less verification if there is a high minimum investment amount).

The rules do mention, however, certain non-exclusive (and non-mandatory) ways to take reasonable steps to verify that a natural person is an Accredited Investor, including:

1. Income-Based Verification: Review any IRS form that reports the person’s income for the two most recent years, plus a written representation that the person reasonably expects to reach the required income level ($200,000 individually or $300,000 jointly with spouse) in the current year.
2. Net Worth-Based Verification: Confirm that the individual investor satisfies the $1,000,000 in net assets threshold, excluding the value of their primary residence or, if the investor is an entity, that the entity has over $5 million in assets or the entity is wholly owned by accredited investors. For assets – review bank statements, brokerage statements, tax assessments, or other documents detailing the person’ assets, if dated within the past three months; and for liabilities – review one of the national consumer reporting agencies and obtain the person’s written representation that all liabilities necessary to determine net worth have been disclosed.
3. Third-Party Verification: Such as a licensed attorney in good standing, a registered CPA in good standing, a registered broker-dealer or investment advisor, indicating that such third party has taken reasonable steps to verify the person’s Accredited Investor status within the past three months and has determined that the person is an Accredited Investor.

The company will carry the burden of proving that your verification process complied with SEC regulations. Keep detailed records of your verification procedures for each investor for future diligence purposes

Another alternative is to engage a third-party service provider or platform to perform the verification procedures required for Rule 506(c) offerings.

Practical Mistakes to Avoid in Accredited Investor Compliance

Once you have gone down the general solicitation path, you can’t pull back and decide midstream that you now want to use the “old way” to offer securities (i.e., with no general solicitation). The general solicitation already has occurred, and you cannot retrieve from cyberspace all of the information that you previously disseminated.

Similarly, if you start with the “old way” of raising money and take in money from investors, you cannot later switch to the “new way” if you have not verified Accredited Investors reasonably or taken money from unaccredited investors before the switch.

You will need to make sure that you pick the right horse to ride at the beginning, so that it will work for your company throughout the entire financing process.

Also, if your company plans to participate in a pitch event that has been (or will be) announced in the media or on the Internet, then there is general solicitation and your company must comply with the “new way” requirements to offer securities, including the reasonable verification of Accredited Investor status.

The above discussion of reasonable verification of accredited investor status is only one piece in the financing puzzle. You should conduct the proper planning and execution of your financing, with the help of experienced legal and other advisors, so that you raise properly and don’t trip up on the various legal requirements.

Your Turn: Share Your Fundraising Journey

Will you use general solicitation to seek potential investors? Are you prepared to handle the burden of Accredited Investor verification and the paperwork that comes with an Accredited Investor letter?

Let us know how you’ve navigated the Rule 506(c) offering process and what worked for your investor outreach under SEC regulations. Or, learn how our team can help navigate the legalities of this next chapter.