With recent buzz surrounding SPACs versus IPOs, you might be wondering how to invest in companies before they go public. Although late-stage pre-IPO investment offerings are generally available only to accredited investors, Regulation Crowdfunding offerings give more individuals the opportunity to invest in startups without being accredited. If you want to jump in on early-stage investing, keep reading to learn more.
Accredited versus not accredited
Investing in private companies is regulated by the Securities and Exchange Commission (SEC) and is generally restricted to accredited investors. “Accredited investors” is a term defined in Rule 501(a), and also found in Rules 215, of the Securities Act of 1933. This term describes the individuals and entities that are allowed to participate in investment opportunities offered under exemptions that do not have the disclosure, procedural, and investor protection requirements provided by SEC registration under the Securities Act of 1933.
Generally, you qualify as an accredited investor if your net worth or income meet the following:
- Your earned income exceeded $200,000 (or $300,000 together with a spouse or spousal equivalent) in each of the prior two years, and you reasonably expect the same for the current year, OR
- You have a net worth over $1 million, either alone or together with a spouse or spousal equivalent (excluding the value of your primary residence).
As of December 8, 2020, an expanded definition of an accredited investor is effective. The previous definition of an accredited investor, as applicable to a natural person, was broadly based on net worth and income qualifications. The expanded definition now allows for individuals to qualify as an accredited investor based on certain professional certifications, designations, or credentials, as well as if they are “knowledgeable employees” of a private fund (with respect to an offering for that fund); it also expanded some of the net worth/income criteria to include “spousal equivalents” and included additional categories of entities.
If you don’t meet the income, net worth, or other criteria to qualify as an accredited investor, then your options for startup investment opportunities shift to Regulation Crowdfunding offerings.
History of Regulation Crowdfunding
If you want to invest in startups without being accredited, you can explore Regulation Crowdfunding (Reg CF) offerings. The Jumpstart Our Business Startups (JOBS) Act of 2012 allowed more individuals the opportunity to invest in certain early-stage capital raises. Reg CF offerings are those operating under an exemption from the registration requirements to offer and sell securities up to $1.07 million ($5 million effective March 15, 2021) without having to register the offering with the SEC.
If you’re not an accredited investor, Reg CF investment opportunities are your chance to invest in early-stage startups.
SEC investment limits for non-accredited investors
Due to the risk inherent in early-stage investing, the SEC limits the amount an individual investor can invest across all Reg CF offerings during a 12-month period; the lesser of annual income or net worth is currently used when calculating investment limits, but the greater of annual income or net worth will be used as of March 15, 2021. Following are the limits that will be in effect after March 15:
- If either your annual income or your net worth is less than $107,000, then during any 12-month period, you can invest up to the greater of either $2,200 or 5% of your annual income or net worth, whichever amount is larger.
- If both your annual income and your net worth are equal to or more than $107,000, then during any 12-month period, you can invest up to 10% of annual income or net worth, whichever is greater, but not to exceed $107,000.
What to consider before investing
Before you invest in startups, you should understand where your money is going. Below are a few factors to consider when investing in startups.
Risk and diversification
Risk is inherent with all investing, but especially so with early-stage startups that haven’t proven themselves in the market yet. Diversification of your investment portfolio can help mitigate some risk by spreading your investment money across multiple investment opportunities and types of investments (i.e., different asset classes, such as stocks, bonds, real estate, etc.).
Not all of your investments, especially Reg CF investments, will yield the returns you want (or any returns at all), but spreading out your investments across multiple opportunities helps even out the potential for risk and reward. To summarize with a cliché, don’t put all your eggs in one basket.
Liquidity and exit timeline
Unlike publicly traded shares, private investments are illiquid and typically involve a long road to a potential exit. Estimates are often somewhere between 7 to 10 years for a startup to reach an exit, assuming it doesn’t fail before then. The most common exits are acquisitions, mergers, and initial public offerings (IPOs).
When you invest in startups, you should expect a long timeline for an exit, and you should be okay with losing your investment should the startup not make it to a liquidity event. Remember that a diversified portfolio can help mitigate certain types of risk by spreading your investments across multiple startups or other opportunities.
Due diligence and other factors to consider
If you’re new to investing, due diligence might be an unfamiliar term. Due diligence refers to the process of carefully reviewing the investment opportunity before investing. You might review the company’s history, financials, founders, team, market, and any other information you can access that’s relevant. How much research you perform on a company before investing is up to you, but it’s generally a good idea to understand a company and its offering before investing.
For Reg CF offerings, you also might look at any perks the issuer is offering. Perks are sometimes offered as a thank you to early investors as a recognition of your investing in them at an early stage when they know they’re a high-risk investment.
Where to find Reg CF investment offerings
According to the SEC, Regulation Crowdfunding can take place online through an SEC-registered intermediary (a broker-dealer or a funding portal). The MicroVentures platform offers access to startup investment opportunities that are open to all investors. Visit the Reg CF offerings page to see what’s live now.
If you’re not signed up for an account yet, you can view Reg CF offerings without logging in, but you’ll need to sign up when you’re ready to invest.
The information presented here is for general informational purposes only and is not intended to be, nor should it be construed or used as, comprehensive offering documentation for any security, investment, tax or legal advice, a recommendation, or an offer to sell, or a solicitation of an offer to buy, an interest, directly or indirectly, in any company. Investing in both early-stage and later-stage companies carries a high degree of risk. A loss of an investor’s entire investment is possible, and no profit may be realized. Investors should be aware that these types of investments are illiquid and should anticipate holding until an exit occurs.