Can a friends and family round include non-accredited investors? Should it?

by Riggs Davie PLC

The so-called "friends and family" round is often the first capital raise a new startup will engage in. Many entrepreneurs often go into it without any knowledge of securities laws and as a result, end up violating them, sometimes with real and significant consequences later. However, plenty of entrepreneurs do take the time and effort to comply with securities laws and make use of an exemption from the registration requirements under the Securities Act of 1933. Regulation D covers the most often used exemptions (at least by smaller companies). The most common form of a Regulation D offering is one conducted under Rule 506, which essentially requires that the issuer offer the securities only to preexisting contacts (no advertising or widespread communication of the offering) who are accredited investors. An accredited investor is someone who either: (i) has an individual net worth, or joint net worth with that person’s spouse, at the time of purchase, exceeding $1,000,000, excluding the value of the primary residence of such person or (ii) had an individual income in excess of $200,000 in each of the two most recent years or joint income with that person's spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year. However, it is often the case that an entrepreneur's friends and family are not accredited and so if he limits his capital raise to accredited investors, the capital raise will go nowhere. Not everyone has a rich uncle. So, if you are an entrepreneur in this situation, can you raise money from investors without those investors being accredited? Yes, you can, but proceed with caution.

The next question that needs to be asked is should you include non-accredited investors in your capital raise as a matters of morals and good business sense. The law may permit it (subject to restrictions), but is it a good idea? Recall the proverb: "Before borrowing money from a friend, decide which you need more." With any entrepreneurial venture there is a substantially high chance of failure. You may think that you have the best idea in the world and it's a sure thing, but chances are there are unforeseen forces that could derail your efforts. Therefore, for both moral and legal reasons, it's a good idea to only take investments from people who can bear the risk of loss of the investment. Therefore, you should never accept investor money from a friend or family member when that money constitutes a significant portion of that person's life savings or if losing that money could substantially harm them or those that depend on them. In any event, before taking an investment from a friend or family member, ask yourself this: if he or she lost all of the money invested because the business failed after you did your very best to make it succeed, would this cause hard feelings? If there answer is yes or maybe yes, then either don't take the money from this person at all, or reduce the amount of the investment to something that this person would consider to be insignificant. If you don't, the hard feelings you create can cause you to lose the relationship and may land you in court.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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