Untangling the Alphabet Soup of Angel Investing Regulation

There are 3 main letters that matter, D, CF, and A. Bear with me till the end and I promise it will make sense.

Vlad Cazacu

Co-founder & Chief Executive Officer

There are 3 main letters that matter, D, CF, and A, but some come in different flavors for a total of 6 so bear with me till the end and I promise it will make sense.

Onto the first one…

Regulation A

Also known as Reg. A, it governs some of the early-stage investing and is most popular on investing platforms such as Republic, StartEngine, and SeedInvest, in tandem with Reg. CF deals. It has been also nicknamed a “mini-IPO”.

Reg. A comes in 2 tiered flavors: Tier 1 and Tier 2.

On either tier, there is no limitation on the number of non-accredited investors that can participate in the round. However, non-accredited investors can invest only up to 10% of their net worth or annual income per each offering.

Tier 1 allows businesses to collect up to $20M in a 12-month period.

Offering can be subject to state registration or qualification, which may add significant time and fees to the raise.
Offering requires only consolidated balance sheets for the previous two fiscal years and consolidated statements of comprehensive income, cash flows, and stockholders’ equity for the issuer.

Tier 2 allows businesses to collect up to $75M in a 12-month period.

Offering cannot be subject to state registration or qualification.
Offering disclosure requirements follow those in Article 8 of Regulation S-X, making this a more complex Reg. A election.

Regulation D

Also known as Reg. D, it governs most of the early-stage investing and is the most popular regulatory framework for startup offerings. This is the primary way most deals are done on Assure, AngelList, and FoundersClub.

Reg. D comes in 3 different flavors: 504, 506(b), and 506(c).

504 allows exemption from registration with the SEC for the offer and sale of up to $10M worth of securities in a 12-month period.

Issuers cannot engage in general solicitation or advertising the securities offered.
Offering can be subject to state registration or qualification, which may add significant time and fees to the raise.

506(b) allows exemption from registration for the offer and sale of an unlimited amount of securities to an unlimited number of accredited investors and 35 non-accredited investors.

Issuers cannot engage in general solicitation or advertising the securities offered.
This is by far the most popular Reg. D election and is often done with an all-accredited investor base.
A maximum of 35 non-accredited investors can participate in such funding rounds if they meet the legal standard of having sufficient knowledge and experience in financial and business matters, either alone or with a purchaser representative.
Including non-accredited investors in the round used to introduce several disclosure requirements more stringent than even Reg. A, but have since been amended to be on par with Reg. A requirements. The issuer must now only disclose unaudited financial statements, as long as the offering amount is no more than $20M. Rule 506(b) offerings over $20M will need to make the disclosures required in Article 8 of Regulation S-X.
It can be costly and, sometimes, impossible to provide this additional disclosure necessary to accommodate the non-accredited investors. Therefore, rule 506(b) offerings are frequently limited to accredited investors only.
Cannot be used by issuers with relevant criminal convictions, regulatory or court orders that occurred after September 23, 2013.
Offering cannot be subject to state registration or qualification, making this the simplest Reg. D election.

506(c) also allows exemption from registration for the offer and sale of an unlimited amount of securities to an unlimited number of accredited investors, but the round must include only accredited investors.

Issuers are permitted to broadly solicit and generally advertise the offering.
Issuers must take reasonable steps to verify the investors' accreditation status. This usually adds more work to the founder or deal syndicator and can slow down the process. However, most investing platforms offer this as a paid service.
Cannot be used by issuers with relevant criminal convictions, regulatory or court orders that occurred after September 23, 2013.
Offering cannot be subject to state registration or qualification, making this the second simplest Reg. D election.

Regulation CF

Also known as Reg. CF, it governs the crowdfunding offerings. This is the primary way most deals are done on Republic, StartEngine, and SeedInvest.

Reg. CF comes in no flavors, making it the shortest part of this article.

A company may not raise more than $5M in aggregate crowdfunding offerings in a 12-month period.
Although most instruments are available, including direct equity, and convertible notes, Republic adapted the YC SAFE and created the Crowd SAFE, following a similar conversion to equity rules like the former.
Offering must take place online through an SEC-registered intermediary, either a broker-dealer or a funding portal. Examples of such funding portals include Republic, StartEngine, SeedInvest, and more.
Because of the online nature of the offering, the investment process is straightforward and easy for investors to complete.
Non-accredited investors can be part of such offerings but there is a maximum amount allowed to be invested, explained below:
The greater of $2,200; OR if your annual income or net worth is less than $107,000, 5% of the greater of your annual income or net worth; OR
if both your income and net worth are equal to or more than $107,000, 10% of the greater of your annual income or net worth, not to exceed an amount of $107,000.
Offering cannot be subject to state registration or qualification, making it easier to set up.

Regulation CF

Accreditation has been a hot topic lately and I found myself discussing this with many folks over the past couple of weeks. The regulation is changing consistently and has significantly expanded the number of people eligible for the accreditation status over the past years.

The risk debate falls between two camps, the investor group, and the founder group:

The former argues that the risk is being borne by the investor since startup investments are inherently risky and they are the ones on the line to lose their investment. While factually correct, it doesn’t bring any relevant insight to this conversation. We all know that private investments, especially at the early stages, are very risky and that on an individual basis, most investments will fail and not return even the principal invested.
The latter argues that the risk is being borne by the founder and/or money manager (in the case of a fund) since they can be sued by the non-accredited investors for not providing the right disclosures to educate them on the real risks of the investments. This is a significantly more plausible theory and I believe this is where the real legal risk lies.

Now that we clarified this topic, let’s talk about accreditation.

There are several ways to get accredited in the United States.

As an entity:

If you are a bank, savings and loan association, insurance company, registered investment company, business development company, or small business investment company, or rural business investment company.
If you are a trust with assets exceeding $5 million, not formed only to acquire the securities offered, and whose purchases are directed by a person who meets the legal standard of having sufficient knowledge and experience in financial and business matters to be capable of evaluating the merits and risks of the prospective investment.
If you are a family office or its family clients if the family office has assets under management in excess of $5 million and whose prospective investments are directed by a person who has such knowledge and experience in financial and business matters that such family office is capable of evaluating the merits and risks of the prospective investment.

As a natural person:

If you are a director, executive officer, or general partner of the company selling the securities, or any director, executive officer, or general partner of a general partner of that company.
If you are an individual with a net worth or joint net worth with a spouse or spousal equivalent of at least $1 million, not including the value of his or her primary residence.
If you are an individual with income exceeding $200,000 in each of the two most recent calendar years or joint income with a spouse or spousal equivalent exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year.
If you are a knowledgeable employee, as defined in rule 3c-5(a)(4) under the Investment Company Act, of the issuer of securities where that issuer is a 3(c)(1) or 3(c)(7) private fund. Rule 3c-5(a)(4) defines the first category of a knowledgeable employee of a Covered Fund as any natural person who is an “Executive Officer, director, trustee, general partner, advisory board member, or person serving in a similar capacity” of a Covered Fund or an Affiliated Management Person of a Covered Fund. This also includes employees who participate in the investment activities of the private fund or other private funds or investment companies managed by the affiliated management person.
If you are an individual holding in good standing any of the general securities representative license (Series 7), the investment adviser representative license (Series 65), or the private securities offerings representative license (Series 82). However, in order to be considered in good standing you must, per FINRA rules:
Pass the Securities Industry Essentials (SIE) and be associated with and sponsored by a FINRA member firm or other applicable self-regulatory organization (SRO) member firm to be eligible to take FINRA representative-level qualification exams such as the Series 7 and Series 82.
Be licensed as an investment adviser representative in your state and would need to comply with all state-specific licensing requirements (e.g., paying annual fees, etc.) if seeking accredited investor status by passing the Series 65 exam.

The last three bullet points are the genesis of this article so I am happy to conclude on the following note:

Before making investments in the private markets or accepting money from investors, take your time to properly educate yourself on the laws and regulations of the US, SEC, FINRA, IRS, and any other applicable bodies. This may save you a lot of time and money later on in life.

Writing this article was my deep dive on the topic and served as a big educational moment for me and I hope it will for you as well.