Why startups must only take financing from accredited investors

Seed stage investing is getting very busy these days, and over the past few months I have started hearing about companies taking money in small amounts from a large number of friends and family investors. Easy money ? Maybe, but…

Whilst it is great to get that kind of support from your close circle, it often involves investors who are not accredited. The accreditation has nothing to do with the sophistication of the investor, nor having gone through a formal exam but a set of criteria clearly defined by the SEC (Rule 501(a) under the Securities Act of 1933) — which are related to a minimum level of yearly income or a minimum NAV (net asset value).

Not complying with this rule, which means — yes — turning money down, will come back and haunt you down the road when it is time to further finance or sell your company. Just as an example: unaccredited investors can rescind their investment at any time — that means they can ask for their money back. You should also get your personal investors to sign a statement regarding their accreditation.

I have been meaning to write this post since I have given this advice 4 or 5 times in the past two weeks (in the context: How/From whom do I raise my initial capital ?), and Brad Feld has beaten me to it: check out his post (and the second comment) for more detailed problems you will be facing if you don’t respect that advice rule.

PS: As I am at it — I apologize to the 50 or so startups that have recently sent me some information about their deal. I am completely swamped and therefore my response/feedback might take a few more days (or weeks ?) to come.

PPS: Should I really go to bed for just one hour ?