Why It Is So Difficult to Take Investment From Non-Accredited Investors
By James Graves
One of the first questions a startup founder asks after drafting a SAFE or equity agreement is: "Can we take investment from non-accredited investors?" The answer is technically yes—but only if you're willing to undertake extraordinary compliance burden. In almost every case, the practical answer is no. Here's why the U.S. securities laws make non-accredited investing in private companies so difficult.
Understanding Accredited vs. Non-Accredited Investors
The SEC divides individual investors into two categories: accredited and non-accredited.
Accredited investors meet one of these financial tests:
- Individual income over $200,000 (or $300,000 if married) in the prior two years with reasonable expectation of continued income at that level, OR
- Net worth over $1 million (excluding your primary residence)
Corporations, limited liability companies, partnerships, trusts, and other business entities can also be accredited if their net worth or assets exceed certain thresholds.
As of 2024, the SEC also expanded the accredited investor definition to include:
- Individuals with certain professional certifications (such as Series 7, Series 82, or Series 65 licenses)
- Knowledgeable employees of the company (employees of the fund being invested in or employees of the investment advisor managing the fund)
Non-accredited investors are everyone else: people whose income and net worth fall below these thresholds. This includes many middle-class professionals, business owners with less than $1M net worth, and retirees living on fixed income.
Why does the SEC draw this distinction? The assumption underlying securities law is that wealthy investors don't need as much protection because they can absorb losses and have sophistication to evaluate investments. Investors with less wealth and experience are presumed to need greater protection through mandatory disclosures and oversight.
Why This Matters: The Disclosure Burden Explained
Here's where it gets complicated. The SEC treats private company investments very differently depending on whether the investors are accredited:
Accredited investors only (Regulation D, Rule 506(c)): You can raise unlimited capital from accredited investors with relatively light disclosure requirements. You must still provide information about your company, but it doesn't have to be audited and can be minimal in early stages. You can raise Series A, B, C with mostly accredited investors through this exemption.
Up to 35 non-accredited investors (Regulation D, Rule 506(b)): If you include non-accredited investors, you trigger massive disclosure requirements. Rule 506(b) allows up to 35 non-accredited investors, but with a catch: you must provide them with the same information you'd provide in a public offering.
The disclosure burden is the problem. For a Rule 506(b) offering with non-accredited investors, you must deliver:
- Audited financial statements: Your last two fiscal years of financials must be audited by an independent certified public accountant. If you're a startup, this means bringing in an auditor at significant cost ($10,000-$30,000+) just to give equity to a handful of people.
- Form 1-A offering statement equivalent: A prospectus-like document that reads like something you'd file with the SEC for a public offering. This document must include extensive information about your business, management team, use of proceeds, risk factors, capitalization, and more.
- Financial condition and results: Detailed financial statements, balance sheets, income statements, and cash flow statements.
- Business description: Your products, market, competitive position, and business model in detail.
- Management and compensation: Names and compensation of all officers and directors, plus significant stockholders.
- Risk factors: A comprehensive list of risks investors face (bankruptcy risk, market risk, regulatory risk, management risk, etc.).
Creating this documentation requires a lawyer (to draft the offering document) and an accountant (to prepare or audit the financials). You're looking at $15,000-$50,000 in professional fees, depending on the complexity of your financials and the thoroughness of your disclosure.
For a company raising $250,000 from a friend and former colleague, spending $30,000 to properly disclose to two non-accredited investors isn't economical. It's cheaper to raise from accredited investors or to structure the investment differently.
Rule 506(b) vs. Rule 506(c): Understanding the Two Paths
Rule 506(b) (Regulation D): Allows up to 35 non-accredited investors, but imposes the disclosure burden described above. Also requires "reasonable steps" to verify that accredited investors are truly accredited (though the verification standard is lighter than for 506(c)).
Rule 506(c) (Regulation D): Allows unlimited accredited investors with light disclosure requirements. However, it PROHIBITS non-accredited investors entirely. If you rely on 506(c) and a non-accredited investor participates, you've violated the exemption.
For 506(c), you must take reasonable steps to verify accredited status. This typically means obtaining a net worth certification, reviewing tax returns, or using a third-party accreditation verification service. It's more rigorous than Rule 506(b), but it eliminates the onerous disclosure requirements.
Most startups use 506(c) because it's simpler and scalable. You can raise from multiple accredited investors without triggering Rule 506(b)'s disclosure burden. The tradeoff: you explicitly exclude non-accredited investors, which can feel exclusionary but is actually the pragmatic choice.
The Title III Equity Crowdfunding Alternative
There is one workaround: Regulation CF (Title III equity crowdfunding).
Regulation CF allows companies to raise capital from both accredited and non-accredited investors through registered funding portals (like SeedInvest, Wefunder, or Forge). The disclosure requirements are less onerous than Rule 506(b):
- You must file a Form C with the SEC (a simpler document than a prospectus)
- Financial statements can be unaudited and light on detail for early-stage companies
- Annual limits apply: you can raise no more than $5M (as of 2024) in a 12-month period
- Individual non-accredited investors are capped at investments of 10% of income or net worth (whichever is lower)
Regulation CF solves the non-accredited investor problem for startups willing to raise through a registered platform and accept the visibility that comes with public crowdfunding. It's ideal for mission-driven companies, software tools, and consumer products with passionate user bases. It's less ideal for B2B businesses or companies pursuing stealth fundraising.
The key advantage of Reg CF: you can take meaningful money from non-accredited investors without the Rule 506(b) disclosure burden. The key disadvantage: you lose privacy, the cap is $5M, and individual investors are limited in how much they can invest.
Recent SEC Changes to Accredited Investor Definition
In 2023-2024, the SEC modernized the accredited investor definition to include:
Holders of certain professional certifications: People with Series 7, 65, 82, or similar securities licenses are now presumed sophisticated enough to make private investments without the income/net worth test. This expanded the pool of accredited investors in the financial services industry.
Knowledgeable employees of investment funds: Employees of registered investment companies, hedge funds, or private equity firms who have professional responsibilities related to investing are accredited. This recognizes that someone working in venture capital or private equity likely understands the risks of early-stage investing.
These changes are helpful at the margins—they expand the accredited investor pool—but they don't solve the core problem: most non-accredited investors remain locked out of private investing without extraordinary disclosure burden.
Practical Advice for Startups: Stick to Accredited Investors
Here's the blunt advice every startup founder should hear: raise from accredited investors, or use Regulation CF.
If you're fundraising, make it a screening criterion that all investors meet the accredited investor test. In your SAFE or term sheet, include a representation and warranty that the investor is accredited (or that you're using Reg CF, in which case the restriction is different).
Why? Because once a non-accredited investor is in the deal, you're locked into disclosure requirements. If you underestimate the burden and cut corners, you've violated securities law. If you spend $30,000 to do it right, you've diverted capital from product and sales.
The accredited investor requirement isn't elitist—it's practical. The SEC designed these exemptions to let startups raise capital quickly without crushing compliance burden. The cost of including non-accredited investors is prohibitive for early-stage companies. Accept it and move on.
What Founders Should Do When a Non-Accredited Friend or Family Member Wants to Invest
You've likely encountered this scenario: a mentor, former colleague, or family friend—someone who genuinely believes in your company and wants to invest—doesn't meet the accredited investor threshold. What do you do?
Option 1: Decline politely and stick to Rule 506(c). Tell them: "I appreciate your support, but I'm fundraising under SEC rules that limit participation to accredited investors to keep compliance costs low. I wish I could include you." This is honest and professional. Most early investors understand the rules and respect your judgment.
Option 2: Use Regulation CF if appropriate. If your company is a fit for equity crowdfunding, you could launch a Reg CF campaign and invite your supporters (accredited or not) to participate. This works if your story resonates with a broader investor base and you're comfortable with public fundraising.
Option 3: Take their investment but do Rule 506(b) properly. This means: (a) Hire a lawyer to draft a prospectus-level offering document, (b) Have an accountant prepare audited financial statements, (c) Deliver all required disclosures, (d) Track their investment separately, (e) Manage investor relations carefully (no side agreements, consistent communication, etc.). This is expensive and burdensome, but it's legal if done correctly. Only do this if you're raising a large amount (enough to justify the cost) and you're committed to doing it right.
Option 4: Structure it as a convertible note rather than equity. Convertible notes are debt instruments that convert into equity at a future financing. They're not technically securities offerings in the same way equity is, and they can sidestep some of the accreditation issues. However, they don't eliminate the problem entirely, and they create tax and accounting complexity. Consult a lawyer before taking this approach.
Option 5: Ask them to become accredited. In some cases, a non-accredited investor can become accredited through minor changes in their financial situation or through professional certification. If they're on the edge (say, their net worth is $950,000), they might be able to cross the threshold in a year or two. In the meantime, you could defer their investment or take a smaller convertible note.
In most cases, Option 1 is the right answer. It preserves your compliance posture, respects the intent of securities law, and allows your investor to remain a supporter without legal risk to either party.
The Bottom Line
Non-accredited investors are locked out of private startup investing not because of anti-consumer policy, but because of practical compliance cost. The SEC designed Rule 506(c) to allow startups to raise capital without incurring massive disclosure burden—but that exemption is only available if you limit yourself to accredited investors.
Take advantage of that exemption. Screen for accredited status early, document it, and build your cap table from accredited investors. Your company, your lawyers, and your future investors will thank you.
If non-accredited investors are central to your business model (like a consumer app with retail backers), Regulation CF is your answer. Build a community of believers and raise through equity crowdfunding. Both approaches work. What doesn't work is trying to thread the needle with Rule 506(b)—the burden is too high and the outcome too uncertain.
Related Reading
For more on startup fundraising and securities law, see our Complete Guide to Regulation D, Rule 506(b) vs. 506(c) Comparison, and Accredited Investor Rules.
