Investors . . .

are those individuals and firms who supply money to companies in return for the prospect of capital appreciation. Federal and state securities laws restrict the number and type of investors to whom a company can sell its securities without conducting an expensive and time-consuming registered public offering. Unless the number and nature of the investors qualify the company for an exemption, the company’s securities cannot be sold without a registration.

The exemptions most commonly used when a venture capitalist is the investor rely on the venture capitalist qualifying as an "accredited investor" under the securities acts. These "accredited investors" are persons or entities which are recognized by the statutes as having sufficient wealth, sophistication (or access to sophisticated advice), and access to company information to fend for themselves when examining and investing in a privately held company.

Often, sales to these investors can be made without having to prepare an elaborate private offering circular. By contrast, most of the exemptions that permit private companies to sell their securities to investors who do not qualify as accredited investors require the company to prepare an offering circular and to pay close attention to the number of investors solicited, the investors’ states of residence, and various state "blue sky" limitations on the number of investors who may reside in each state.

Whoever the investors are, company management should be careful to conduct its stock offering in a manner that complies with all the rules of an exemption from the registration requirements of the federal and state securities laws. Overlooking a single detail can create significant liability for the issuing company and its management.

Whenever an exemption requires a company’s investors to qualify as accredited, management should investigate the credentials of the investors to determine whether they meet all of the requirements. The financing agreements should also contain representations from the investors that they are accredited, that they have had adequate access to the company and its management, and that they are capable of bearing the loss should the investment fail.

Elsewhere in this book, we have discussed the value of dealing with good investors, and the negative consequences of dealing with poor ones. Being accredited does not mean an investor is good or ethical. It means simply that he has sufficient wealth and sophistication to fend for himself. Generally, he is someone who has enough other investments that losing his money on one deal will not break him. It is not true, from an entrepreneur’s point of view, that money from anyone is better than no money at all. Entrepreneurs should be careful to whom they sell their securities. See: Blue Sky Laws, Ethics, Investment Reps, Private Placements, Reg D, 33 Act.