Requirements for Angel Investors

Authored by Bryan Springmeyer Bryan Springmeyer is a California corporate attorney who represents startup companies and investors. The information on this page should not be construed as legal advice.

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The requirements for someone to engage in angel investing are a function of securities laws.  Securities laws are designed to protect investors, and there are certain criteria that distinguish investors who need extra protection from those who do not.  At the federal level, one of the most significant distinctions is whether the investor is an “accredited investor.”   The categories of accredited investor are defined in Rule 501.  For purposes of angel investing, the definition is met by an individual whose income is $200,000, or whose joint income is $300,000, in the two most recent years, with an expectation of meeting that income again, or by an individual with individual or joint net wealth of $1 million (excluding primary residence).

The default position of securities laws is that securities (stock or any other instrument for an investment) cannot be sold without being registered.  Registration is the same process that a company goes through as it IPOs.   This is completely unfeasible for a startup (or most any company, for that matter).  As such, securities attorneys look for “exemptions” to the registration requirement.  The exemption that is used for most private sales is Rule 506.  While a 506 offering allows participation by unaccredited investors, the disclosure requirements are so onerous that the process is unfeasible.  As such, unaccredited investors are typically prohibited by the company’s counsel from participating in investments.

There are other exemptions to the securities registration requirement, and some might look to Rule 504, which allows an unlimited number of unaccredited investors without extra disclosure requirements, for sales under $1 million in 12 months.  While this might work to exempt the present transaction, instruments that are used in early stage investing often convert to securities that may be part of a later round that does not qualify for 504 exemption.

Rule 506 supersedes state securities laws, but use of a federal exemption that does not could mean that the investor would need to meet the criteria set forth in various state exemptions.  The most common exemption in California, for example, might require that the investor have a previous business or personal relationship with the company or its officers, or that they be savvy enough to protect their own interests.