There’s no one right way to build your financial future. If you had talked to me a decade ago and asked me, “How do you invest in startups?” I would’ve said that you probably have to have an amazing network, you have to have gone to certain schools.
Well, guess what? I’m a normal person with a normal job. And I’m proud to say that I am a startup investor. So today we’re going to demystify the whole process of investing in startups. You just need to know who can invest and how you do it. So let’s get started.
The big thing to know is that private company shares are super different from public company shares like the kind that you would buy on the stock market. Public company shares are registered with the Securities and Exchange Commission, which is a federal agency. And if that sounds serious, it is. This means that public companies have to report their financials and a whole range of other information that would be material to a buyer or seller of the shares. What is material information? Anything that’s meaningful that helps you make a decision.
So if you’re looking for information about public companies, you can find that information pretty easily on the internet. You can find their quarterly earnings, their annual earnings, and all of this information is intended to do one thing: Protect shareholders.
So if you own shares of a public company, or if you’re thinking about buying shares of let’s say Google or Apple, you have access to all of their financial information at any time. And guess what that does? It puts you on a level playing field with everybody else. Whether you’re a big institutional investor or just sitting at home on your computer, you have access to basically the same information.
But with private companies, it’s way different. A private company doesn’t have to release any of that information to the public. So what does that mean? It means that in private companies comes with a lot less information—and as a result, a lot more risk.
So in order to invest in a private company like a startup, you have to meet some special criteria. We’re going to talk about those criteria.
There are accredited investors and there are qualified purchasers. Both of these are terms that are set by the Securities and Exchange Commission. And what they basically mean is that you have to have a certain level of financial sophistication which allows you to purchase securities that are not registered with the SEC. And that’s because you are assumed to be sophisticated enough to understand the heightened risk involved with investing in private companies, where you have very little information.
So in other words, if you are one of these two things—an accredited investor or a qualified purchaser—then you are legally qualified to take on the additional risk of investing in private companies.
So what’s the difference between an accredited investor and a qualified purchaser? Well, an accredited investor is typically more relevant to individuals. It means that you, as an individual, meet certain lifestyle and educational criteria, like your income, your net worth, or your education. Whereas a qualified purchaser is usually more relevant for funds, institutional investors, family offices, or companies. And it’s less about their assets and more about their investments.
So a simple way of putting this is if you want to be an accredited investor, you have to pass a financial exam, or have a certain net worth, or have a certain income. And if you want to be a qualified purchaser, then you have to be investing a large amount of money.
So let’s talk about the criteria for each one. What is an accredited investor? This is someone who meets a specific set of criteria pertaining to their assets, their education, and their lifestyle. So what does all that mean? It usually means that your income, or your net worth, or your education meet a certain criteria.
Let’s talk specifics. So if Iris wants to be an accredited investor, she has to tick at least one of these boxes. As of today, as an individual, Iris has to have earned income of at least $200,000 per year for the last two years. And she has to have a reasonable expectation that she’ll earn that much again in the coming year.
And remember, right now Iris is filing her taxes as single, but let’s say she has a big life event and she gets married. Well great—that actually changes her situation a little bit. She’s going to still need to meet an income threshold, but now that income threshold goes up. So she and her partner will need to make $300,000 a year jointly to qualify to be an accredited investor.
Another way Iris can become accredited is through her net worth. So if you thought it was hard to make $200,000 a year, get this: She or her family will qualify if they have a net worth of over a million dollars. But here’s the catch: It cannot include her primary residence, meaning the place where she lives. So if Iris saved her money and she bought a house, she cannot include that in the value of her net worth. Her million dollars needs to be independent of the value of her residence.
So those are two of the three pathways towards accreditation, but let’s say Iris doesn’t meet either of these criteria. That’s OK. She can still become an accredited investor by passing a financial exam and holding a specific license, like a Series 7, a Series 82, or a Series 65, which are issued by FINRA. She can also invest through a trust, but those rules start to get a little more complicated, so we’ll cut it off there.
The big thing to take away, becoming an accredited investor is typically all about meeting certain metrics for your assets in your everyday life. And the criteria for who can be an accredited investor have changed over time. So make sure to check the latest guidelines from the SEC.
And what these metrics indicate is that you are able to take on extra risk, the extra risk of investing in a private company that does not report its financials to the public. And whether it’s your education, your income, or your net worth, you’re able to communicate that you are able to withstand the ups and downs of startup investing.
So, there are many different types of investors who are qualified to invest in startups. We just talked about accredited investors. So in terms of risk, if a normal, everyday investor is here, an accredited investor is up here. Now we’re going to talk about a third level of qualification, which is up here. And that’s our qualified purchaser.
Now, you can imagine that if the road to becoming an accredited investor means you have to make a good bit of money, have a high net worth, or pass a financial exam, the road to becoming a qualified purchaser is even harder.
Being an accredited investor is typically all about assets, income, net worth, or in some cases, qualifications. But being a qualified purchaser is all about investments. It’s all about purchasing power, which is why the criteria to be a qualified purchaser is a lot higher.
So a qualified purchaser is an entity—could be an individual, a family office, a business, an endowment, a foundation, or a pension—that has a significant amount of capital. That capital is their purchasing power. They have the potential to buy tens to hundreds of millions of dollars worth of investments. They are at an entirely different level than our accredited investor.
So if we’re talking about an individual like Iris or a family office, if they have five million dollars of investable capital, they would qualify as a qualified purchaser.
Now let’s say Iris owns a million dollars in real estate, again, not counting her primary residence. And she also has five million dollars in a retirement account. One million plus five million equals six million. She would be a qualified purchaser. She meets that minimum threshold to become a qualified purchaser.
Now let’s look at another scenario. Let’s say Iris is managing a larger entity, like a trust that’s owned by other qualified purchasers. And they have invested at least 25 million dollars in private capital. This would also mean that Iris is a qualified purchaser.
You can be a qualified purchaser, but what you really need to remember is these measures and these definitions exist to protect us normal people so that we don’t take on too much risk that we’re not yet prepared for.
The upside to investing in startups, once you’re able to do it, is not only can the startup have a huge return for you as an individual or as an entity—you can also help create jobs, create new technology, et cetera. And that is the kind of risk that we want people to take. And so it’s super important to have more pathways for people to participate in this startup ecosystem.
And at the end of the day, if you want to invest in startups, the SEC wants to make sure that you’re able to take that risk on. Say you were one of the early investors in Amazon or Google before the company went public. As the company grew, it must have been thrilling to watch the value of the equity grow along with it.
And that type of opportunity is happening all the time today. You join the company as an investor or an early employee, and you watch it grow. And you’re along for that ride as they build new products, hire new people, expand globally. And along with that growth, the value of your equity is growing along with it.