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Although just about anyone can start a startup, not everyone can invest in them.

The rules and regulations behind who can and can鈥檛 invest in private companies is the subject of this installment of an open, ever-expanding guide to the VC industry that we on the SA国际传媒 News team are compiling.

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Part 1 of this series covered the very basics of venture capital and where it exists in the universe of investment opportunities. We explained that private-company equity is considered an alternative asset, and today we鈥檒l explore the various regulatory hoops one must jump through to invest in startups.

One thing to note: we are not lawyers, nor do we play them on the internet. Please speak with our own legal and financial counsel before investing in a startup or startup investment fund. Books, seminars, or online articles are no substitute for personalized professional advice.

Who Can Invest In Startups?

As with answers to most questions about the venture capital field, this one starts with 鈥渋t鈥檚 complicated, and it depends.鈥�

First, before continuing, it鈥檚 important to note that we鈥檙e coming from a U.S.-centric approach here. So who gets to invest in startups? For the longest time, it was just 鈥渁ccredited investors鈥� who could invest in private company equity. And that鈥檚 where we will start.

Accredited Investors

Being an 鈥渁ccredited鈥� investor assumes you鈥檙e sophisticated enough to make risky financial decisions. And in this case, as in most, sophistication is a euphemism for wealth.

According to the , last updated with the passage of the Dodd-Frank Act in 2010, an accredited investor is an individual who:

• 鈥淓arned income that exceeded $200,000 (or $300,000 together with a spouse) in each of the prior two years, and reasonably expects the same for the current year, or鈥�
• 鈥淗as a net worth over $1 million, either alone or together with a spouse (excluding the value of the person鈥檚 primary residence).鈥�

One or more of these criteria must be met for three consecutive years before a person is considered an 鈥渁ccredited investor.鈥澛燗lternately, certain investment professionals are also designated as accredited investors.

Other Investors And The Rules That Govern Them

There are other tiers of investors, , which correspond to higher levels of wealth and institutional backing. While sometimes relevant to the internal financial management of venture funds, the qualified client/purchaser designation is less relevant to the fundamental question of who gets to invest directly into private companies or the funds that back them.

Basically, it鈥檚 only accredited investors (and wealthier) who get to invest in private company offerings and VC firms.

Here鈥檚 why. The surpassing majority of capital raised by private companies in the U.S. is done through a 鈥減rivate placement,鈥� 1 which is accessible accredited investors, or up to 35 non-accredited investors who are able to prove they are knowledgeable and fully understand the risks involved with investing in a given business. However, because the burden of proof for such knowledge is high, non-accredited investor participation in a private placement is and seldom happens.

This being said, recent rule changes open up investing in startup equity to more people.

Although signed into law in 2012, Title III of the 鈥攖he part of that legislation covering equity crowdfunding鈥攄idn鈥檛 get implemented until 2014. The new-ish crowdfunding regulations (appropriately named Regulation CF) allow companies to offer shares of stock in exchange for money from non-accredited investors. But there are limitations on the policy.

For example, a company can鈥檛 issue more than $1 million worth of crowdfunded securities within the same twelve-month period. And depending on retail investors鈥� income bracket, the amount they can invest per year is also limited. Regulation CF also imposes a number of reporting requirements that aren鈥檛 present in Regulation D.

Stay tuned for more installments of SA国际传媒 News’s VC guide. Next up on the docket: how VC firms are structured.

If you have any questions or topics you’d like to see covered, feel free to contact the author: jason [at] crunchbase [dot] com.

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