Changes to Accredited Investor Definition Give Private Funds More Flexibility to Issue Equity to Employees

On August 26, 2020, the Securities and Exchange Commission (SEC) revised the “accredited investor” definition in Rule 501(a) of Regulation D promulgated under the Securities Act of 1933. The changes become effective on December 12, 2020. The SEC published a good summary here, and you can read the complete rule here.

I regularly represent emerging growth companies raising capital and represent private funds deploying capital in the private markets, almost universally in so-called “accredited-only” deals. These new changes to the definition of accredited investor will help private funds issue equity to employees.

But first, some background. After the stock market crash of 1929 and the ensuing Great Depression, state and federal regulators took action to rein in the worst abuses and excesses in the capital markets. Between 1933 and 1940, Congress passed a slew of new laws to regulate private and public capital markets, including the Securities Act of 1933, frequently referred to as the “Securities Act” or occasionally as the “1933 Act,” and the Investment Company Act of 1940 that is simply referred to as the “Investment Company Act.”

While many of these laws were aimed at structural regulation of the capital markets, the Securities Act and Investment Company Act were designed to protect investors from unsafe investments, and even to protect investors from themselves. The Securities Act generally requires securities to either be registered with the SEC (a very complicated and expensive process) or qualify for an exemption from registration. The Investment Company Act imposes significant disclosure and reporting requirements and a regime of fiduciary duties on investment funds offering investment securities like mutual funds. Similar to the Securities Act, these investment companies (funds) must either be registered or qualify for an exemption from registration.

In implementing the Securities Act, the SEC established the concept of an “accredited investor” who was capable, either through access information or wealth, of “fending for themselves” in a securities transaction. Section 3(c)(1) of the Investment Company Act exempts from registration “private funds” that have not more than 100 accredited investors. Because only accredited investors can invest in the 3(c)(1) private funds, these private funds cannot allow their employees who are not accredited investors to participate in the equity of the private fund, whether as cash investors or as recipients of stock options or profits interests.

Until recently, the only way an individual could qualify as an accredited investor was to meet the income or asset tests, or to be an executive officer or director of the issuer. The new changes will expand the accredited investor definition and allow non-executive employees more ways to qualify as an accredited investor. This will greatly enhance the efforts of private funds and their sponsors to extend equity participation to their employees.

The changes:

  • add a new category to the definition of accredited investor that permits natural persons to qualify as accredited investors based on certain professional certifications, designations or credentials or other credentials issued by an accredited educational institution, which initially include holders in good standing of the Series 7, Series 65, and Series 82 license;
  • include as accredited investors, with respect to investments in a private fund, natural persons who are “knowledgeable employees” of the fund;
  • add “family offices” with at least $5 million in assets under management and their “family clients,” as each term is defined under the Investment Advisers Act; and
  • add the term “spousal equivalent” to the accredited investor definition, so that spousal equivalents may pool their finances for the purpose of qualifying as accredited investors.

Edward R. Culhane is an experienced cannabis and hemp attorney focused primarily in the areas of venture capital, private equity, securities and mergers and acquisitions. Mr. Culhane is a cannabis and hemp industry veteran and is licensed to practice law in the states of California, Colorado and Minnesota. You can reach him at or (612) 483-5385.