The rules and regulations behind who can and can’t invest in private companies is the subject of this installment of an open, ever-expanding guide to the VC industry that we on the Crunchbase 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’ll 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 “it’s complicated, and it depends.”

First, before continuing, it’s important to note that we’re coming from a U.S.-centric approach here. So who gets to invest in startups? For the longest time, it was just “accredited investors” who could invest in private company equity. And that’s where we will start.

Accredited Investors

Being an “accredited” investor assumes you’re 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:

• “Earned 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”
• “Has a net worth over $1 million, either alone or together with a spouse (excluding the value of the person’s primary residence).”

One or more of these criteria must be met for three consecutive years before a person is considered an “accredited investor.” Alternately, 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’s only accredited investors (and wealthier) who get to invest in private company offerings and VC firms.

Here’s why. The surpassing majority of capital raised by private companies in the U.S. is done through a “private placement,” 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 —the part of that legislation covering equity crowdfunding—didn’t 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’t issue more than $1 million worth of crowdfunded securities within the same twelve-month period. And depending on retail investors’ income bracket, the amount they can invest per year is also limited. Regulation CF also imposes a number of reporting requirements that aren’t present in Regulation D.

Stay tuned for more installments of Crunchbase 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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Exciting? Not to everyone. Important? Yes. For better and worse, a huge amount of money is controlled by a relatively small number of folks who make decisions about what the future might look like based on the businesses they back. It’s rarified air, to be sure, but air all the same.

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And that is why we’re compiling an open, ever-expanding guide to the VC industry. We’ll start with the very basics here.

Chances are, you’ve got some familiarity with the subject. You might work for a venture-backed startup. You may even have founded one. Or, heck, you could be a general partner at one of the many firms which have raised billion-dollar funds this year.

Just like Wall Street is just a bunch of glass buildings with computers in them, —a major center of gravity in the North American VC market—is just a hodgepodge of drab office buildings situated on a hill in Menlo Park, CA that, we acknowledge, is kinda sandy. There’s even computers there, too. It’s really not that exciting.

But before delving into greater depth about who invests in VC (hint: rich folks), how VC firms are structured (hint: it’s complicated), and how they get paid—all of which, and more, are coming in future parts of this guide—we’ve got to start from square one: Where is VC in the universe of investment opportunities?

Key Terms Defined: What Is Venture Capital?

VCs invest other people’s money in young companies in the hopes of generating an outsized return, despite the risks.

The first order of business is to triangulate VC’s location in the world of finance and investments. Let’s start super big picture before narrowing it down a bit, shall we?

• Investment Assets: This is the whole universe of money that’s “looking for work.” In this particular reading of the capitalist system, money’s only job is to make more of itself.

• Alternative Assets: As opposed to more conventional assets like publicly-traded stocks and corporate or sovereign bonds, alternative asset classes comprise basically everything else. Hedge funds of varying strategies, real estate, commodities, and expensive art are all considered alternative assets. Although each country’s laws differ, alternative assets are typically accessible only to high-income and high net worth individuals and professional money managers. More on these folks in a bit.
• Private Equity (PE): Private equity, in the most inclusive sense of the term, simply refers to the equity (stock) of privately-held companies. Because stock in private companies isn’t traded on open markets, it tends to be illiquid (difficult to exchange for cash on short notice) and inefficiently priced. Except for the earliest phase of company development, where some intrepid individuals invest their own capital in a fledgling business, most investment comes from institutional money managers often specializing in a particular stage or sector.
• Venture Capital (VC): Although technically a subset of private equity investors, venture capitalists have carved out a distinct niche for themselves in the investment ecosystem. Though definitions abound, basically, a venture capital firm is a type of company which invests capital from its investors into a portfolio of companies with a high-risk, high-reward profile. It is in turn the fiduciary responsibility of investment professionals at the VC firm to diligently monitor and, wherever possible, actively assist their portfolio companies to maximize the likelihood of a positive financial outcome.

One quick note about the distinction between VC and PE. For a long time, investment strategies clearly differed: VCs would invest typically for minority stakes in scrappy startups, whereas PE investors would invest in more mature businesses, often along different strategic lines. However, giant new funds from the likes of SoftBank, Sequoia, and others, are beginning to blur that line a bit.

Primary Deal Types

Crunchbase tracks a wide variety of funding events, mostly involving privately held companies. The full set of funding round types , but here’s a selection of the most common equity funding round types you’ll hear about:

• Angel: is typically a small round designed to get a new company off the ground. Investors in an angel round include individual angel investors, angel investor groups, friends, and family.
• Pre-Seed: is a pre-institutional seed round that either has no institutional investors or is a very low amount, often below $150k.
• Seed: are among the first rounds of funding a company will receive, generally while the company is young and working to gain traction. Round sizes range between $10k–$2M, though larger seed rounds have become more common in recent years. A seed round typically comes after an angel round (if applicable) and before a company’s Series A round.
• Series A and Series B. are for earlier stage companies and range, on average, between $1M–$30M.
• Series C and above. and onwards are for more established companies. These rounds are usually $40M+ and are often much larger. (We’ve written a lot about “supergiant” rounds of $100M or more, and many of them are Series C or later.)
• Private Equity: is led by a private equity firm or a hedge fund and is a late stage round. It is a less risky investment because the company is more firmly established, and the rounds are typically upwards of $50M.

It’s worth mentioning that, over time, the definitions of very early-stage round types like “seed” and “Series A” have become somewhat muddied. Seed financing stratified into “seed” and “pre-seed.” New sources and methods of funding—crowdfunding platforms, convertible and SAFE notes, and an explosion of incubator and accelerator programs—helped more entrepreneurs secure capital for their ventures. But, at the same time, because rounds have gotten bigger over time, it’s hard to guess what stage a company is at solely based on their total capital raised.

The Taxonomy Of Investors

Crunchbase tracks many kinds of investors, most of which are listed and defined . Here’s a selection of the most common participants private company funding rounds:

• Venture Capital: invest in startups at a variety of stages, ranging from seed to Series A and beyond. Venture Capital firms take equity in exchange for capital, seeking to invest in firms from the first VC round, Series A, through to later stages as the company grows.
• Angel Investor: who invest in startups using their own money.
• Accelerator: takes a set amount of seed equity from a number of young startups in exchange for capital and mentorship.
• Micro-VC: invests in startups and typically has a fund size less than $100M. Micro-VCs are a type of Venture firm that focuses on early stage seed and Series A investments.
• Private Equity Firm: A is an investment management company. When they do invest in startups, it is typically in the private equity, or later stage venture rounds (Series C and beyond).

Stay tuned for future installments of Crunchbase News’s guide to venture capital. The next questions up on the docket:

• Who gets to invest in startups and why?
• How VC firms are structured?
• What’s the structure of a VC deal?
• How do investors get paid?

We’ll be sure to link it back here! Stay tuned!

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