Increasingly, ICO investments are entering the mainstream. And with this development comes a whole new world of fundraising opportunities for startups: Initial Coin Offerings (ICOs), also referred to as token sales. In the second half of 2017, ICOs raised more than $350 million per month, and 2018 is set to continue the trend.
As alluring as fundraising in the world of crypto investment might sound, Initial Coin Offerings come with some important legal considerations. This article focuses on one of those considerations in particular: when raising funds through an ICO, do your investors have to be accredited?
What is an Accredited Investor?
Accredited investors are considered by the SEC to be investors that are able to protect themselves, or at least better able to protect themselves than the average investor out there. According to the SEC, an individual accredited investor must meet at least one of the following criteria:
- Have an annual income of $200,000 annually (or $300,000 combined income if married) for at least the past two years
- Have a net worth in excess of $1 million (excluding the value of his/her primary residence)
- Be a general partner, executive officer, or director for the security in question. This criterion will usually not be relevant: unless you are raising funds from your general partner, executive officers, or directors, this will not apply for ICOs
If an individual is an accredited investor, the SEC considers that person in a position to defend him-or-herself, and is accordingly willing to relax some of the regulation that usually governs any sale of securities. As a consequence, the distinction between accredited and non-accredited investors will become important for your ICO if it can be considered considered a securities offering.
The Key Question: Are Your Coins Utility Tokens or Security Tokens?
If your coins are considered utility tokens, they are not securities, and therefore not regulated by the SEC. In this case, there will be no requirement that your investors be accredited. No need to take the “accredited investor” question into account.
Your coin will be a utility token if its value is driven by the utility that your product offers token holders exclusively. In other words, only when your token forms an integral, functioning part of your product will it be a utility token. In practice, this is very rarely the case.
In all other instances, your token will be considered a security, and subject to SEC regulation.
SEC regulation of crypto investments
All securities offerings, and therefore for almost all Initial Coin Offerings, are required to be registered with the Securities and Exchange Commission. If you do register your ICO with the SEC, there is no restriction on the type of investors you attract – you can issue tokens to accredited or non-accredited investors.
However, securities registration is a complicated, lengthy, and expensive process. As a result, most companies issue securities under one of the exemptions provided for by the SEC. The most common exemptions used for ICOs are Rule 506(c), Reg A+, Reg S, and Reg CF (although Reg CF is much more onerous than the first three on this list and therefore used less often).
Rule 506(c) offerings are by far the easiest to use, and most commonly used. Under Rule 506(c), all investors must be accredited, and you (the issuing company) must be able to prove that the investors are accredited.
In short: if you are looking to bypass lengthy and complicated SEC regulations by using Rule 506(c), you will have to offer coins exclusively to accredited investors, and be able to prove that they are accredited. If you want to offer tokens to non-accredited investors, you will necessarily face the increased burden of using one of the more complicated exemptions, or of registering your coins with the SEC.
Hire a Cryptocurrency Attorney Today
At LawTrades, we are serious about staying on top of the ever-changing legal realities of crypto. Whether you are considering an ICO, implementing smart contracts, or concerned about the tax implications of your crypto transactions, our cryptocurrency attorneys are here to help. Get in touch today!