An accredited investor is an individual or a business entity authorized to trade securities that may not be registered with financial authorities. They obtain this privileged status by meeting a specific set of criteria related to income, net worth, asset size, governance status, or professional experience.
Key Takeaways
- Accredited investors are those individuals classified as qualified to invest in complex or sophisticated types of securities.
- To become accredited, certain criteria must be met, such as having an average yearly income over $200,000 ($300,000 with a spouse or domestic partner) or working in the financial industry.
- Sellers of unregistered securities are mandated to sell only to accredited investors, who are deemed financially sophisticated enough to bear the risks.
- Accredited investors can buy and invest in unregistered securities by satisfying one or more requirements concerning income, net worth, asset size, governance status, or professional experience.
- Unregistered securities are inherently riskier due to the absence of standard disclosures mandated by SEC registration.
Grasping the Concept of Accredited Investors
Accredited investors can legally purchase securities not registered with regulatory bodies like the SEC. Many companies prefer to offer these securities to accredited investors directly. This approach often spares companies from the substantial costs associated with registering securities.
This type of offering is known as a private placement. While it presents potential risks, regulatory authorities need to verify that investors are financially stable, experienced, and knowledgeable enough to handle these ventures.
Companies offering shares to accredited investors require regulatory guidelines to set benchmarks determining who qualifies as an accredited investor. These regulations ensure the investors have the financial means and knowledge to undertake risks in unregistered securities.
Accredited investors also enjoy exclusive access to sectors such as venture capital, hedge funds, angel investments, and other complex, higher-risk investments.
Eligibility Criteria for Accredited Investors
Regulations for accredited investors vary across jurisdictions, typically defined by local market regulators or competent authorities. In the U.S., the SEC specifies accredited investor criteria in Rule 501 of Regulation D.
To qualify as an accredited investor in the U.S., an individual must:
- Have an annual income exceeding $200,000 ($300,000 for joint income) for the last two years, with the expectation of maintaining or exceeding that income level in the current year.
- Maintain a net worth, either individual or joint with a spouse, surpassing $1 million, excluding the primary residence’s value.
- Be a general partner, executive officer, or director of the company issuing the unregistered securities.
For an entity to be considered an accredited investor:
- It must be a publicly traded business development company or an organization with assets exceeding $5 million.
- Its owners must be accredited investors.
Entities cannot be formed solely to purchase specific securities. Additionally, individuals with sufficient education or professional experience in unregistered securities may also qualify.
Recent Changes to the Accredited Investor Definition
Recent amendments have broadened the accredited investor definition to include registered brokers and investment advisors.
As of Aug. 26, 2020, the SEC’s revision details:
- It includes individuals with specified professional certifications, designations, or credentials.
- Recognizes ‘knowledgeable employees’ of private funds as accredited investors.
- Expands the list of qualifying entities by including any entity that meets an investments test.
The Purpose Behind Accredited Investor Requirements
Regulatory authorities are tasked with promoting investments while safeguarding investors.
- Promoting Investment: Encouraging investments in high-risk ventures and entrepreneurial activities, which have the potential to generate significant returns.
- Safeguarding Investors: Protecting novice investors from high-risk ventures while allowing financially equipped and knowledgeable investors to participate.
There’s no formal process for becoming an accredited investor. It is the responsibility of securities sellers to verify the status of potential investors. Typically, this involves financial questionnaires and verifying documents like tax returns, bank statements, financial statements, and professional certifications.
An Accredited Investor in Action: Real-Life Example
Imagine an individual with an annual income of $150,000 over the past three years. Despite failing the income test, they are an accredited investor based on their net worth, which excludes the primary residence’s value. This individual’s assets total $1,050,000 (excluding their primary residence), while liabilities equal $50,000, creating a net worth of exactly $1 million. Thus, they qualify as an accredited investor.
Who Qualifies as an Accredited Investor?
Accredited investors typically meet these criteria:
- Income: Individual gross income over $200,000 for the past two years or joint income over $300,000 with a spouse, along with an expectation of earning the same or more in the current year.
- Net Worth: Individual or joint (with spouse) net worth exceeding $1,000,000, excluding the primary residence.
Other Ways to Attain Accredited Investor Status
- Professional Roles: Firm directors, executive officers, or general partners can be accredited if issuing the securities being offered.
- Financial Professionals: Holders of FINRA Series 7, 65, or 82 can qualify.
- Large Trusts or Entities: Trusts managing over $5 million in assets also qualify.
Exclusive Benefits for Accredited Investors
Accredited investors access special investment opportunities, including shares in private placements, structured products, private equity, and hedge funds. These offerings demand a level of financial sophistication to manage the associated risks.
The Consequences of Misrepresentation
Both the individual seeking accreditation and the financial entity must ensure truthful representation of accredited status. It typically involves providing tax returns, financial statements, or other proofs of financial stability and sophistication.
The Bottom Line
The rules governing accredited investors aim to shield less financially knowledgeable investors from risky ventures. Yet, they accord significant advantages to those with substantial financial resources, enabling them to explore a wider array of investment opportunities.
Related Terms: private placement, venture capital, hedge fund, angel investment, professional investor.
References
- U.S. Securities and Exchange Commission. “Accredited Investor”.
- U.S. Securities and Exchange Commission. “Accredited Investors – Updated Investor Bulletin”.
- Electronic Code of Federal Regulations. "§230.501 Definitions and Terms Used in Regulation D".
- U.S. Securities and Exchange Commission. “Final Rule: Amending the ‘Accredited Investor’ Definition”, Pages 41–42.
- U.S. Securities and Exchange Commission. “SEC Modernizes the Accredited Investor Definition”.
- U.S. Securities and Exchange Commission. “Accredited Investor”.
- Electronic Code of Federal Regulations. "§230.506 Exemption for Limited Offers and Sales Without Regard to Dollar Amount of Offering".
