Accredited Investor

Accredited investors can be legal entities and individuals. They trade securities outside the SEC register. SEC considers these people skillful and experienced enough to bear the risks.

Unregistered securities are riskier. They don’t come with the guarantees and disclosure from the Securities and Exchange Commission. They might be perfect for you if you have a high-risk tolerance. Those with the money and nerves can earn more than regular investors.

The net worth and income requirements stop some people from trading in unregistered securities. Initial investments and investment fees are on the high side as well. If you choose this thorny path, you can forget about investment liquidity. On the plus side, you’ll have more lucrative investment opportunities.

The chance to make a lot of money appeals to many. If you like taking risks, you might like accredited investing.

The High Risk

The US Securities and Exchange Commission (SEC) allows some private funds to opt out of registering some investments. They can trade these to accredited investors. Accredited investors can choose to invest their money in:

Private equity
Hedge funds
Equity crowdfunding
Venture capital
Private placements

There are no legal guidelines to follow if you want to become an accredited investor. You won’t have to prove your credentials to a government agency either. Certification for an accredited investor is non-existent. You won’t have to take exams. There’s not a plastic card you can show around to prove your status either.

Qualified Investor Vs Accredited Investor

The two terms sound similar but describe very diverse types of investors. A qualified purchaser uses their funds to earn as much money as possible. They are under management. An accredited investor is the status for someone who can purchase private market securities.

The Qualities of Qualified Investors

To be considered a qualified investor you have to have:

At least $25 million in private capital investments
Invest your own money or money you’ve gathered from other investors
You can be an individual or a legal entity

A qualified purchaser can be the sole proprietor of an investment fund. Or, it can be a trust under the management of a qualified investor. Entities with the sole purpose of investing in a fund can’t become qualified investors.

Private funds and hedge funds can accept investments only from qualified purchasers. The same goes for venture capital funds. The only rule is they should not plan on making initial public offerings in the years to come.

In contrast to accredited investors, qualified investors are funds in many cases. They need much more cash upfront to operate than accredited investors. Funds wanting to become accredited investors need more than $5 million to get certified. Five times that amount is required to qualify as an investor. A qualified fund tries to trade securities to accredited investors. In this way they avoid the registration.

Going through the SEC is both time-consuming and expensive. Hedge funds prefer to reinvest the money rather than to give it to the SEC. This mode of operation is appealing for its high return rates. Funds tend to ignore the inherent risk.

Is Accredited Investing Worth It?

Opinions differ on the cost-benefit of accredited investments. You need to evaluate the pros and cons of unregistered securities. The soundest advice you can get is to do your research beforehand.

The Case for Accredited Investments

There are many benefits for anyone considering accredited investments:

Financial advantage over your fellow investors
You’re considering becoming accredited, which means you possess a net worth and/or income above average
You get the chance to invest in stocks and securities people of less wealth can’t access
Accredited investors have a chance to earn much more from their purchases.

The higher rates of return go hand-in-hand with broader diversification. The return rates are shorter in most cases as well.

Accredited investments allow you to put your money in a hedge fund. That is by far the most positive aspect. Hedge funds have a high threshold of initial money you need to put in. That makes them perfect for accredited investors. They are riskier than more traditional methods of investing. However, at the same time, they yield profits none other can rival.

Points for Skipping on Accredited Investments

The nature of accredited investing is a topic of attention. Any investment that comes with an accredited status is riskier than the average investment. The funds try to beat the market to accumulate larger profits. This makes them take bigger risks that more conservative investors would avoid.

Risk aside, the high threshold stops a lot of people. Some funds ask for $200 000, others millions in advance. Small businesses find it hard to qualify for securities offerings. This means if the investment doesn’t go the way you hope, you lose the money.

You should stay away from accredited investment if you don’t want to risk losing a large part of your liquid assets.There’s no option to pull out your money any time you want either.

When you buy stocks from an online platform, you can sell them promptly. Hedge funds lock up your money for one to five years. No matter what happens on the market, you don’t have access to your cash. This is a major reason many stay clear of accredited private investments.

Another thing you need to consider is fees. To make accredited investments, you’ll have to pay management and performance fees. These can eat up as much as 20% of your money.

How Can You Become an Accredited Investor?

It’s up to the fund or company selling you the investment to determine your status. They need to go through a due diligence process to decide whether you are suitable. Only then can you buy unregistered assets from them.

It should happen before the sale and it’s a long, complicated process. Knowing the ins and outs will help your accredited investor status.

Who Becomes an Accredited Investor?

The short answer is high net worth individuals ready to take the risk. Companies usually look for any or a combination of these qualities in accredited investors:

Certain income level
High net worth
Reliable governance status
Great asset size
Proven track record as a registered investment adviser or investment advisor

There isn’t a law to prescribe the path to getting an investor’s accreditation. There is, however, a regulation that defines an accredited investor.

Rule 501 of Regulation D of the Securities Act of 1933 (Reg. D) says you need an annual income exceeding $200 000 for the past couple of years. A natural person and the person’s spouse who have a joint income of more than $300 000 over the past two years also qualifies as well. Regulation D sets a reasonable expectation for the income level. It has to remain the same in the current year.

Another way to become an accredited investor is a natural person’s net worth. The joint net worth with a spouse counts as well. It should exceed a million dollars at the time of the purchase. The value of the person’s primary residence doesn’t come into the equation. The net worth needs to consist of assets outside the place they live.

The Dodd-Frank Act

Many people don’t know about the “primary residence not included in the net worth” requirement. It wasn’t the case until 2010 when the Dodd-Frank Act came to fruition. People who held unregistered securities prior to 2010 were grandfathered into the law. That means they could continue holding the investment according to the previous rules. So, you don’t have to worry about breaking the law if you have some unregistered securities from before 2010. Your past net worth isn’t over a million dollars. House or apartment included.

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Is Accredited Investment Only for the Super-Rich?

One might be tempted to think so. The stone-cold facts differ, though. As of 2020, there are 13 665 475 accredited investor households in the United States. That is more than 10% of the population of the country. The number equates to $73.3 trillion. A large wealth, which you can become a part of with a little preparation.

SEC Amendments to Rule 501

Last year (2020) the Securities and Exchange Commission introduced several changes to the old definitions. The goal was to allow qualified investors to become accredited more easily. Professional knowledge, certifications, and proven experience can help. There is a sort of an investment test for quality that allows legal entities to qualify as well. The SEC opened the door to the accredited investors’ status to:

Knowledgeable employees of private funds
Investment advisors with registration with SEC and state commissions
People with the necessary credentials. Those include professional certifications or designations

The new rules allow those with Series 7, Series 65, and Series 82 licenses to become accredited investors. The amendment was the Commission’s attempt to stimulate more people to put their money to work.

In addition, accredited investments aren’t only for natural people. Rule 501 has several provisions that allow other legal entities to buy unregistered assets.

Legal entities that can buy unregistered assets include:

Charitable institutions
Corporations
Partnerships
Financial institutions
Insurance companies
Limited liability companies with $5 million or more in assets
Company directors
Executive officers
General partners
Equity owners
Partnerships

The easiest way, however, is to be a private individual or a couple looking to invest some cash.

How Do You Know if You Are Accredited?

Do you meet the income or net worth requirements? If you do then you can consider yourself an accredited investor. The onus isn’t on you to prove your status before the government. The equity firms selling you the assets have to do the work.

The entities doing the sales are the ones that need to see if you qualify. The SEC has regulations about the process. You won’t need to deal with them as an accredited sophisticated investor, but it’s still a good idea to know them. In this way, you can prepare for the review of the company you want to buy the securities from. The confirmation process changed less than ten years back. Before 2013, it was enough to just tell the company you qualify.

The Confirmation Process

Now, however, you must go through the following steps:

Go to the investment company and tell them you want to know if you are an accredited investor.
Fill out a questionnaire. You’ll need to prove you own the assets by providing info about your accounts. Prepare financial statements as well.
Credit report check. The company would like to know how well you deal with debt.

Let’s say you base your qualification on annual income. You’ll have to get your tax returns, documents about wages, tax exemption and W-2 forms as well. You need to prove you make over $200 000 a year (or over $300 000 spousal equivalent). Some companies ask for family clients reviews from tax attorneys. Investment brokers, and other pros contribute reviews as well. In short, the more documented proof of your qualification you have, the better.

Additional points to Bear in Mind

The rules for accredited investors differ in other countries
Brokerage firms can be issuers of accredited bonds
The same goes for real estate brokers
Rural business investment companies deal with accredited investors as well
The regulatory bodies (SEC, FINRA) are trying to make accredited investing safer
Single investors of good standing and family offices make the best investors

A Note About Foreign Countries

The accredited investor status isn’t unique to the United States. Other countries have such a status as well. The rules in Singapore, Australia, and Canada are similar to those in the US.

If you’d like to be an accredited investor in the EU, however, you’ll have to abide by other regulations. First, you’ll need at least ten notable transactions on the local market, for the last four months. On top of that, you need a portfolio of EUR 500 000 or more. Last but not least, you need at least a year’s experience in the financial sector. The firm that sells you the assets has to provide you with a written letter that states your status. You need to prove your position to the authorities, so knowing the local securities laws and rules is crucial. Do your research before buying assets in a foreign territory. The potential legal fallout can eat up any profit you make.

Conclusion

If you’re thinking about becoming an accredited investor, you won’t have an issue if you meet the net worth and income requirements. However, make sure you can bear the risk of losing your investment. Access to angel investors can bring in a lot of profits. The same goes for private equity and hedge funds. In any case, you’ll have access to investment opportunities others don’t.

There is more good news. The new SEC rules mean funds have to be more careful about their accredited investors. You have to work harder to meet the eligibility requirements. They won’t allow you to put your money in their funds and the risk becomes lesser for you.

Do you have experience with accredited investing? Any thoughts or questions? Don’t hesitate to share them in the comments.