Accredited Investors: What It Means and How to Qualify
Published on
August 29, 2023
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Table of Content
Introduction
Definition of an Accredited Investor
Purpose of Accredited Investor Requirements
Privileges and Responsibilities
Recent Developments
Becoming an Accredited Investor
Why do you have to be an accredited investor?
Conclusion
Introduction
An accredited investor is a term used to describe individuals or entities that are allowed to trade securities not registered with financial authorities. They are considered financially sophisticated and have the means to handle the risks associated with complex investments. This article will delve into the definition, requirements, and significance of accredited investors.
Definition of an Accredited Investor
An accredited investor is an individual or business entity that meets specific financial criteria, allowing them to invest in unregistered securities. These investors are considered financially stable, experienced, and knowledgeable about their investment ventures.
Key Requirements
You are an accredited investor if you qualify under any one of these scenarios:
- Income Requirements: An individual must have an annual income exceeding $200,000 ($300,000 for joint income) for the last two years, with the expectation of earning the same or higher income in the current year.
- Net Worth: A net worth exceeding $1 million, either individually or jointly with a spouse, excluding the primary residence. See here for an example on how to calculate your net worth.
- Professional Experience: Financial professionals holding Series 7, 65, or 82 licenses, or those with sufficient education or job experience in unregistered securities, can also qualify. You can think of an executive working at the company that is issuing the security.
- Entities: Private business development companies, organizations with assets exceeding $5 million, or entities where all equity owners are accredited investors. The entity must not be created with the sole-purpose of investing in a specific security, so most businesses apply here.
Recent changes have expanded the definition to include registered brokers and investment advisors, and certain professional certifications and designations. Please view our article here around the redefinition of accredited investors.
Purpose of Accredited Investor Requirements
The concept of accredited investors is rooted in the need to balance investment promotion with investor protection. It aims to:
- Promote Investments: Encourage investments in risky ventures that have the potential for high returns.
- Protect Investors: Safeguard less-knowledgeable investors who may not have the financial cushion to absorb high losses or understand the associated risks.
Privileges and Responsibilities
Accredited investors have access to private placements, venture capital, hedge funds, and other complex and higher-risk investments. They are deemed financially sophisticated enough to bear the risks and lack the normal disclosures that come with SEC registration.
Recent Developments
On June 5, 2023, the U.S. House of Representatives passed the Fair Investment Opportunities for Professional Experts Act, aiming to broaden the criteria for accredited investors. This includes people determined by the SEC to have "professional knowledge through educational or professional experience."
Becoming an Accredited Investor
There is no formal certification for becoming an accredited investor. The issuer of the unregistered securities may ask the applicant to respond to a questionnaire and provide financial statements, tax returns, and other documents to verify qualification. The burden of proof varies dramatically based on the type of offering you are engaging in such as a Reg D 506(b) vs a Reg D 506(c).
Why do you have to be an accredited investor?
The concept of an accredited investor is not merely a financial classification but serves a vital purpose in the investment landscape.
Ensuring Financial Sophistication
The accredited investor exemption seeks to ensure that all participating investors are financially sophisticated and able to fend for themselves or sustain the risk of loss. This makes the protections that come from a registered offering unnecessary, according to the SEC[1].
Regulatory Background
The rules regarding accredited investors are governed by SEC Rule 501 under Regulation D of the Securities Act of 1933. This act was a government response to the Great Depression and is also known as the “truth in securities” law [2]. It aimed to improve financial disclosure requirements, ensuring that investors are well-informed about the investments they are buying. Additionally, it tightened rules prohibiting fraud and misrepresentation in the sale of securities.
Specific Investment Requirements
Certain investments specifically require accredited investors due to their nature and associated risks:
- Hedge Fund Investments: Since hedge funds can invest in more speculative investments, they typically only accept accredited investors and qualified purchasers.
- Private Equity Investments: Most forms of private equity investing, require you to be an accredited investor or a qualified purchaser as well.
- Online Real Estate Investment Providers: Platforms like Crowdstreet and EquityMultiple are only open to accredited investors. There are however other platforms that allow for non-accredited investors to participate in historically private real estate investments like Concreit.
- Venture Capital Investments and Startups: Typically Reg D offerings do not require the same degree of disclosures as offerings registered or qualified with the SEC (think a company going public via a S-1 or Reg A), and thus usually require you to be an accredited investors due to the higher risks [3].
Conclusion
Accredited investors play a vital role in the financial market, providing efficient capital to ventures that may otherwise not be capitalized to take an offering public quite yet. The regulations surrounding accredited investors are designed to ensure that these individuals and entities are capable of understanding and bearing the risks associated with unregistered and potentially riskier investments. The SEC hopes that these hurdles result in a better match up of investors that understand the risk to the potential reward of the offering. It'll also help with lowering the amount of potential lawsuits in the event that things don't turn out well.
Understanding the criteria and responsibilities of an accredited investor is essential for both investors and issuers of unregistered securities. With recent changes and ongoing developments in the definition and requirements, staying informed is key to navigating this complex landscape.
1: https://www.sec.gov/education/capitalraising/building-blocks/accredited-investor
Disclaimer
This information is educational, and is not an offer to sell or a solicitation of an offer to buy any security which can only be made through official documents such as a private placement memorandum or a prospectus. This information is not a recommendation to buy, hold, or sell an investment or financial product, or take any action. This information is neither individualized nor a research report, and must not serve as the basis for any investment decision. All investments involve risk, including the possible loss of capital. Past performance does not guarantee future results or returns. Neither Concreit nor any of its affiliates provides tax advice or investment recommendations and do not represent in any manner that the outcomes described herein or on the Site will result in any particular investment or tax consequence.Before making decisions with legal, tax, or accounting effects, you should consult appropriate professionals. Information is from sources deemed reliable on the date of publication, but Concreit does not guarantee its accuracy.
