When it comes to investing, there is always a measure of risk to bear. You can’t avoid it and you may never eliminate all the risks involved.
But the right person and structures can help facilitate investments that do not take on unnecessary risks. This is where an accredited investor comes into play.
If you’re asking this question “what are accredited investors?”, or seeking to be one, you are in the right place. This article will provide an in-depth look into what an accredited investor is and how you could possibly become qualified to be one.
How Does Accredited Investing Work?
There are different kinds of investment instruments and many are more complex than the traditional securities the general public trades, available to accredited investors. The more complex they are, the more risk involved in investing in the security or asset.
This also means that not everyone can have access to these instruments or have the in-depth knowledge to trade and manage them. But most times investors can be too headstrong for their good.
So the title of “accredited investor” was created to help prevent unnecessary loss. The accredited investor must meet several requirements to participate in such complex investments (that we will cover next).
Accredited Investor Definition
What does the term accredited investor mean? To answer this, an accredited investor is a person or entity that is allowed to trade more complex securities than traditional securities.
They are given this privilege because they meet several requirements that prove they are of knowledge to the complex nature of these securities.
Do You Have to Prove You Are an Accredited Investor?
No, you do not need to prove that you are an accredited investor. However, the investment vehicle you want to invest in would most likely ask for some form of confirmation of if you qualify as one.
While it may be easy to lie about being accredited, that would not be a smart move. For one, every investment vehicle requiring an accredited investor will ask and require you to provide certain documents (tax returns and financial statements) that will prove you are accredited.
If for some reason, a person gets around these accredited investor requirements, he/she could face serious legal action.
Can a Non-U.S. Person Be an Accredited Investor?
The SEC has clearly defined what an accredited investor is and the requirements to be one in Rule 501 of Regulation D. There are no definitions that limit non-U.S. persons from becoming an accredited investor.
Whether you are a resident in the U.S or not, as long as you meet the defined requirements of how to become an accredited investor, you can be one.
What Investments Are Available to Accredited Investors?
Again, one of the reasons why an accredited investor exists is because the investment instruments and vehicles they choose to invest in are rather complex and may not be listed with other public securities. These investments could be:
- Hedge funds
- Venture capital
- Real estate / REITs
- Crowdfunding
- Interval funds
- And more
These investments exist in different forms and structures but all bear a higher form of risk and complexity.
What Counts as Income for Accredited Investors?
With that said, what would the income of an accredited investor look like? Typically, in the U.S, an accredited investor must have an annual income of over $200,000 within the last 24 months.
In some cases, the income is set at $1 million when single individuals or a couple create joint net worth.
Are There Other Ways to Become an Accredited Investor?
The requirements for becoming an accredited investor are pretty much straightforward. A person is required to meet at least one of the defined requirements.
The only other way to become an accredited investor is through a venture with a spouse or someone you have a relationship with that is somewhat equivalent to a spouse.
Example of an Accredited Investor
Here’s an example of an accredited investor. Let’s assume that Richie has earned $250,000 annually for the past two years. Let’s also say Richie owns his house and it is valued at $1 million and has a mortgage on his car worth $50,000.
By his earned income, Richie qualifies to be an accredited investor. If his income were lower, say $75,000 for example, deciding if he qualifies to be an accredited investor would depend on his net worth (subtracting his total liabilities from his total assets).
What Makes Someone an Accredited Investor?
A lot has been said about what an accredited investor is. But how do you become an accredited investor? We’ve taken the liberty to provide 5 top requirements you should pay attention to.
Net Worth Requirements
A person’s net worth places an important role in determining if one qualifies to be an accredited investor. The stipulated requirement for net worth is that you must have a total net worth of $1 million.
This figure can be an individual net worth or joint net worth with a spouse or significant other.
Income Minimums
When it comes to income, a person will be recognized as an accredited investor if and when they earn a minimum of $200,000 annually. And this must be the minimum for the last two years.
If a person decided to become a joint accredited investor with a spouse or significant other, the total minimum income annually must not be lower than $300,000.
Series 7, Series 65, or Series 82 Licenses
Recently, the SEC amended regulations which opened a new way for a person to become an accredited investor. This amendment allows people who have three certifications recognized by the Financial Industry Regulatory Authority to be designated as accredited investors.
These certifications are:
- Licensed General Securities Representative (Series 7);
- Licensed Investment Adviser Representative (Series 65); and
- Licensed Private Securities Offerings Representative (Series 82).
“Knowledgeable Employees” of a Private Fund
Another way a person becomes an accredited investor is by being an employee of a private fund and having sufficient knowledge about the fund. So the directors and certain executive positions can become accredited investors to that private fund.
Here’s the catch with this though, you can only be an accredited investor to the private firm but cannot invest in other outside investment opportunities that require an accredited investor.
Verification of Status
Lastly, for a person to be an accredited investor, their status must be verified by the company offering the investment vehicle. Before 2013, there was virtually no verification process.
A person could simply just write on paper saying they were accredited and that would be all. But all that has changed with the introduction of an amendment under Rule 506(c).
The issuers of the securities must verify the status of the individual in any of the following three ways:
- Verify that the individual falls under the category of “knowledgeable employee”
- Verify if the individual’s income meets the $200,000 minimum for an individual and $300,000 with a spouse. Tax filings and forms are usually required to do this.
- Verify if the net worth of the individual meets the $1 million requirement. This will require the individual to provide sensitive documents that show their assets and liabilities.
Advantages of Being an Accredited Investor
There are great advantages that come with being an accredited investor. For one, you get access to a diverse range of investment opportunities with higher rewards as well as risks.
This will do wonders in diversifying your portfolio and increasing the cap on how much you can invest which ultimately determines how much more you can make. But this does not mean you can invest indiscriminately.
There are rules of course to regulate how much you can invest even as an accredited investor but with fewer restrictions. Secondly, by becoming an accredited investor you get to partner with other accredited investors.
You are swimming with the whales; people with the kind of deep pockets to partner with you and invest in your business. You are in a class of wealthy investors different from the rest.
Accredited vs Non-Accredited Investors
So far we’ve seen what an accredited investor is. We’ve seen the requirements and the privileges that go with being one.
But what happens when someone doesn’t fit this bill? They fall under the category of non-accredited investors.
The next question would then be, “what is the difference between accredited and non-accredited investors”? Non-accredited investors are investors who do not meet the requirements of accredited investor status.
Another term for non-accredited investors is retail investors. They earn less than $200,000 annually and their net worth is lower than $1 million.
Although this does not mean they are of a lower class, it just means non-accredited investors have access to different opportunities.
Bottom Line
The business of investing can be a thrilling one when you are rightly positioned to do so. So far we’ve seen the varying opportunities that come with being an accredited investor.
It is a big step to take in your journey as an investor. But not one you should take lightly. Before making any decision, we recommend that you speak to a financial advisor to help guide you through the process.
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