What is an accredited investor?
An accredited investor is a person or company who is authorized to buy and sell securities that are not registered with financial authorities, such as shares in a new business that has not yet gone public.
Accredited investors earn this designation by meeting at least one requirement regarding income, net worth, asset size, governance status, or professional experience. In the United States, the term is used by the Securities and Exchange Commission (SEC) under Regulation D to refer to investors who are financially sophisticated and require less protection from regulatory disclosure documents. Masu.
Accredited investors include high net worth individuals, banks, insurance companies, brokers, and trusts.
Important points
Accredited investors are defined by the SEC as eligible to invest in complex or sophisticated types of securities that are not strictly regulated. You must meet certain criteria, such as having an average annual income of more than $200,000 ($300,000 with a spouse or domestic partner) or being employed. Sellers of unregistered securities are only permitted to sell to accredited investors who are deemed able to bear the risk. Unregistered securities are inherently riskier because they lack the normal disclosure requirements associated with SEC registration.
Investopedia / Katie Karpel
Accredited Investor Obligations
Accredited investors have privileged access to a variety of transactions including pre-IPO companies, venture capital firms, hedge funds, angel investments, and complex and high-risk investments and products.
Companies looking to raise capital may decide to approach accredited investors directly. An example is a young technology company whose product is in late-stage development and needs more funding to bring it to market. Although the company is not a public company, it plans to hold an initial public offering (IPO) in the near future.
Such companies may decide to offer securities directly to accredited investors. This type of stock offering is called a private placement.
For accredited investors, there is more potential for risk or reward. The SEC wants to make sure they are financially stable, experienced, and knowledgeable about high-risk businesses.
Accredited Investor Requirements
Regulations for accredited investors vary by jurisdiction. In the United States, the definition of an accredited investor is set forth by the SEC in Regulation D, Rule 501.
To become an accredited investor, you must have earned more than $200,000 ($300,000 for joint income) annually for the past two years and expect to earn the same or more this year. The income test is not satisfied by simply showing an individual’s income for one year and their joint income with their spouse for the following two years.
Accredited investors must have a net worth of more than $1 million, individually or jointly with a spouse. This amount cannot include your primary residence.
The SEC also considers an applicant to be an accredited investor if the applicant is a general partner, executive officer, or director of a company issuing unregistered securities.
If a private business development company or organization has more than $5 million in assets, the entity is considered an accredited investor.
Additionally, an entity is itself an accredited investor if it is comprised of stockholders who are accredited investors. However, an organization cannot be established solely for the purpose of purchasing specific securities.
You can qualify as an accredited investor by demonstrating sufficient education or work experience in the financial industry.
Recent changes to the definition of an accredited investor
Congress changed the definition of accredited investor in 2020 to include registered brokers and investment advisers.
According to an SEC press release, the amendments would allow investors to “qualify as accredited investors based on defined measures such as expertise, experience, and certifications, in addition to existing tests for income and net worth.” This amendment also allows investors to qualify as accredited investors. Qualify as an accredited investor, including qualifying any entity that passes an investment test. ”
The SEC currently defines accredited investors as, among other categories: An individual with a particular professional certification, designation, or qualification. An individual who is a “knowledgeable employee” of a private fund. SEC and state registered investment advisor.
How to become an accredited investor
People who want to become accredited investors do not apply for designation with the SEC. Rather, it is the responsibility of the company offering the private placement to ensure that all investors approached are accredited investors.
Individuals or entities wishing to become accredited investors may contact issuers of unregistered securities. The issuer may ask applicants to fill out a questionnaire and provide financial documentation.
Required documents may include account information, financial statements, balance sheets, etc. This can range from tax returns, W-2 forms, pay stubs, and even letters from CPAs, tax accountants, investment brokers, and advisors.
The Company may check the Applicant’s credit report as part of the evaluation.
Most participants in a private placement do not need to go through this process. Those with certain financial qualifications, hedge fund managers, and partners at private equity firms are among those who do not need to prove their qualifications to purchase unregistered securities.
Accredited investor example
For example, an individual may have earned $150,000 for the past three years. They have a principal home value of $1 million ($200,000 mortgage), a car worth $100,000 ($50,000 loan balance), $500,000 in a 401(k) account, and a savings account. reported having $450,000.
Although this individual fails the income test, he is an accredited investor according to the net worth test, but his net worth cannot include the value of the individual’s principal residence. Net worth is calculated as assets minus liabilities.
This person’s net worth is exactly $1 million. This includes calculating your assets (excluding your primary residence) as $1,050,000 ($100,000 + $500,000 + $450,000) minus your $50,000 auto loan. They meet the net worth requirement and are therefore eligible to be an accredited investor.
Who is eligible to become an accredited investor?
The SEC defines an accredited investor as one of the following:
Individuals with gross income of more than $200,000 in each of the most recent two years, or individuals with joint income with a spouse or partner of more than $300,000 in those years and expected to earn the same amount this year. An individual’s net worth and joint net worth with his or her spouse or partner exceeds $1 million, excluding the person’s principal residence.
Are there other ways to become an accredited investor?
Under certain circumstances, accredited investor designation may be assigned to a director, executive officer, or general partner of a company if the company is the issuer of the securities being offered or sold. In some cases, financial professionals who hold a FINRA Series 7, 65, or 82 may be able to act as accredited investors.
There are also some less common qualifications, such as managing a trust with assets over $5 million.
What privileges do accredited investors have that others don’t?
Under federal securities laws, only accredited investors may participate in certain securities offerings. These may include private placements, structured products, and equities such as private equity and hedge funds.
Why do I need to be certified to invest in complex financial products?
Accredited investors hear pitches about investments that are not regulated by the government and are not subject to the same disclosure rules that publicly traded companies must follow.
Regulators want to ensure that participants in these risky and complex investments can protect themselves and assess risk in the absence of government protection.
conclusion
The Accredited Investor Rule is intended to protect potential investors with limited financial knowledge from risky ventures and losses they are ill-equipped to withstand.
Conversely, those who already have large financial assets can enjoy a greater advantage than those with more modest assets.
