How to Become an Accredited Investor: Essential Criteria
By David Brummer
An accredited investor is a person or entity that satisfies specific standards established by regulatory authorities, making them eligible to participate in particular private securities offerings that are not registered. These criteria commonly involve factors like income, net worth, or professional expertise in the investment market.
This article explains what an accredited investor is, how you can understand the criteria necessary to become one, what the advantages of attaining accreditation are, as well as the challenges and risks accredited investors face. For additional information read our article: Accredited Investor 101: Definition, Requirements, and FAQs.
Note: This article is written for US-based investors. It is up-to-date at the time of publication. As regulations change, we will try to update this information accordingly.
Key Highlights
- The SEC defines accredited investors by specific income thresholds, net worth, professional expertise, or holding certain FINRA licenses.
- Accredited investors gain access to investment opportunities not available to the general public, such as private placements and venture capital.
- The verification process for becoming an accredited investor requires documentation and potentially third-party services.
Understanding the Accredited Investor Definition
An accredited investor isn’t just any individual with money to invest. The Securities and Exchange Commission (SEC) sets specific qualifications that an individual or entity must meet to earn this designation. This might include income thresholds, a particular net worth, or professional expertise. Even entities such as trusts, corporations, and financial institutions can qualify as accredited investors if they meet certain criteria.
Notably, the SEC recently expanded the definition of an accredited investor to include:
- Those with recognized professional knowledge, experience, or certifications
- Those deemed a ‘spousal equivalent’
- Individuals occupying certain professional positions, such as directors, executive officers, or general partners of the issuing entity
- Knowledgeable employees of private funds
This means that certain individuals, who would previously have been considered non-accredited investors, can now become accredited investors under specific circumstances.
The ongoing modernization of investor accreditation is reflected in the SEC’s recent amendments, which include expanding the ‘qualified institutional buyer’ definition. For more information about the differences between a Qualified Purchaser and an Accredited Investor read our article. This means that the landscape of who can become an accredited investor is continuously evolving, offering new opportunities for individuals and entities to access exclusive investment vehicles.
What are the Essential Criteria for Becoming an Accredited Investor?
Let’s take a closer look at the requirements for an individual to become an accredited investor.
Income Requirements
An individual’s income is crucial in determining their accreditation. To qualify, an individual must have an earned income exceeding $200,000 in the previous two years with at least the same expectation for the current year.
If you’re applying for joint accreditation with a spouse or spousal equivalent, your combined annual income must be at least $300,000 for the previous two years, with the expectation to maintain or exceed this income in the current year.
To prove that you meet these income thresholds, you’ll need to provide at least one of the following documents:
- Tax returns
- W-2s
- Pay stubs
- An employment verification letter
These provide concrete evidence of your income, which will help smooth the verification process. However, it should be noted that meeting these criteria does not guarantee being granted accreditation.
Net Worth Requirements
Your net worth is another important factor in determining whether you become an accredited investor. To qualify, an individual or joint couple’s net worth must exceed $1 million, excluding the value of their primary residence. This means, that when calculating net worth for accreditation, your primary residence is not included, but vacation and investment properties can be considered.
FINRA Licenses
Even if you do not meet the income or net worth requirements, you can still qualify as an accredited investor if you hold specific FINRA licenses. These include the Series 7, Series 65, or Series 82 financial securities licenses. However, to qualify, you must hold these licenses in good standing.
The SEC, in collaboration with the Financial Industry Regulatory Authority, has updated its regulations to permit individuals holding in good standing professional certifications such as Series 7, Series 65, and Series 82 licenses to qualify as accredited investors. This opens up the accredited investor designation to a wider pool of professionals within the financial sector.
This ensures that individuals who have demonstrated financial sophistication through professional certifications are recognized as accredited investors.
You can learn more in our article: Accredited Investor Verification: How to Prove Your Status
To understand the different rules and regulations for becoming a sophisticated investor in other countries, check out our similar articles for:
What are the Advantages of Gaining Accreditation?
Becoming an accredited investor typically offers broader investment choices, though it's worth noting that these can vary depending on the jurisdiction and specific regulations.
Access to Private Investments – Accredited investors often enjoy a wider array of investment opportunities, such as private equity, venture capital, hedge funds, and other alternative investments not typically available to non-accredited investors.
Exemption from Certain Regulatory Restrictions – In certain instances – under Rules 504 and 506 of Regulation D1 – accredited investors may be exempt from specific regulatory limitations that affect retail investors. This exemption can provide greater flexibility in investment strategies and choices.
Potential for Higher Returns – Accredited investors are presumed to possess a higher degree of financial expertise and risk tolerance. This positions them for investments with the potential for higher returns, albeit with increased risk.
Moreover, these investment vehicles such as private equity funds, venture capital funds, private placements, or alternative investment opportunities, often offer a level of exclusivity, giving accredited investors the advantage of being part of a select group of investors with access to unique investments. This exclusivity can be highly desirable in the world of investing.
What Challenges and Risks do Accredited Investors Face?
While the perks of being an accredited investor are evident, it's essential to acknowledge the potential drawbacks and factors to consider. These downsides can vary depending on individual circumstances and investment objectives. Here are some general aspects to bear in mind:
High-Risk Investments – Accredited investors often have access to a broader spectrum of investment opportunities, including high-risk ventures.
Lack of Liquidity – Alternative investments, accessible to accredited investors, often lack the liquidity of traditional assets such as stocks and bonds. This means it might be difficult to sell or exit an investment swiftly, possibly tying up funds for an extended period.
Limited Regulatory Protections – Certain alternative investments are subject to fewer regulatory safeguards compared to traditional ones. Consequently, accredited investors may encounter fewer legal avenues for redress in case of investment disputes or other issues.
Higher Fees – Alternative investments typically come with elevated fees in comparison to traditional options. These fees can considerably impact overall returns.
Market Volatility – Investments in certain asset classes, particularly those offering high potential returns, may experience greater volatility. Accredited investors should be prepared for increased market fluctuations and able to withstand short-term losses.
It's crucial for individuals contemplating becoming accredited investors to thoroughly assess their risk tolerance, investment objectives, and financial position. Seeking guidance from financial experts and conducting extensive due diligence on potential investments can often help mitigate these potential downsides. Additionally, it's essential to stay informed as regulations and investment environments may evolve over time.
Verification Process for Accredited Investors
To attain accredited investor designation, one must go through a comprehensive verification process. This involves:
- Submitting official documents such as tax returns, pay stubs, financial statements, IRS forms, credit reports, brokerage statements, and tax assessments;
- Completing a questionnaire;
- Checking credit reports.
The SEC also requires completing a questionnaire and checking credit reports.
Under Rule 506(c) of Regulation D, individuals provide documentation demonstrating their accreditation for review by the managing firm. This involves completing investor questionnaires and providing personal and financial information. To assist with this process, specialized third-party services are available to perform accredited investor verifications.
The burden of proof that an investor meets the accredited criteria falls both on the investor as well as the issuer. This means that firms utilize a screening process and questionnaire to determine if an individual qualifies as an accredited investor.
How are Investment Opportunities Exclusive to Accredited Investors?
One of the main benefits of becoming an accredited investor is access to investment opportunities. These include offerings not listed on the public stock exchange, such as private placements, non-registered securities, and private companies. Exclusive access to non-registered investment opportunities provided by private equity funds, angel investments, venture capital firms, and other private companies is available to accredited investors. This access is not open to the general public.
Private equity funds also offer accredited investors a way to engage with diverse portfolios of institutional private equity within a regulated private fund structure, contributing to economic growth through private market investments.
Private equity and private placements are both methods of raising capital for companies, but they operate in different contexts and have different purposes. Private equity (PE) refers to investments made in privately held companies, usually with the aim of acquiring a significant stake in the company. These investments are made by private equity firms, which pool together funds from various sources (such as high-net-worth individuals, institutional investors, and pension funds) to invest in private companies. Meanwhile, private placements involve the sale of securities (such as stocks, bonds, or equity) directly to a select group of investors, rather than through a public offering. These offerings are typically made to institutional investors, accredited investors, or wealthy individuals.
Legal entities, including banks, investment broker-dealers, insurance companies, charitable organizations, and trusts with assets over $5 million, can qualify as accredited investors if all equity owners are themselves accredited investors.
Conclusion
Becoming an accredited investor is a milestone that can unlock unique investment opportunities. It’s a process involving meeting specific income, net worth, or professional certification criteria. However, the potential benefits, including exclusive access to high-growth potential investment opportunities, can make it a worthwhile endeavor for those who qualify.
Take advantage of our exciting investment opportunities.
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Frequently Asked Questions
Why is the concept of accredited investors important?
The concept is important because it determines eligibility to invest in certain types of private securities offerings, which may involve higher risks and fewer regulatory protections than publicly traded securities.
Can accreditation be withdrawn?
Yes, if an individual or entity no longer meets the financial criteria, they may no longer be considered accredited investors. This can happen due to changes in income, net worth, or other financial circumstances.
Can non-US citizens be accredited investors?
Yes, there is no residency or citizenship requirement to become an accredited investor, as long as they satisfy one or more of the qualifying requirements.