How to Become an Accredited Investor

An accredited investor is someone or anything that is permitted to invest in securities that have not been registered with the Securities and Exchange Commission (SEC).An person or business must achieve specific income and net worth requirements to be considered an accredited investor.

It takes money to earn money, and authorized investors have greater chances than non-accredited investors. This is because the Securities and Exchange Commission (SEC) permits businesses and private entities to avoid having to register certain investments if the assets are sold to authorized investors. 1 Accredited investors may make direct investments in the lucrative worlds of private equity, private placements, hedge funds, venture capital, and equity crowdfunding. The SEC, on the other hand, determines who may and cannot be accredited investors and participate in these possibilities.

There is a prevalent misperception that there is a “process” for becoming an accredited investor. There is no government organization or independent entity that assesses an investor’s qualifications, and there is no certification test or piece of paper that certifies a person as an accredited investor. Instead, corporations that offer unregistered securities do due diligence prior to sale to establish a prospective investor’s status.

This page delineates the qualifications for becoming an accredited investor, how to determine whether you qualify, and the screening procedure used by investment managers to confirm qualified investor status.

Key Takeaways

• An accredited investor is one who satisfies particular income, net worth, and qualifying requirements. They are affluent folks who have access to assets that other people do not have.
• The investment vehicle has the responsibility of showing a person is an accredited investor, not the investor.
• Access to unusual and limited assets, high returns, and better diversification are all advantages of being an authorized investor.
• The disadvantages of becoming an authorized investor include high risk, high minimum investment quantities, expensive fees, and investment illiquidity.
• Many nations have a class of accredited investors with varying income, net worth, investment, and regulatory criteria.

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Accredited Investor

Who Is an Accredited Investor?

The definition of an accredited investor is found in Rule 501 of Regulation D of the Securities Act of 1933 (Reg. D). Simply explained, the SEC defines an accredited investor in two ways based on income and net worth:

• A natural person who earned more than $200,000 in each of the two most recent years, or who earned more than $300,000 in combined income with a spouse in those years, and who has a realistic expectation of earning the same amount in the current year.
• A natural person whose solo net worth, or combined net worth with the person’s spouse, surpasses $1 million at the time of purchase, excluding the value of such person’s principal dwelling. 2

The final passing of the second bullet is noteworthy since it represents a significant shift implemented with the 2010 enactment of the Dodd-Frank Act. Prior to the enactment of the financial legislation, the principal house was not excluded from calculating a person’s net worth. Anyone who had accredited investments before to the law’s enactment was excluded. 3

It is anticipated that there will be 13,665,475 certified investor households in the United States in 2020. This accounts for around 10.6% of all households in the United States. This figure represented $73.3 trillion in wealth. 4

In addition to corporate directors, equity owners, and financial institutions, Rule 501 includes rules for corporations, partnerships, charity organizations, and trusts. 2 The accompanying calculations and screening methods, however, are designed for individuals or couples seeking the title of accredited investor.

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SEC Amendments to the Accredited Investor Definition

The Securities and Exchange Commission (SEC) of the United States modified the definition of an accredited investor on August 26, 2020. According to a press statement issued by the SEC, “In addition to the current requirements for income or net worth, the modifications enable people to qualify as accredited investors based on established metrics of professional expertise, experience, or qualifications. The revisions significantly broaden the number of entities that may be accredited investors, including any business that fulfills an investing condition.” 5

The SEC currently defines accredited investors to include, among other things, the following:

• People who have certain professional certificates, titles, or credentials
• Individuals who work for a private fund as “knowledgeable workers”
• Investment advisers who are SEC and state-registered5

Accredited investors now include individuals with Series 7, Series 65, and Series 82 licenses. The SEC may add certifications and designations in the future, and the public is encouraged to make recommendations for further certificates, designations, or qualifications to be considered. 5

Employees of a private fund who are regarded “knowledgeable employees” are now considered accredited investors in that fund. 5

The SEC’s definition has also been expanded to include many other entities, such as “Indian tribes, governmental bodies, funds, and entities organized under the laws of foreign countries that “own” investments in excess of $5 million as defined in Rule 2a51-1(b) under the Investment Company Act and that were not formed for the specific purpose of investing in the securities offered.” 5

Limited liability firms with $5 million in assets, SEC- and state-registered investment advisors, exempt reporting advisers, and rural business investment corporations are also eligible. 5

How to Determine if You’re Accredited?

Individuals who have earned $200,000 or more in income in the last two years, as well as those who have earned $300,000 or more when coupled with a spouse, automatically qualify as qualified investors. 2

Individuals might also have a net worth of $1 million or more after deducting the value of their principal house. 2 The only time the principal residence may affect net worth is when an investor has an underwater mortgage or a balance on a home equity line of credit. 3

Example of an Accredited Investor

To assess eligibility as an accredited investor, an individual should generate a personal balance sheet similar to the one below by subtracting the total number of obligations from the total number of assets.

As seen in the above example, Allen is an accredited investor since his net worth exceeds $1 million. However, Brian and Carla are both ineligible owing to extra responsibilities associated with their home house. In Brian’s situation, he has a $100,000 home equity line of credit, which increases his obligations and reduces his net worth to less than $1 million. Carla’s underwater mortgage, on the other hand, raises her obligations and reduces her net worth.

Due Diligence

As previously stated, no official organization or institution certifies an investor’s accreditation, and no certification is granted. However, the SEC has mandated that anybody selling to accredited investors take a variety of procedures to verify this status since September 2013. Simply informing a company or marking a box that a person is qualified is no longer acceptable. 6

Individuals who believe they qualify might visit a fund and inquire about prospective investments. At this stage, the securities issuer will administer a questionnaire to assess if a person is a “accredited investor.” In order to authenticate the ownership of assets indicated on a balance sheet like the one above, the inquiry will most likely demand the attachment of financial statements and information from other accounts. Companies would also most likely review a credit record to examine any debts held by a person seeking accreditation.

Individuals who base their credentials on yearly income will very certainly be required to present tax records, W-2 forms, and other wage-related papers. Individuals may also take into account letters from CPAs, tax lawyers, investment brokers, or advisers.

Accredited Investors in Other Countries

Other countries have accredited investor certifications with comparable restrictions. Certain nations’ criteria for becoming an accredited investor are comparable to those of the United States, such as Canada, Australia, and Singapore, which have similar income and net worth requirements, while others have different requirements. 7

In the EU and Norway, for example, three standards are used to evaluate if a person is an accredited investor. The first is a qualitative examination, which assesses an individual’s skill, knowledge, and experience to evaluate whether or not they are competent of making their own investing choices. The second is a quantitative exam in which the candidate must fulfill two of the following criteria:

1. Over the preceding four quarters, has carried out big size transactions on the relevant market at an average frequency of ten each quarter.
2. Has a financial portfolio worth more than EUR 500,000
3. Working in the financial industry for at least one year 7

Finally, the customer must express in writing that they wish to be regarded as a professional client, and the company with whom they want to conduct business must notify them of the safeguards they may lose. 7

Other nations, like as India and Switzerland, do not have clear restrictions, but do demand that you consult with local counsel beforehand to ascertain whether you are an authorized investor. 7

Pros and Cons of Becoming an Accredited Investor

Being an authorized investor has advantages and disadvantages.

Pros

The main advantage of being an authorized investor is that you have a financial edge over others. Being an authorized investor gives you access to assets that others with less wealth do not have since your net worth or income is already among the top. This might lead to a rise in your wealth.

These investments might offer greater rates of return, better diversification, and a variety of other characteristics that aid in the accumulation of wealth, and most crucially, the accumulation of wealth in a shorter time period.

One of the most basic benefits of being an authorized investor is the ability to participate in hedge funds. Hedge funds are often only available to authorized investors due to the large minimum investment amounts required and the greater associated risks, but their returns may be outstanding.

That being said, hedge funds have had a difficult time outperforming the market in recent years, but many have historically been able to do so, rewarding their investors with extraordinarily large returns in a relatively short period of time.

Pros

• Access to more investment opportunities

• High returns

• Increased diversification

Cons

• High-Risk investments

• High minimum investment amounts

• High performance fees

• Long capital lock up time

Cons

There are additional disadvantages to becoming an accredited investor in terms of the investments themselves. Most investments that need a person becoming an authorized investor are high risk. Many funds’ strategies include a greater level of risk in order to attain the aim of outperforming the market.

Another disadvantage, in addition to the significant risk, is that most investments need a large minimum investment. Simply putting a few hundred or thousand dollars into an investment will not enough. Accredited investors will need to contribute a few hundred thousand or a few million dollars to participate in accredited investor investments. This is a lot of money to lose if your investment fails.

Furthermore, authorized investor investments come with higher costs. These are largely in the form of performance fees, as well as management fees. Fees for performance might vary from 15% to 20%.

Another disadvantage of being an authorized investor is having access to your investment cash. For example, if you purchase a few stocks online using an electronic platform, you may withdraw the funds whenever you choose. With a hedge fund, for example, your money may be locked up for as long as a year, five years, or more. Being an accredited investor entails a great deal of illiquidity.

Accredited Investor FAQs

What Qualifies as an Accredited Investor?

In the United States, an accredited investor is defined as somebody who fulfills one of the following criteria:

• Individuals having an income of more than $200,000 in each of the previous two years, or a combined income of more than $300,000 in those years, and a realistic forecast of the same income level in the current year.
• Individuals having an individual net worth of more than $1 million, or a combined net worth with the person’s spouse, at the time of the investment (The net worth sum cannot include the value of the person’s principal house.)
• Individuals with certain certifications, designations, or qualifications, such as Series 7, Series 65, and Series 82 licenses
• Individuals who work for a private fund as “knowledgeable workers” 2

Do You Have to Prove You Are an Accredited Investor?

The responsibility of demonstrating that you are an accredited investor does not rest directly on you, but on the investment vehicle in which you want to invest. An investment instrument, such as a fund, must assess if you are an accredited investor. They would require you to fill out a questionnaire and maybe give papers such as financial statements, credit reports, or tax returns to do this.

What Is the Benefit of Being an Accredited Investor?

The advantages of being an authorized investor include access to unique investment options that non-accredited investors do not have, high returns, and enhanced portfolio diversity.

What Happens if You Lie About Being an Accredited Investor?

If you lie about being an accredited investor, the fund or investment vehicle is normally held responsible since it is their obligation to evaluate your eligibility. Non-accredited investors have the right to rescission in several jurisdictions. This implies that if an investor chooses to withdraw their money early, they may claim they were a non-accredited investor the whole time and demand a refund.

That being said, it’s never a good idea to offer faked papers to an investment vehicle, such as bogus tax returns or financial statements, merely to invest, since this might get you in legal problems in a variety of ways.

How Much Can an Accredited Investor Invest?

There is no overall limit to how much of an authorized investor’s personal cash may be invested in all of their assets. Having said that, each transaction or fund may have its own constraints and ceilings on the amount of money that it will take from an investor.

The Bottom Line

Accredited investors are individuals who fulfill particular income, qualification, or net worth standards. They are usually rich people. Accredited investors may invest in non-registered investments offered by enterprises such as private equity funds, hedge funds, angel investments, venture capital firms, and others.

These vehicles provide accredited investors with access to unique and limited investments that provide significant returns and other benefits. They do, however, have substantial disadvantages, including as high risk and large minimum investment amounts.

The SEC requires corporations to take a variety of measures to authenticate the status of an investor claiming accredited status. If you are an authorized investor, it may be worth your time to look into these unusual investment possibilities that might help you develop money quickly.

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