In a moment, we’ll discuss these specific criteria to become an accredited investor in the U.S. It should be known that in 2020, the SEC recently expanded the definition of accredited investor. Now, individuals who have specific professional certifications or who are “knowledgeable employees” of a private fund are also included in the accredited investor definition. If you’ve recently started learning how to invest, it’s just a matter of time before you hear the term “accredited investor.” You’ll then start wondering what this term means, how to become an accredited investor, and what the associated drawbacks and benefits are. In this guide, we’ll be covering all of that and much more, such as accredited investor requirements and real-life examples. First, let’s start with the definition.
What Is An Accredited Investor?
An accredited investor is either an individual or an entity that is allowed to buy or invest in securities that are not registered with financial regulatory agencies. In the United States, the main financial regulatory body is the U.S. Securities and Exchange Commission (SEC).
The term stems from the word “accredited.” This implies that the individual or entity has to meet the required standards to achieve accreditation. Accredited investors meet criteria that are based on asset size, net worth, and income. For business entities, the requirements are also based on governance.
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Accredited Investor Requirements
The requirements for becoming an accredited investor change based on your location. In the U.S., the rules are outlined by the Security Exchange Commission (SEC), but local financial regulatory bodies also determine them.
You may be asking, “What do I need to become an accredited investor?” The main criteria for becoming an accredited investor are specified in Regulation D, Rule 501 of the 1933 Securities Act. You can view these regulations in the Electronic Code of Federal Regulations.
Here is a summary of the requirements:
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An individual with credentials such as Series 7, Series 65, or Series 82 licenses.
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Family offices with at least $5 million in assets.
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Business entities that own over $5 million or more in assets.
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An individual with a professional certification, or status as a private fund’s “Knowledgeable Employee.”
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Married couple in which one spouse qualifies based on their finances.
Shad Elia from New England Home Buyers says that “to qualify as an accredited investor, an individual must have earned an annual income of at least $200,000 ($300,000 for joint income) in the preceding two years with the intention of generating the same or a greater annual income in the current year”.
You may be wondering, “why all the restrictions and requirements for accredited investors?” The accredited investor requirements are set pretty high as a measure of protection, both for investors and the businesses or companies they choose to invest in. The SEC does not want beginner investors to take risks with their money. These requirements were designed to limit large, risky investments to investors who have the financial means to withstand significant risk and loss. In addition, it’s assumed that you are a successful and knowledgeable investor by the time you achieve the accredited status, and the requirements above make it easier to establish this experience.
Example Of An Accredited Investor
If you’re still not clear if you qualify as an accredited investor or not, perhaps an example would be helpful. Let’s take a look at how you would become an accredited investor, first by analyzing and accurately calculating your net worth.
Begin by creating a balance sheet that lists all of your assets and all of your liabilities. Next, add up all of your assets, including bank account balances, retirement account balances (such as a 401(k) or IRA), the value of other investments, and physical assets such as your car. The one thing you should not include in your list of assets is the value of your primary residence. Remember, one of the criteria for accredited investors is based on net worth, not including the value of the home that they live in. Other properties in your possession that you do not inhabit can be included. After all of the individual’s assets have been calculated, add up all liabilities.
Common liability examples include student loans, car loans, and credit card debt. Finally, subtract your total liabilities from your total assets to find out your net worth. If your final number is over $1 million, then you qualify as an accredited investor. If your number is under $1 million, then you do not qualify as an accredited investor. This information is still helpful if you’ve reviewed the accredited investor requirements and have determined you’re ineligible. You at least now know how far away you are from becoming an accredited investor and can make the correct financial decisions to set yourself up for investing success!
What Can You Do As An Accredited Investor?
Now you’re probably wondering what kind of special powers you would attain as an accredited investor. By law, companies have to register their investment options, or securities, with the SEC. However, there are a small number of exceptions. One of these popular exceptions is selling unregistered investments to accredited investors. Companies are incentivized to do this because they can avoid the trouble of registering their securities through the SEC, but can still benefit from the financial assistance found with an accredited investor.
While the specific responsibilities of an accredited investor will vary based on the investor’s portfolio and interests, there are numerous types of financial environments that an accreditor might find success in. Here are the type of investments you’ll be able to make as an accredited investor:
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Hedge funds
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Real estate crowdfunds
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Venture capital funds
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Private equity funds
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Angel investing
As a “regular” investor, you can invest in stocks, bonds, and mutual funds, so you might ask yourself, “Why do I need to be an accredited investor?” Becoming an accredited investor can be thought of as a “level-up” within the world of financial investing. Accredited investors gain access to exclusive investment options that they would otherwise never receive exposure about. However, keep in mind that these investments can reap higher rewards but can come with significant risks. It’s always best to proceed with caution for any major financial investment.
Who Can Be An Accredited Investor?
So far, we’ve discussed investor accreditation from the lens of the individual but this is a very narrow concept of what it means to be an accredited investor. As we mentioned earlier, financial and business entities could be looped into this category of accreditation as well, so it’s wise to be aware of if your chosen field might provide an avenue toward investing. Under Regulation D, Section 501, the SEC states that the following business entities can also achieve accredited investor status:
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Banks
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Brokerages
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Employer-sponsored retirement plans
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Trusts
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Registered investment advisor firms
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LLCs with at least $5 million in assets
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SEC-registered investment advising firms
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Rural business investment firms
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Native American tribe governments
How To Become An Accredited Investor
Now that we’ve explored what an accredited investor is and the requirements that are involved in becoming one, let’s cover how an individual would begin the process of receiving accredited investor status. By having a firm grasp of everything we covered above, the process of verifying yourself is much simpler.
Follow these steps to become an accredited investor:
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Calculate Your Net Worth
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Gather Financial Documentation
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Get Verified
1. Calculate Your Net Worth
We described precisely how to calculate your net worth earlier in our example section. To summarize, you simply take your total liabilities and subtract them from your total assets. If you included the value of your primary residence, make sure to subtract that out as well, per the SEC rules.
2. Gather Financial Documentation
Next, you’ll need to gather the documents to help prove the net worth you calculated above. This means collecting copies of your tax returns, credit report, bank statements, retirement, and other investment account statements.
3. Get verified
Last but not least, it’s time to get verified! The SEC requires companies to collect investor questionnaires when issuing unregistered securities to help prove that the investor has the proper qualifications and credentials for the financial connection. As the investor, you will need to fill out these questionnaires as a method of verification for each company you’d like to invest in.
When getting verified as an accredited investor, be prepared to provide personal and financial information and to provide the documentation you collected in the previous step as proof. Finally, you’ll sign the questionnaire document to complete the process. Make sure to keep a copy for yourself and always keep an eye on potential funds or investments that might add some diversity to your investment portfolio.
Are There Other Ways of Becoming an Accredited Investor?
Note that there are other ways of becoming an accredited investor. Although most will follow the orthodox process, there are unique scenarios when the accredited investor designation might be assigned. For example, the directors, executives, and partners of a securities firm may be given this designation. Financial processionals holding FINRA Series 7, 62, or 65 may also act as an accredited investor as well. Finally, a professional managing a trust holding over $5 million in total asses may be given the designation as well.
Pros Of Being An Accredited Investor
As we discussed, the main benefit of achieving accredited investor status is your sudden access to several new investment opportunities. If you’re serious about investing, then this will come as a welcome step up. In a sense, you’re being rewarded for achieving a level of net worth and income. Some of the most notable benefits of learning how to become an accredited investor and become verified include, but are not limited to:
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Higher Level of Returns: With these new investment opportunities, you’ll likely be able to make higher rates of return. In other words, you’ll continue building your wealth, but at a faster pace.
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Diversify a Portfolio: As an accredited investor you’re able to gain access to a surplus of opportunities. For example, you can invest your money into a hedge fund or participate in some large-scale real estate crowdfunding projects.
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Stay Financially Competitive: Becoming verified as an accredited investor allows entrepreneurs and investors the ability to stay competitive within any financial environment.
Cons Of Being An Accredited Investor
Now that we’ve touched on some of the biggest advantages of learning how to become an accredited investor, let’s look at some of the challenges that new investors can anticipate experiencing at some point during their careers. By anticipating the cons of being an accredited investor, you can easily prepare yourself for what the world of financial investments will bring.
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High-Risk Investments: It should come as no surprise, but investment opportunities that promise higher rewards always signal that you’re facing increased risk. Also, these types of investments typically require a high minimum investment.
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High Minimum Investment Amounts: As an accredited investor, you’re no longer playing around with small investments. We’re not just talking a few hundred, or even a few thousand, bucks. We’re talking tens and hundreds of thousands of dollars, all at higher levels of risk for each investment. If your investment fails, you’ll be losing a lot of money.
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Locked Capital: When making larger investments as an accredited investor, accessing capital isn’t as simple as cashing out stock once things perform well. For many investors, they can anticipate money being tied up within a project for years.
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High-Performance Fees: Finally, accredited investment opportunities are associated with higher performance and management fees, ranging between 15 to 20 percent.
Accredited Investor FAQs
Do you feel ready to become an accredited investor after weighing the pros and cons? You may not have arrived at a decision if you have some remaining questions. Here are the answers to some commonly-raised questions that could sway your decision either way:
Do You Have to Prove You Are An Accredited Investor?
Although the burden of proving that you’re an accredited investor doesn’t fall directly on you, it still falls on your selected investment vehicle. For example, the fund you choose to invest in is responsible for determining your eligibility. You will typically be required to fill out questionnaires and submit documentation.
What Happens if You Lie About Being an Accredited Investor?
Again, the fund or investment vehicle is ultimately responsible for determining your accredited investor status. If you were to lie, the onus is on the fund to find out. That’s why the qualification determination process is quite stringent through most firms. Keep in mind that falsifying information or fabricating documents is illegal and could bring about serious legal trouble for you down the line.
How Much Can An Accredited Investor Invest?
There is no standardized limit on how much an accreditor investor can invest. It’s best to consult your fund or investment vehicle to find out if they have any limits or caps on investment amounts.
SEC Modifies Accredited Investor Definition
As of August 2020, the definition for “Accredited Investor” has been modified by the U.S. Securities and Exchange Commission. Per the SEC’s press release, “Historically, individual investors who do not meet specific income or net worth tests, regardless of their financial sophistication, have been denied the opportunity to invest in our multifaceted and vast private markets. The amendments update and improve the definition to more effectively identify institutional and individual investors that have the knowledge and expertise to participate in those markets.”
This new definition broadens the list of who qualifies as an accredited investor, as well as allows investors to qualify based on investment tests which can now include knowledge, certifications, and experience. The new definition has also expanded to include entities such as Indian tribes, funds, government bodies, and many more. Limited Liability Companies with assets of at least $5 million now may qualify now as well.
All in all, this new definition has expanded the amount of investors in the market who now qualify to participate in all of the benefits that come with being an accredited investor.
Summary
If you’ve been wondering how to become an accredited investor, we hope you found this guide helpful! The actual process of becoming an accredited investor is next to nothing. The hard part is meeting the SEC criteria to achieve the status. However, it’s always a great idea to know your net worth anyway. Use this as an opportunity to calculate your net worth and find out whether or not you’re eligible. If not, you’ll know how much more wealth you’ll need to accumulate!
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