Becoming an accredited investor is a significant milestone for any individual looking to access more lucrative investment opportunities. Accredited investors are considered to have a higher level of financial sophistication, which allows them to participate in private placements and other alternative investments that are often not available to the general public.
To become an accredited investor, you must meet certain criteria set forth by the Securities and Exchange Commission (SEC). In this article, we'll discuss how and why should you become an accredited investor.
Accredited Investor Requirements and Qualifications
The accredited investor is assumed to be a sophisticated financial entity that can handle higher levels of risk. The accredited investor can be a natural person or a business entity.
Source: Wikimedia
The current standard for a natural person is as follows:
- Income over $200,000 per year (for married couples, $300,000) in the prior 2 years and can prove a similar income for the current year, or
- A net worth of over $1 million that does not include the value of the primary residence.
The criteria for other categories of accreditation are as follows:
- A trust with more than $5 million in assets, or
- A business entity with 100% accredited investors as equity owners.
Opponents of this standard point to the fact that individuals and firms can make money without investment sophistication. For instance, a surgeon who makes $500,000 is automatically considered a sophisticated investor — even though that surgeon may not know the first thing about buying a common stock or reading a balance sheet.
Last year, the SEC expanded eligibility, allowing more individuals to meet the accredited investor requirements to those who hold certain financial professional licenses. People with the following licenses may have accredited status whether or not they meet the income or net worth requirements.
- General Securities Representative license (Series 7)
- Private Securities Offering Representative license (Series 82)
- Licensed Investment Adviser Representative (Series 65)
How Do Firms Determine if You’re an Accredited Investor?
Taking money from non-accredited investors can mean big trouble for a company, whether it succeeds or fails. Failure means court cases from angry investors, but success without compliance can bring penalties and sanctions once you get on the SEC’s radar. If you are looking to invest in unregulated opportunities, you should be ready to prove your accredited status. Most reputable opportunities require this.
Companies looking for accredited investors may check your status as they see fit. You will probably be asked for a professional record of your finances. You may also be asked to prove how will you make $200,000 minimum this year if you don’t have at least $1 million in net worth. Each investor chooses the amount of scrutiny he is willing to face in order to gain access to a certain opportunity.
Not all firms are worried about accreditation, however. Regulation crowdfunding and the Jumpstart Our Business Startups (JOBS) Act are relatively new mods to securities law that work around accreditation.
Regulation crowdfunding allows companies to raise up to $5 million within 12 months with no accreditation standard. The JOBS Act created a Tier 2 standard business under Regulation A that allows companies to raise up to $50 million from non-accredited investors. Companies are not required to disclose as much information about themselves when compared to companies raising money under traditional regulations.
Depending on who you ask, companies looking for investments break securities law all the time. If you get money from your working-class cousin to start a neighborhood fish fry, you might be breaking SEC Regulation D. Fortunately, the SEC makes some provisions for smaller companies and family businesses in Rule 504 and Rule 506. To stay in general basic compliance, you cannot make a securities offer to anyone you don’t already know or market the offering to the public in any way.
Rule 506(b) allows a company up to 35 non-accredited investors in a funding round. These investors must meet an experience requirement that is purposely worded to give courts the ability to judge problems on a case-by-case basis.
Under Rule 506(c), companies and syndication sponsors solicit their offerings to the general public and raise an unlimited amount of capital from an unlimited number of accredited investors, but are not allowed to receive investments from any non-accredited investors.
Source: Flickr
Who Can Be an Accredited Investor?
As long as you meet the financial or professional licensing criteria set forth in Rule 501 of Regulation D from the SEC, you can legitimately claim to be an accredited investor. The SEC doesn’t actually certify you, nor is there any official documentation you can apply for. Determining your accreditation is left up to the companies who are scrutinizing investors.
What Can Accredited Investors Invest In?
Accredited investors have access to many unregulated hedge funds, private equity investments and venture capital investments that common investors legally do not. The main advantage of being accredited is access to these unregistered investment opportunities.
The process of getting registered with the SEC is costly and time-consuming. SEC registration also requires that companies maintain a certain financial stability and accounting transparency. Early-stage companies often do not want to invest the resources necessary to become registered.
Instead, they limit investment offers to accredited investors only. Those offers usually have substantially more upside than public offerings, but they come with no government protection in case of default, unethical behavior or even illegal behavior.
Pros of Becoming an Accredited Investor
- Access to Exclusive Investment Opportunities: Accredited investors have access to private placements, hedge funds, and other alternative investments that are not available to the general public.
- Diversification of Investment Portfolio: By gaining access to a wider range of investment options, accredited investors can diversify their portfolios and reduce risk.
- Potential for Higher Returns: Because accredited investors have access to more exclusive and potentially lucrative investment opportunities, they have the potential for higher returns compared to traditional investments.
- Increased Control Over Investments: Accredited investors have the ability to make more informed decisions about their investments and have greater control over where their money is allocated.
Cons of Becoming an Accredited Investor
- Higher Risk: While accredited investors have access to potentially higher returns, they also face higher risks. Alternative investments can be more volatile and less regulated than traditional investments, which could lead to greater losses.
- Higher Investment Minimums: Many alternative investments require a higher minimum investment amount than traditional investments, which may not be feasible for all accredited investors.
- Limited Liquidity: Some alternative investments have restrictions on when you can access your money, meaning your funds may be tied up for a longer period of time compared to traditional investments.
Don’t Jump the Gun
If you’ve opened an account with any brokerage firm, you have been asked to accredit yourself. Before the brokerage decides on your margin status or options level, you are asked for your income and level of investment sophistication. Hint: They don’t check. You can easily self-assert a $2 million net worth, 20 years of stock trading experience and an average trade size of $50,000. They’ll give you 4X of your capital for day trading and all of the unlimited options tradings you can handle.
As 80%-90% of investors quickly find out, pretending to be smarter than you are is the fastest way to lose all your money.
You are practically free to lose every dime you have despite the standards the government tries to put in place. So before you go jumping into a Regulation A Tier 2 investment pool or some crowdfunding pool because it sounds cool, consider that caution may be the best accreditation you have until you get that $1 million minimum.
What qualifies you as an accredited investor?
To qualify as an accredited investor, you must meet certain criteria outlined by the SEC. One common way to qualify is by having a net worth of at least $1 million, excluding the value of your primary residence. Alternatively, you can qualify if your annual income has exceeded $200,000 (or $300,000 for joint income) for the past two years and you expect the same for the current year.
Can anyone be an accredited investor?
Meeting the criteria to become an accredited investor is not something that everyone can achieve. However, for those who do meet the qualifications, the benefits can be substantial.
How long does it take to become an accredited investor?
It takes two years of showing an income of at least $200,000 to become an accredited investor.
