Becoming an accredited investor is a great way to get access to opportunities that are not open to everyone. The process of becoming an accredited investor can be complicated and time-intensive, but it is worth it when you consider all the benefits you’ll gain.
To become an accredited investor:
- Have a net worth of at least $1 million excluding your home, or have earned income in excess of $200,000 for each of the last two years with reasonable expectation of earning similar income in the current year.
- Be able to afford a minimum of $100,000 per year for three years on an investment that may not be profitable.
- Be able to afford a minimum of $5 million in liquid assets (cash or securities).
How To Become Accredited Investor
Anybody can invest in stocks, bonds and mutual funds, but there’s a whole range of assets that are off-limits to everyday investors—startups, certain real estate ventures, private equity and venture capital funds, to name just a few.
You must be an accredited investor to put your money in unregulated investments. Being an accredited investor means you have either the money or the know-how to cope with the greater risks involved. Here’s what it takes to call yourself an accredited investor.
What Is an Accredited Investor?
An accredited investor is a person who is allowed to invest in securities not registered with the Securities and Exchange Commission (SEC). These types of assets can be quite lucrative but also carry high levels of risk and complexity, which is why they are open only to sophisticated investors with considerable capital. They include:
- Private equity firms
- Hedge funds
- Real estate crowdfunding vehicles
- Shares of startup companies
- Venture capital funds
- Angel investing
The Securities Act of 1933 mandated that all securities issued for sale to the public must be registered, with detailed financial and operating information submitted to the SEC.
Registration has two purposes. It’s intended to protect investors from fraud or misrepresentation, as well as ensure that investors receive full financial disclosure about securities and issuers. Full disclosure ensures that investors have all the information necessary to support an informed investment decision.
Who Can Become an Accredited Investor?
The rationale underlying the accredited investor rules is that people with sufficient income or wealth are financially sophisticated enough to understand complex, unregistered investments and have the financial strength to withstand the total loss of invested capital.
Unfortunately, there is no special process by which an individual can become an accredited investor. There’s neither a government agency nor an independent board that certifies accredited investors.
Instead, companies and financial institutions that issue unregistered securities are required to verify that their investors are accredited by conducting diligence prior to any sale.
Here are the criteria that determine who is considered an accredited investor. Note that individuals or couples meeting any one of these criteria are considered accredited investors:
- Income: Individuals with annual income of $200,000 or more (and couples making $300,000 or more) for at least two years in a row can be accredited investors. They must be able to demonstrate their income came from the same source each year, and there must be a reasonable expectation of equal or greater income over the next year.
- Net Worth: An individual or couple with a net worth of at least $1 million at the time of investment, excluding the value of a primary residence. Prior to passage of the Dodd-Frank Act in 2010, a primary residence could be included in the net worth calculation, but now primary residences are excluded.
- Professional credentials: Individuals who hold certain professional designations may also qualify as accredited investors. These qualifications include certain licenses from the Financial Industry Regulatory Authority (FINRA), including the Series 7, Series 65 and Series 82.
- Insider status: Individuals who work for an entity offering non-registered investments. They are classed as “knowledgeable individuals.”
How to Qualify as an Accredited Investor
Qualifying as an accredited investor is a process that takes place between a company or financial institution that’s selling an unregistered investment asset and the buyer of the investment.
Here’s a look at the typical process a seller may use to determine whether a potential client is qualified as an accredited investor in terms of net worth or income. The seller may:
- Provide a detailed questionnaire for the potential investor to complete.
- Request verification of financial information via financial statements, tax returns or other documents to determine whether income or net worth standards are met.
- Evaluate a credit report to verify net worth and determine if there are any unreported outstanding liabilities.
- Request an attestation letter from a certified public accountant (CPA), tax attorney, or financial advisor.
To qualify as an accredited investor as a knowledgeable individual or insider, the buyer would request evidence of the buyer’s status as a director, general partner or executive at a firm that sells unregistered securities. This evidence may include governing documents, resolutions, or other supporting documents.
To qualify based on professional certifications, the potential investor can provide verification of securities licenses from FINRA.
Advantages of Being an Accredited investor
The greatest advantage of being an accredited investor is access to investments that may yield higher returns, albeit with higher risk. Some of the other benefits include:
- Greater returns that are not correlated with overall market performance
- Enhanced diversification
- Access to a greater range of investment opportunities
Disadvantages of Being an Accredited Investor
Unregistered securities are typically high-risk investments, and buyers face a greater likelihood of losing some or even all of their invested capital. Moreover, hedge funds, private equity funds, and the like have high investment minimums. Investors may be required to invest $100,000 or more to participate.
These types of investments have lock-up periods during which withdrawals aren’t allowed, so investors must be prepared for the lack of liquidity. Finally, the fees are high; the most common fee structure is the classic two plus 20 arrangement—a 2% annual management fee plus a 20% performance fee based on profits.
The Takeaway
Accredited investor status isn’t for everyone. Wealth is the principal qualification, with a few exceptions. It’s assumed that high-net-worth individuals have a more sophisticated knowledge base in finance as well as the financial strength to tolerate big losses.
But those who can meet SEC requirements may benefit significantly through the expanded universe of investments and the potential for much higher returns. At the end of the day, access to unregistered investments helps the rich get richer.