Becoming an accredited investor is a complex process. It can also be time consuming and costly to ensure you are meeting each requirement. With over 8,800 specific requirements, it is important to work with someone who understands the complexities of becoming an accredited investor.
Have you ever wanted to be an accredited investor? It can feel like a secret club where all the cool kids hang out. Well, if you have enough financial assets or income, then you’re qualified. If this sounds like it might be your kind of club, then I’ll show you how to gain access to the inner workings of this exclusive clique.
How To Become An Accredited Investor
An accredited investor is a person or entity that is allowed to invest in securities that are not registered with the Securities and Exchange Commission (SEC). To be an accredited investor, an individual or entity must meet certain income and net worth guidelines.
It takes money to make money, and accredited investors have more opportunities to do so than non-accredited investors. That’s because the Securities and Exchange Commission (SEC) allows companies and private funds to skip the need to register certain investments as long as the firms sell these assets to accredited investors.1 Accredited investors are able to invest money directly into the lucrative world of private equity, private placements, hedge funds, venture capital, and equity crowdfunding. However, the requirements of who can and who cannot be an accredited investor—and can take part in these opportunities—are determined by the SEC.
There is a common misconception that a “process” exists for an individual to become an accredited investor. No government agency or independent body reviews an investor’s credentials, and no certification exam or piece of paper exists that states a person has become an accredited investor. Instead, the companies that issue unregistered securities determine a potential investor’s status by conducting diligence prior to sale.
This article breaks down the requirements to become an accredited investor, how to determine if you qualify, and the screening process completed by investment managers to verify accredited investor status.
KEY TAKEAWAYS
- An accredited investor is one who meets certain criteria regarding income, net worth, and qualifications. They are wealthy individuals who are allowed access to investments that many people are not allowed.
- The burden of proving an individual is an accredited investor falls on the investment vehicle rather than the investor.
- Pros of being an accredited investor include access to unique and restricted investments, high returns, and increased diversification.
- Cons of being an accredited investor include high risk, high minimum investment amounts, high fees, and illiquidity of the investments.
- Many countries have an accredited investor class that has various income, net worth, investing, and legal requirements.
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Accredited Investor
Who Is an Accredited Investor?
Rule 501 of Regulation D of the Securities Act of 1933 (Reg. D) provides the definition for an accredited investor. Simply put, the SEC defines an accredited investor through the confines of income and net worth in two ways:
- A natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year.
- A natural person who has an individual net worth, or joint net worth with the person’s spouse, that exceeds $1 million at the time of the purchase, excluding the value of the primary residence of such person.2
The last passage of the second bullet is critical because it is an important change that was introduced during the 2010 passage of the Dodd-Frank Act. Prior to the financial law’s passage, the primary residence was not excluded from determining a person’s net worth. Anyone who held accredited investments prior to the passage was exempted into the law.3
For 2020, it is estimated that there were 13,665,475 accredited investor households in the U.S. This represents approximately 10.6% of all U.S. households. This number accounted for $73.3 trillion in wealth.4
Rule 501 also has provisions for corporations, partnerships, charitable organizations, and trusts in addition to company directors, equity owners, and financial institutions.2 However, the following formulas and screening processes are prepared for individuals or couples seeking the designation of being an accredited investor.
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SEC Amendments to the Accredited Investor Definition
On Aug. 26, 2020, the U.S. Securities and Exchange Commission (SEC) amended the definition of an accredited investor. According to the SEC’s press release, “the amendments allow investors to qualify as accredited investors based on defined measures of professional knowledge, experience or certifications in addition to the existing tests for income or net worth. The amendments also expand the list of entities that may qualify as accredited investors, including by allowing any entity that meets an investments test to qualify.”5
Among other categories, the SEC now defines accredited investors to include the following:
- Individuals who have certain professional certifications, designations, or credentials
- Individuals who are “knowledgeable employees” of a private fund
- SEC- and state-registered investment advisers5
Individuals holding Series 7, Series 65, and Series 82 licenses are now included as accredited investors. The SEC can add certifications and designations going forward to be included as well as encouraging the public to submit proposals for other certificates, designations, or credentials to be considered.5
Employees who are considered “knowledgeable employees” of a private fund are now also considered to be accredited investors in regards to that fund.5
The SEC has also broadened its definition to include many other entities, such as “Indian tribes, governmental bodies, funds, and entities organized under the laws of foreign countries, that “own” investments as defined in Rule 2a51-1(b) under the Investment Company Act, in excess of $5 million and that was not formed for the specific purpose of investing in the securities offered.”5
Other entities that may qualify include limited liability companies with $5 million in assets, SEC- and state-registered investment advisers, exempt reporting advisers, and rural business investment companies.5
How to Determine if You’re Accredited?
Individuals who have earned $200,000 or more in income over the past two years automatically qualify as an accredited investor, as does a person whose income—when combined with a spouse’s—totals $300,000 or more.2
An individual can also maintain a net worth of $1 million or more, minus the value of a primary residence.2 The only situation where the primary home can weigh on net worth is when an investor has either an underwater mortgage or a balance on a home equity line of credit.3
Example of an Accredited Investor
For an individual to determine qualification as an accredited investor, they should create a personal balance sheet like the one below by subtracting the total number of liabilities against the total assets.
| Allen | Brian | Carla | |
| Primary Residence | |||
| Home Value | $ 500,000 | $ 500,000 | $ 500,000 |
| Mortgage | $ 50,000 | $ 300,000 | $ 600,000 |
| Home Equity Line | $ 100,000 | ||
| Assets | |||
| Bank Accounts | $ 500,000 | $ 500,000 | $ 500,000 |
| 401(k)/IRA | $ 300,000 | $ 300,000 | $ 300,000 |
| Other Investments | $ 400,000 | $ 400,000 | $ 400,000 |
| Car | $ 25,000 | $ 25,000 | $ 25,000 |
| Total Included Assets | $ 1,225,000 | $ 1,225,000 | $ 1,225,000 |
| Liabilities | |||
| Student and Vehicle Loans | $ 100,000 | $ 100,000 | $ 100,000 |
| Other Liabilities | $ 100,000 | $ 100,000 | $ 100,000 |
| Underwater Mortgage | $ 100,000 | ||
| Balance of Home Equity Line | $ 100,000 | ||
| Total Included Liabilities | $ 200,000 | $ 300,000 | $ 300,000 |
| Net Worth | $ 1,025,000 | $ 925,000 | $ 925,000 |
As noted in the example above, Allen qualifies as an accredited investor because his net worth is more than $1 million. However, both Brian and Carla do not qualify due to additional liabilities tied to their primary residence. In Brian’s case, he has a $100,000 home equity line that boosts his liabilities and drops his net worth below $1 million. Meanwhile, Carla’s underwater mortgage increases her liabilities and limits her net worth.
Due Diligence
As mentioned, no formal agency or institution confirms the accreditation of an investor, and no certification is issued. However, since September 2013, the SEC has required that anyone selling to accredited investors must take a number of different steps in order to verify this status. Simply telling a firm or checking a box that signals a person is qualified is no longer allowed.6
Individuals who feel they qualify can visit a fund and ask for information about potential investments. At this time, the issuer of securities will give a questionnaire to determine whether a person qualifies as an “accredited investor.” The questionnaire will also likely require the attachment of financial statements and information of other accounts in order to verify the ownership of assets listed on a balance sheet like the one above. Companies will also likely evaluate a credit report in order to assess any debts held by a person seeking accredited status.
Individuals who base their qualifications on annual income will likely need to submit tax returns, W-2 forms, and other documents that indicate wages. Individuals may also consider letters from reviews by CPAs, tax attorneys, investment brokers, or advisors.
Accredited Investors in Other Countries
Accredited investor designations also exist in other countries and have similar requirements. The requirements to be an accredited investor in certain countries are similar to those of the U.S., such as Canada, Australia, and Singapore, which have similar income and net worth requirements, while other countries have differing requirements.7
In the EU and Norway, for example, there are three tests to determine if an individual is an accredited investor. The first is a qualitative test, an evaluation of the individual’s expertise, knowledge, and experience to determine that they are capable of making their own investment decisions. The second is a quantitative test where the individual has to meet two of the following criteria:
- Has carried out transactions of significant size on the relevant market at an average frequency of 10 per quarter over the previous four quarters
- Has a financial portfolio exceeding EUR 500,000
- Works or has worked in the financial sector for at least one year7
Lastly, the client has to state in written form that they want to be treated as a professional client and the firm they want to do business with must give notice of the protections they could lose.7
Other countries, such as India and Switzerland, don’t have explicitly stated requirements but instruct that one must meet with local counsel beforehand to determine if they are an accredited investor.7
Pros and Cons of Becoming an Accredited Investor
There are both pros and cons of being an accredited investor.
Pros
The primary benefit of being an accredited investor is that it gives you a financial advantage over others. Because your net worth or salary is already among the highest, being an accredited investor allows you access to investments that others with less wealth do not have access to. This, in turn, could further increase your wealth.
These investments could have higher rates of return, better diversification, and many other attributes that help build wealth, and most importantly, build wealth in a shorter time frame.
One of the simplest examples of the benefit of being an accredited investor is being able to invest in hedge funds. Hedge funds are primarily only accessible to accredited investors because they require high minimum investment amounts and can have higher associated risks but their returns can be exceptional.
That being said, in the last few years, hedge funds have had a hard time beating the market, but many have historically been able to do so, providing their investors with extremely high returns in a very short period.
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 also cons to being an accredited investor that relate to the investments themselves. Most investments that require an individual to be an accredited investor come with high risk. The strategies employed by many funds come with a higher risk in order to achieve the goal of beating the market.
Coupled with the high risk is another con; most investments require a high minimum investment. Simply depositing a few hundred or a few thousand dollars into an investment will not do. Accredited investors will have to commit to a few hundred thousand or a few million dollars to partake in investments meant for accredited investors. If your investment goes south, this is a lot of money to lose.
Furthermore, there are higher fees associated with accredited investor investments. These primarily come in the form of performance fees in addition to management fees. Performance fees can range between 15% to 20%.
Another con to being an accredited investor is the ability to access your investment capital. For example, if you buy a few stocks online through an electronic platform, you can pull that money out any time you like. With an investment in a hedge fund, for example, your money can be locked up from anywhere to a year, to five years, or more. Being an accredited investor comes with a lot of illiquidity.
Accredited Investor FAQs
What Qualifies as an Accredited Investor?
In the U.S., an accredited investor is anyone who meets one of the below criteria:
- Individuals who have an income greater than $200,000 in each of the past two years or whose joint income with a spouse is greater than $300,000 for those years, and a reasonable expectation of the same income level in the current year
- Individuals who have an individual net worth, or joint net worth with the person’s spouse, that exceeds $1 million at the time of the investment (The net worth amount cannot include the value of the person’s primary residence.)
- Individuals who hold certain certificates, designations, or credentials, such as Series 7, Series 65, and Series 82 licenses
- Individuals who are “knowledgeable employees” of a private fund2
Do You Have to Prove You Are an Accredited Investor?
The burden of proving that you are an accredited investor does not fall directly on you but rather the investment vehicle you would like to invest in. An investment vehicle, such as a fund, would have to determine that you qualify as an accredited investor. To do this, they would ask you to fill out a questionnaire and possibly provide certain documents, such as financial statements, credit reports, or tax returns.
What Is the Benefit of Being an Accredited Investor?
The benefits of being an accredited investor include access to unique investment opportunities not available to non-accredited investors, high returns, and increased diversification in your portfolio.
What Happens if You Lie About Being an Accredited Investor?
If you lie about being an accredited investor, the blame usually falls on the fund or investment vehicle as it is their responsibility to determine your qualifications. In certain regions, non-accredited investors also have the right to rescission. What this means is that if an investor decides they want to pull out their money early, they can claim they were a non-accredited investor the whole time and receive their money back.
That being said, it’s never a good idea to provide falsified documents, such as fake tax returns or financial statements to an investment vehicle just to invest, and this could bring legal trouble for you down the line in many ways.
How Much Can an Accredited Investor Invest?
There is no overarching limit to how much of their own capital an accredited investor can invest in all of their investments. That being said, each deal or each fund may have its own limitations and caps on investment amounts that they will accept from an investor.
The Bottom Line
Accredited investors are those that meet certain requirements regarding income, qualifications, or net worth. They are typically wealthy individuals. Accredited investors have the opportunity to invest in non-registered investments provided by companies like private equity funds, hedge funds, angel investments, venture capital firms, and others.
These vehicles allow accredited investors access to unique and restricted investments that offer high returns and other advantages. They do also come with significant drawbacks, such as high risk and high minimum investment amounts.
Strict regulations from the SEC require that companies take a number of steps to confirm the status of an investor claiming accredited status. If you qualify as an accredited investor, it could be worth your time seeking out these unique investment opportunities that could help build your wealth in a short time frame.
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