What is an Accredited Investor?
By: Casey Botticello
Tags: Business, Venture Capital, Finance, Government, Investing

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. 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.

What is an Accredited Investor?

An accredited investor is a person or entity that can deal with securities not registered with financial authorities by satisfying one of the requirements regarding income, net worth, asset size, governance status or professional experience. The term is used by the Securities and Exchange Commission (SEC) under Regulation D to refer to investors who are financially sophisticated and have a reduced need for the protection provided by regulatory disclosure filings. Accredited investors include natural individuals, banks, insurance companies, brokers and trusts.

In the United States, to be considered an accredited investor, one must have a net worth of at least $1,000,000, excluding the value of one’s primary residence, or have income at least $200,000 each year for the last two years (or $300,000 combined income if married) and have the expectation to make the same amount this year.

Definition by the U.S. Securities and Exchange Commission

The term “accredited investor” is defined in Rule 501 of Regulation D of the U.S. Securities and Exchange Commission (SEC) as:

a bank, insurance company, registered investment company, business development company, or small business investment company;

an employee benefit plan, within the meaning of the Employee Retirement Income Security Act, if a bank, insurance company, or registered investment adviser makes the investment decisions, or if the plan has total assets in excess of $5 million;

a charitable organization, corporation, or partnership with assets exceeding $5 million;

a director, executive officer, or general partner of the company selling the securities;

a business in which all the equity owners are accredited investors;

a natural person who has individual net worth, or joint net worth with the person’s spouse, that exceeds $1 million at the time of the purchase, or has assets under management of $1 million or above, excluding the value of the individual’s primary residence;

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; or

a trust with assets in excess of $5 million, not formed to acquire the securities offered, whose purchases a sophisticated person makes.”

Advantages of Being an Accredited Investor

Investments like hedge funds and venture capital funds can be exciting and have high potential for returns. They are also riskier and more complex than most other types of investments, and for this reason, they are not open to the general public.

In order to invest in a hedge fund, venture capital fund, or most private equity deals, you’ll need to be an accredited investor, which means you need to have a certain level of income or assets. And in some cases, you may need to meet even higher standards if the fund charges performance-based fees or doesn’t wish to register as an investment company.

Examples of the investment opportunities you gain access to:

Hedge Funds

Venture Capital

Private Equity

Verifying Your Accredited Investor Status

To be clear, the accredited investor and other distinctions are in place to protect investors from getting into situations they don’t fully understand, and from taking risks they can’t afford to take. They are not for the protection of investment companies and hedge funds.

For this reason, the burden of verification is on the party selling the investment. Hedge funds, venture capital funds, and other private placements are legally required to take steps to verify your eligibility to invest in any opportunity.

So, if you decide to invest in, say, a hedge fund, you should expect a thorough verification process before you’re actually allowed to invest. To expedite this process, it’s a smart idea to gather documents that can prove your net worth, investment value, and/or income. Just to name a few possibilities, you may need:

W-2s and 1099s

Copies of your last few tax returns

Pay stubs

Bank account and brokerage account statements

Verification of other investments held outside thee accounts (ex. deeds to investment properties you own)

Personal balance sheet

Unfortunately, there’s no “one-and-done” way to become an accredited investor (or qualified purchaser or client), so you should expect a verification process for every opportunity you pursue that requires such a status.