What is an Accredited Investor?

Accredited investor status is like a backstage pass…

Anybody willing to pay the price of admission can attend a concert. But only those with backstage passes can enter restricted areas and interact with the band. Likewise, accredited investor status grants you access to restricted investment opportunities and is only available to more sophisticated and wealthy investors.

An accredited investor is an individual or entity that meets requirements set by the Securities and Exchange Commission (SEC) to gain access to restricted investment opportunities, including:

• Sale of shares in a private company prior to an initial public offering (IPO)
• Venture capital funds
• Issues of corporate bonds in primary markets, where companies sell bonds to eligible investors for the first time
• Participation in a hedge fund, an investment fund that undertakes sophisticated or aggressive investments, such as obscure real estate deals and complicated stock trading strategies
• Investment in a high-risk, early-stage startup

These types of offerings are restricted to accredited investors because they are risker and require more advanced financial knowledge than other investments.

One reason these investments are riskier is that they’re exempt from SEC disclosure requirements. Organizations or individuals pitching investments to accredited investors don’t have to reveal detailed information about their risks the same way they would in a regulated investment market, like the New York Stock Exchange or NASDAQ.

While the people pitching these riskier investments can’t make false or misleading statements and omit important information, they don’t have to meet the higher disclosure requirements of a regulated offering. For example, they don’t have to provide financial statements that follow Generally Accepted Accounting Principles (GAAP).

Individuals and organizations that meet accredited investor guidelines signal that they have the financial stability to withstand potentially losing their entire investment. And they are likely to have the financial skill to understand a risky investment opportunity, even with limited information.

According to Securities and Exchange Commission (SEC) rules, individuals and entities have different requirements to be considered accredited investors.

An individual is an accredited investor when meeting one of these requirements:

Net worth exceeds $1M: The net worth — the difference between what you own and what you owe — can be individual or joint with a spouse. To calculate your net worth, subtract your total liabilities from total assets following SEC guidelines:

• You can’t include the value of your primary residence (the house you live in).
• For couples, an asset doesn’t need to be owned jointly.
• Mortgages or liabilities on a primary residence don’t count as a liability, unless they exceed the fair market value of the primary residence. The excess value counts as a liability.
• Any increase in the amount of your home loan on a primary residence in the 60 days before you make an investment counts as a liability, even when the loan amount is below the fair market value of the asset.

Earned annual income exceeds $200,000: In each of the two most recent years, your income is over $200,000 or your joint income with a spouse is over $300,000.

• There must be a reasonable expectation you will earn that income in the current year.
• When calculating joint earned annual income, use the two most recent years for each spouse.

Registered broker or investment adviser: Investment professionals can demonstrate their financial knowledge through SEC registration.

Any director, executive officer, or general partner of the organization or individual offering the investment.

The following types of entities are also considered accredited investors:

• Any entity in which all equity owners are accredited investors
• Banks, savings associations, and insurance companies
• Any small business investment company holding a license from the US Small Business Administration
• Any entity with assets over $5M that wasn’t formed for the sole purpose of purchasing the offered investment
• In the case of trusts that have more than $5M in assets, they must also be directed by someone with the necessary business and financial acumen to evaluate the pros and cons of the investment

The main purpose of accredited investor requirements is to ensure that a person or company has enough funds and sophistication to handle a high-risk investment.

Accredited investors have access to different types of investment markets, like private company shares prior to an initial public offering or venture capital funds. If a risky private investment pans out, it can create a lot of wealth: Think of venture capitalist Peter Thiel’s $500,000 investment in Facebook in 2004, which turned into an estimated $1B eight years later.

But the higher potential reward of opportunities available to accredited investors comes with higher risks. The Securities and Exchange Commission (SEC) sets requirements to ensure that individuals and entities that put their money in these investments are better equipped to face that risk. Accredited investors should have enough wealth or income to sustain potentially losing their entire investment. And they should have enough expertise to evaluate the high-risk investment opportunity.

Some accredited investors can join distributions lists from investment bankers to keep up-to-date on new investment opportunities limited to this group.

While the Securities and Exchange Commission (SEC) sets minimum accredited investor requirements, it doesn’t provide a formal process to secure the status.

There is no form you fill out to become an accredited investor. Instead, the SEC advises that issuers of restricted investments take reasonable actions to justify that the investor meets the requirements.

Examples of steps that companies could take to verify accredited investor status include:

• Request two years of federal tax returns or W-2 forms to verify that an individual earned $200,000 per year (or $300,000 in joint income with a spouse) for the past two years.
• Collect copies of statements from bank accounts, brokerage accounts, retirement accounts, loans, and mortgages to verify whether an individual’s net worth is over $1M.
• Check that an investment adviser is registered with the SEC.
• Ask for documentation proving that all owners of an entity are accredited investors.

If you would like to become an accredited investor, check SEC Rule 501 of Regulation D, select the applicable requirement, and have documentation ready to back up your choice.

An accredited investor and a qualified purchaser must meet different requirements set by the Securities and Exchange Commission (SEC) to gain access to restricted investment opportunities.

The Securities Exchange Act sets qualified purchaser requirements, which are not the same as those for accredited investors. All registered investment companies and banks are considered qualified purchasers. Other companies and individuals must own and invest at least $25M, while government agencies must own and invest at least $50M to qualify. The SEC doesn’t set a minimum investment value for accredited investors.

In recent years, some organizations have requested that the SEC consolidate the definitions of accredited investor and qualified purchaser to streamline the process of connecting buyers and sellers of restricted investments.