When I was learning about investing, I discovered there’s something called “accredited investors.” I wondered how I could become one, as well as invest with a broker like RealtyShares.
Are you curious now as well? Then you’re in luck. In this article, I’ll lay out exactly what it means to be an accredited investor, the guidelines you have to follow, the income and asset levels you have to meet, why you’d want to become an accredited investor, and whether or not it’s feasible.
Let’s first start with what an accredited investor really is.
What is an accredited investor?
An accredited investor can either be an individual or a business entity permitted to execute transactions involving securities not registered with financial regulatory bodies. They may be extended this privilege if they fulfill criteria on asset size, net worth, income, professional experience, and/or governance.
Trusts, brokers, insurance companies, banks, and high net worth individuals are examples of accredited investors.
What does “accredited investor” mean?
This term comes from the word accredited, which implies an individual given sanction or special authority for meeting required standards. Accredited investors are well-known for their legal right to buy securities (stocks, bonds, etc.) not registered with financial regulatory bodies such as the U.S. Securities and Exchange Commission (SEC).
Offering securities and shares
Since raising capital includes a costly and intricate process such as regulatory filings, companies may benefit by offering securities directly to accredited investors. Companies may not need to register with the SEC, and this can save them plenty of expenses.
They can also offer shares to eligible, accredited investors. Participants who execute private placements face the risk of heavy investment losses, so authorities determine their financial stability, knowledge, and experience necessary for such risky ventures.
Financial authorities do not control these transactions directly, but they do determine who qualifies as an accredited investor.
What else accredited investors do
Applicants must be able to mitigate the risks of dealing in unregistered securities, high-risk investments, angel investments, hedge funds, and venture capital.
Requirements for becoming an accredited investor
Regulations on accredited investors may differ between various jurisdictions. These rules are determined by local financial regulatory bodies or some other authority. In the United States, the SEC has defined the accredited investor’s criteria in Rule 501 of Regulation D.
A yearly income of over $200,000
To qualify as an accredited investor, the applicant must have a yearly income of over $200,000. Annual income must be above $300,000 with joint income.
The applicant must have earned income beyond the defined limits during the preceding two years and should expect the same for the current year. This income test will not be fulfilled if the applicant shows individual income for one year and joint income (with a spouse) for the next two years.
A net worth of over $1 million
Individuals may be regarded as an accredited investor if their net worth exceeds $1 million. This rule applies even for joint income with a spouse.
The SEC will also consider an individual as an accredited investor if that person is an executive officer, director, general partner, or some combination of these positions as an issuer for unregistered securities.
Businesses with over $5 million
An entity will be considered as an accredited investor if its assets exceed $5 million. Also, if the entity comprises of equity holders who themselves are accredited investors, then the entity will qualify as an accredited investor.
Investment advisors may qualify
During 2016, the United States Congress changed the definition for accredited investors to include investment advisors and registered brokers.
And if individuals can demonstrate enough experience or knowledge that manifests their understanding of unregistered securities, then they can also qualify as accredited investors.
Reasons for accredited investor rules
Any financial regulatory body has two broad purposes. One is to promote investments, and the other is to protect investors.
Since these are conflicting requirements, the regulatory authority must establish rules that balance both of these purposes.
How investors are protected
If the authority adopts a lazy approach or lenient regulations to encourage investments, investors may be exposed to high market risks and may face substantial financial losses. But if the authority comes up with strict rules to safeguard investors, then this may act as a barrier to the securities market that may discourage investments.
However, formulating such rules is easier said than done. Regulators need to encourage investments in promising startups and developing enterprises that have the potential to become formidable financial entities in the future.
Taking risks investing in startups
Unfortunately, investments in such organizations are inherently risky, since startups and new businesses have a high failure rate. Often, high-tech startups focus on research and development that might yield high dividends in the future if successful, and they do not possess a marketable product to generate revenue.
Research and development may lead to such products, but there is no guarantee. But if R&D endeavors create a lucrative product, then these startups can be profitable. However, the high probability of failure means there is a high risk that investors may lose their money.
Ensuring investors have experience
Financial authorities are also concerned about individuals with little knowledge and experience. These small investors often have fewer financial resources, meaning they have no backup to rely on if they suffer heavy investment losses. Such people often have a limited understanding of where to invest their money and can, therefore, commit significant errors, which can cost them their hard-earned money.
Rules for accredited investors
These individuals must be prevented from risky investment ventures. Therefore, authorities have created rules for accredited investors, so high-risk ventures are undertaken only by those who have:
- Deep knowledge of the investment market for making good investment decisions.
- Plentiful resources to fall back on should their investment fail.
Those who meet these criteria may invest in high-risk unregistered securities and other such investments.
Why you may want to become an accredited investor
As an accredited investor, you suddenly have many more investment options than everyday investors. However, just because you have access to these investments doesn’t mean they’re a good fit for you.
Here a few investments you may want to access as an accredited investor.
Hedge funds are special investments much like a mutual fund or ETF but with fewer regulations and restrictions. These funds aim to get outsized returns over traditional investments but often come with much higher risks, too. They also usually charge higher fees.
Real estate crowdfunding
If you want to invest in real estate but don’t want to be a landlord, real estate crowdfunding may be a good bet. It allows multiple people to fund real estate deals that are professionally managed, giving you exposure to real estate without the management headache.
You have to carefully vet the company managing the investments to make sure they keep your best interests in mind. Some real estate crowdfunding companies include EquityMultiple and Realty Mogul.
EquityMultiple is a platform where you can invest in professionally managed commercial real estate, giving you a way to get into this exciting market. The site is exclusive, carefully choosing which commercial real estate companies they partner with by looking at cash flow, success rate, experience, and many other factors.
When you sign up, you’ll need to self-certify that you’re an accredited investor and let the platform know how you qualify. Each time you invest, you will need to re-confirm your status.
Another site that lets you get in on commercial real estate deals is Realty Mogul, which invests in just one out of 100 projects offered to them. They’ve paid out more than $136 million to investors.
Your investment options with Realty Mogul include Real Estate Investment Trusts (REITS), individual properties, and 1031 exchanges.
There are minimums for these options, such as a $5,000 minimum for REITS.
Venture capital or private equity funds
If you become a particularly wealthy accredited investor, you may be able to be part of a venture capital firm or a private equity fund. These groups invest in private companies at the beginning stages with the goal of hitting a home run when a company eventually sells or goes public.
How can I become an accredited investor?
There is no formal process or procedure through which one can become an accredited investor. There is no application, form-filling, or registration process for obtaining this coveted status. Nor is there any certification that can elevate one to this status.
However, sellers of unregistered securities can take different measures to validate individuals and entities as accredited investors.
Earning accredited investor status
Business entities and individuals who want to earn an accredited investor status should first approach issuers of unregistered securities. The issuers will then ask the applicant, via a questionnaire, relevant questions to determine whether the applicant will qualify.
Different attachments may need to be included to fully answer the questionnaire, such as a balance sheet, financial statements, and account information. This list may also include documents like payslips, W2 forms, tax returns, and even letters issued by advisors, investment brokers, tax attorneys, and CPAs. The issuer may review the credit report of the individual as well.
An example to illustrate conditions for becoming an accredited investor
Consider a person who earns $150,000 per year, and has for the past three years. This individual also reports a primary residence with a value of $1 million together with a mortgage worth $200,000.
This individual also possesses a savings account worth $450,000, a 401(k) account worth $500,000, a loan with an outstanding amount of $50,000, and a car valued at $100,000.
This person falls short on the income test. However, based on the net worth, this person will qualify as an accredited investor.
Note the fact that the value of primary residence cannot be included in the net worth, which is calculated as assets minus liabilities. The value of a car may, however, be included.
This individual’s net worth stands at precisely $1 million. The assets add up to $1,050,000 ($100,000 + $500,000 + $450,000). The liabilities include the car loan, which has an outstanding amount of $50,000.
Therefore, net worth = total assets – total liabilities = $1,050,000 – $50,000 = $1,000,000.
The SEC has formulated rigorous criteria for people to qualify as accredited investors. Since these investors can make risky investments in unregistered securities, the SEC has publicized regulations so only financially-savvy and knowledgeable people can execute these high-risk/high-return deals.
Financial regulations aside, you should personally evaluate your own investment knowledge and experience.
Do you have an in-depth understanding of the stock market?
Are you aware of the risks and rewards involved in venture capital, hedge funds, and private equity funds?
How big is your portfolio, and how high are the returns?
Does your portfolio performance reflect intelligent investment decisions?
High-risk investments and unregistered securities are not for everyone since they require sound financial judgment. If you are confident that you have a comprehensive understanding regarding the investment avenues mentioned above, then you should approach issuers of unregistered securities you consider worthwhile.