Left to its own devices, investing can be a ruthless game. The government regulates how companies connect to the public to protect people from potential scams and very high-risk investments. The Accredited Investor receives less of this protection, but also has the ability to invest in commercial real estate syndication and even start-up companies before they go public.
Becoming a limited partner in a major commercial real estate development can generate impressive returns and getting into a company like Uber (NYSE: UBER) or Slack (NYSE: WORK) early means huge profits – gains far beyond what anyone can expect a public offering.
Rule 501 of Regulation D of the United States Securities and Exchange Commission (SEC) defines an accredited investor. We will discuss the main points of this definition and what it means for your investment opportunities.
Accredited Investor Requirements and Qualifications
The Accredited Investor is assumed to be a sophisticated financial entity that can handle higher levels of risk. The qualified investor can be a natural person or a commercial entity.
The current standard for a natural person is as follows:
- Income greater than $200,000 per year (for married couples, $300,000) in the previous 2 years and can prove similar income for the current year, or
- A net worth of over $1 million that does not include the value of the primary residence
The criteria for the other categories of accreditation are as follows:
- A trust with more than $5 million in assets, or
- A business entity with 100% accredited investors as shareholders
Opponents of this standard point to the fact that individuals and businesses can make money without being sophisticated in investing. For example, a surgeon who earns $500,000 is automatically considered a sophisticated investor – even though that surgeon might not know the first thing about buying stock or reading a balance sheet.
Last year, the SEC expanded eligibility, allowing more people to meet requirements from accredited investors to those who hold certain financial professional licenses. Individuals with the following licenses can have credentialed status whether or not they meet the income or net worth requirements.
- General Securities Representative license (series 7)
- Representative in private placements of securities license (series 82)
- Certified Investment Advisor Representative (Series 65)
How do companies determine if you are an accredited investor?
Taking money from unaccredited investors can mean big trouble for a business, whether it succeeds or fails. Failure means lawsuits from angry investors, but success without compliance can result in penalties and sanctions once you’re on the SEC’s radar. If you are looking to invest in unregulated opportunities, you must be prepared to prove your accredited status. Most reputable opportunities require it.
Companies looking for accredited investors can verify your status as they see fit. You will likely be asked for a professional record of your finances. You may also be asked to prove how you will earn your minimum $200,000 this year if you don’t have at least $1 million in net worth. Each investor chooses the level of scrutiny they are willing to face in order to access a certain opportunity.
However, not all companies worry about accreditation.
Regulatory crowdfunding and the Jumpstart Our Business Startups (JOBS) Act are relatively new mods of securities law that operate around accreditation.
Regulatory crowdfunding allows companies to raise up to $5 million in 12 months without any accreditation standards. The JOBS Act created a standard Tier 2 company under Regulation A that allows companies to raise up to $50 million from non-accredited investors. Companies are not required to disclose as much information about themselves as companies raising funds under traditional regulations.
Depending on who you ask, companies looking for investments break securities law all the time. If you get money from your working class cousin to start a neighborhood fry, you may be in violation of SEC Rule D. Fortunately, the SEC has provisions for small businesses and family businesses in Rules 504 and 506. any way.
Rule 506(b) allows a company up to 35 non-accredited investors in one funding round. These investors must meet an experience requirement that is expressly formulated to give courts the ability to judge issues on a case-by-case basis.
Under Rule 506(c), corporations and syndication sponsors solicit their offerings to the general public and raise an unlimited amount of capital from an unlimited number of accredited investors, but are not permitted to receive investment non-accredited investors.
Who can be an accredited investor?
As long as you meet the financial or business license criteria set forth in SEC Rule 501, Regulation D, you can legitimately claim to be an Accredited Investor. The SEC doesn’t actually certify you, nor is there any official documentation you can request. The determination of your accreditation is left to the companies that review the investors.
What can accredited investors invest in?
Accredited investors have access to many hedge funds, private equity investments, and unregulated venture capital investments that regular investors do not legally have. The main benefit of being accredited is access to these unregistered investment opportunities.
The SEC registration process is expensive and time consuming. Registration with the SEC also requires companies to maintain financial stability and accounting transparency. Start-ups often don’t want to invest the resources to register. Instead, they limit investment offers to qualified investors only. These offerings generally have many more benefits than public offerings, but they have no government protection for default, unethical behavior, or even illegal behavior.
Why become an Accredited Investor?
The reason for becoming an accredited investor is simple: other investors will trust you more. As stated earlier, upgrading to the government’s minimum standards doesn’t pay you anything on its own. But when other investors open your books and see the financial stability and sophistication, they’ll be much more likely to invite you to the VIP table.
Don’t jump the gun
If you opened an account with a brokerage firm, you were asked to accredit yourself. Before the brokerage decides your margin status or options level, you are asked about your income and level of investment sophistication. Hint: They don’t check. You can easily claim a net worth of $2 million, 20 years of stock trading experience, and an average trade size of $50,000. They will give you 4X your capital for day trading and all the unlimited options trades you can handle.
As 80-90% of investors quickly find out, pretending to be smarter than you are is the fastest way to lose all your money.
You are virtually free to lose every penny you have despite the standards the government is trying to put in place. So before you jump into a regulation A Tier 2 investment pool or a crowdfunding pool because it sounds cool, consider caution may be the best credential you have until you get that $1 million minimum.
How to become a qualified investor?
To become an Accredited Investor, you must have earned a minimum of $200,000 in the past two years and expect to earn that in the current year.
Who can write an accredited investor letter?
A CPA, investment advisor, licensed attorney, or broker can write an accredited investor letter.
How long does it take to become an accredited investor?
It takes two years to show an income of at least $200,000 to become an accredited investor.