What is an Accredited Investor and Why Does it Matter?
If you have ever read about hedge funds or venture capital and looked into making your own investment, you may have been disappointed. These investments are available only to so-called accredited investors.
So what is an accredited investor? Why does it matter? How do you become one? Here’s an introduction to everything you need to know.
What is an Accredited Investor?
An accredited investor is an individual or entity that is allowed to trade unregulated securities. The term is used by the Securities and Exchange Commission (SEC) under Regulation D to refer to investors who are financially sophisticated and require lower amounts of protection provided by regulatory disclosure filings. In order to qualify, investors must satisfy at least one requirement regarding their income, net worth, asset size, governance status, or professional experience.
Allowing investments to skip regulation and disclosure requirements expedites funding for these investments, opens up new capital raising avenues, and allows for different types of investment opportunities. On the other hand, these investments have the potential to be highly complex and cary significant risk because of the lack of disclosure.
That is why the SEC requires investors to be accredited, meaning they are legally recognized as having sufficient assets and financial sophistication to weather a potentially serious loss and understand complex financial instruments. Accredited investors can include high-net-worth-individuals (HNWIs), brokers, banks, trusts, or insurance companies. On an individual level, there are just over 10 million households in the US that qualify as accredited investors, according to the SEC.
Types of Investments Available to Accredited Investors
Accredited investors are legally authorized to buy and sell securities that are not registered with a financial regulatory authority such as the SEC. These securities are not offered to the public because they often involve complex and higher-risk investments and instruments. Examples include:
- Hedge funds
- Venture capital
- Private equity deals
- Equity crowdfunding
- Angel investing
There are also certain common investment options which provide privileged access to accredited investors. For example, a company may choose to offer some of their shares exclusively to accredited investors. This is called a private placement. At this point, regulatory authorities verify the company’s benchmarks for deciding who is an accredited investor.
Requirements to Become an Accredited Investor
Both entities and individuals can be considered accredited investors under SEC guidelines, but the requirements differ. To claim accredited investor status, an individual must meet at least one of the following requirements:
- Net worth exceeding $1 million individually or combined with a spouse (or spousal equivalent), not including the value of primary residence
- Earning income in excess of $200,000 ($300,000 if combined with spouse) during each of the last two calendar years AND demonstrate credibility that they will maintain these income thresholds in the current year
- Have certain professional certifications or other credentials such as a FINRA Series 7, Series 65, or Series 83 license, or have a status as a private fund’s “knowledgeable employee”
An entity can qualify as an accredited investor if it is a private business development company or an organization with assets exceeding $5 million. If an entity consists of equity owners who are accredited investors, the entity itself will be considered an accredited investor.
In August 2020, the SEC updated its definition of accredited investor to better account for financial sophistication. After all, being a millionaire doesn’t implicitly mean you have the financial wherewithal to know how to invest your money, just that you have enough money to weather losing it. The new definition includes people based on professional certifications (thus the Series 7, Series 65, or Series 83 licenses) as well as knowledgeable employees of a private fund, among others.
Purpose of the Requirements
While these requirements wall off a huge segment of the population from qualifying as accredited investors (most investors, in fact), that’s not the goal. The goal isn’t to privilege the rich, either.
The goal of these requirements is to protect investors from investments that are far more risky than those widely available on the market. If average investors participate in these instruments without understanding what they’re doing or having sufficient capital to weather the risk, they may end up in serious trouble.
In addition, accredited investors have privileged access to certain assets that are loosely regulated by financial authorities—or in some cases, not regulated at all. Investors need to have the financial sophistication to do their homework on an unregulated investment. Otherwise, they’re venturing into the financial Wild West without a horse or water. In the eyes of financial authorities, accredited investors are financially sophisticated enough to do their own homework and take educated risks.
Why Being an Accredited Investor Matters
What’s all the fuss about being an accredited investor? In short, because accredited investors have access to financial tools that most other investors cannot access—and if they know what they’re doing, they can earn quite a bit of money on those investments.
Remember, risk and reward often go hand in hand in investing. If you’re willing to put more on the line, you may reap more benefits from that money. It’s not guaranteed—no investment is guaranteed—but for the right investor, the potential for huge rewards can pay off.
However, financial authorities don’t want just any average investor thinking they can make their fortunes only to lose everything. Their job is to make sure that investors know what they’re getting into, but with high-risk, loosely regulated investments, there’s very little oversight protection. Accredited investors are those who authorities trust to know what they’re getting into.
Is It Worth Becoming an Accredited Investor?
Is it worth becoming an accredited investor? It depends on your goals.
Even if you meet the criteria to be considered an accredited investor, you’re not obligated to become one. The only reason you would become an accredited investor is to gain access to certain investment opportunities that are only available to such individuals.
As such, if you do meet the criteria to become an accredited investor, it’s worth investigating the types of assets that could be available to you. If you aren’t comfortable with them or they don’t suit your personal investment style, it’s not worth becoming an accredited investor.
Democratization of Sophisticated Investments
Here’s the good news: you don’t need to be an accredited investor to access great investment options. In fact, there are several fantastic investment options available to ordinary investors that were once limited to accredited investors.
Like blue-chip art.
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