Understanding Investor accreditation
When it comes to the investment world, there are many different vehicles that allow individuals to grow their wealth over time and it certainly depends on each individual’s preferences and risk aversion. Nevertheless, there are some investment opportunities that require the investor to be accredited by the Securities and Exchange Commission (SEC) in order to be able to participate. These investments are usually more sophisticated and with higher risk-adjusted returns. Our goal with this article is to explain who is considered an accredited investor, how to become one, and the benefits that come with it.
An accredited investor is a person or entity that is allowed to invest in securities that are not registered with the SEC. To be qualified as an accredited investor, an individual or entity must meet certain income and net worth requirements.
The SEC uses the term Accredited to refer to individuals or business entities who have the financial capacity and knowledge to take the risks associated with investing in unregistered securities. Unregistered securities are securities – a financial instrument that holds value and is traded between parties – that are not registered with the SEC. Because accredited investors can trade securities not available to the general public, they have access to:
- Hedge Funds
- Venture Capital
- Private Equity
- Private Placements
- Equity Crowdfunding
- Angel Investing
- And all other types of unregistered offerings
The SEC regulates who can be considered accredited as a means to keep the general public away from unnecessary risks that are beyond their financial means to handle.
Requirements for Becoming an Accredited Investor
There are a variety of requirements to be considered an accredited investor by the SEC. These requirements are primarily to assess if an individual has financial sophistication and wealth necessary to trade securities that are not registered with regulatory authorities such as the SEC. As previously stated, the SEC creates these qualifications to ensure no individual will take on any risk that is beyond their realm of expertise.
Requirements for accredited investors:
- An individual must have an annual income exceeding $200,000 ($300,000 for joint income with a spouse) for the last two years with the expectation of earning the same or higher income in the present year.
- An individual can also be considered an accredited investor if their net worth, excluding their primary residence, exceeds 1 million dollars.
- An individual is considered an accredited investor if they are a general partner, executive officer, or director for a company that is issuing unregistered securities.
- An entity is considered accredited if it is a private business or an organization whose assets exceed $5 million. Also, if an entity is conformed of equity owners who are all accredited investors, the entity itself is considered an accredited investor.
Satisfying any of these requirements will allow an individual or entity to be considered an accredited investor, but there have been recent amendments by the SEC to not only assess people based on their wealth but also on their financial sophistication.
New Ways to Become an Accredited Investor
On August of 2020, the SEC amended and expanded the definition of an accredited investor. According to press release by the SEC, “the amendments allow investors to qualify as accredited investors based on defined measures of professional knowledge, experience or certifications in addition to the existing tests for income or net worth. The amendments also expand the list of entities that may qualify as accredited investors, including by allowing any entity that meets an investments test to qualify.”
Since then, the SEC now recognizes as accredited investors the following:
- Individuals who are *knowledgeable employees” of a private fund.
- SEC and state-registered investment advisors.
- “Knowledgeable employees” of a private fund are now considered to be accredited investors in regards to that fund as well.
- Individuals that have a Series 7, Series 65, and Series 82 licenses are now also considered accredited investors. The amendment clearly states that additional credentials can be added in the future. The following is a brief explanation of each of the three series licenses mentioned above:
- Series 7 – this license allows the holder to sell all types of securities products except commodities and futures. Stockbrokers in the United States have to pass this exam to obtain a license to trade, and it focuses on investment risk, taxation, equity, and debt instruments; packaged securities, options, retirement plans, and interactions with clients for prospective securities industry professionals.
- Series 65 – this license is required for individuals to act as investment advisers in the United States and it covers laws, regulations, ethics, and various topics important to the role of a financial adviser.
- Series 82 – this license provides the ability to transact private securities for clients, allowing commercial banks to offer a more diverse set of services and could conveniently partner with broker-dealers to provide securities transactions to customers.
- Limited liability companies (LLCs) with $5 million in assets.
- Any entity that owns investments worth $5 million or more, such as an Indian tribe or government body.
- Family offices with a minimum of $5 million in assets under management
Why is it Important to Become an Accredited Investor?
As stated before, Accredited Investors have access to privileged investment opportunities not available to the general public. This privileged access investment opportunities allows for diversification of portfolio and access to higher risk-adjusted returns. Also, some of these investments allow for a great upside potential without the operational requirements that hands-on investing demands.
As an example, real estate was previously only available to wealthy individuals, but with the connectivity provided by the internet and the availability of investment vehicles, such as syndications, the real estate marketplace is rapidly evolving. These new ways to achieve accreditation will help make many great investment opportunities more attainable to the masses.
By: Neil Raguthu
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