How to Become an Accredited Investor and Grow Your Wealth

What Is an Accredited Investor?

One way to ascertain what it means to be an accredited investor is to see how the Securities and Exchange Commission (SEC) qualifies one as such. Under Regulation D, the SEC regards them as financially-sophisticated investors. They need to be because some of the investments they can make are very risky.

In most circumstances, most individual and institutional investors trade with registered securities. But there are private companies that offer shares without registering with the SEC. These unregistered securities, in effect, are only available to accredited investors.

Lacking SEC oversight and public scrutiny, unregistered securities pose higher risks. Some companies, for example, may not provide full disclosure. As a result, investors may not realize they are making bad investment decisions.

No doubt, these types of investments are risky. Thus, it is understandable that the SEC would bar access to non-accredited investors. While this may limit the investment opportunities of small, inexperienced investors, they are also not exposed to potentially substantial losses.

Becoming an accredited investor is possible by satisfying one of the conditions based on:

• Income

• Net worth

• Professional certifications

• Knowledge (as employees of private funds)

The group of accredited investors is not only high net worth individuals (HNWIs). They may also be entities such as insurance companies, banks, trusts, and brokers.

Apart from trading with unregistered securities, accredited investors can also have privileged access to other investment opportunities, including:

• Angel investments

• Equity crowdfunding

• Hedge funds

• Private equity

• Private placements

• Venture capital

Who Can Get an Accredited Investor Status?

In the United States, the SEC defines accredited investors as follows:

• Financial institutions such as:

  • Banks

  • Registered investment companies

  • Business development companies

  • Small business investment companies

• Employee benefit plans within the meaning of the Employee Retirement Income Security Act (ERISA) that meet one of the following:

  • If banks, insurance companies, or state-registered investment advisor firms makes the investment decisions

  • If the total assets of the plan are more than $5 million

• Corporations, partnerships, and charitable organizations with assets that exceed $5 million

• Businesses in which the equity owners are all accredited investors

• Directors, executive officers, and general partners of companies selling unregistered investments

• Trusts that meet the following:

  • Not founded to buy unregistered securities

  • Has a sophisticated person making the purchases

  • Has assets that exceed $5 million

• Individuals and spouses with a joint net worth (not including the primary residence) that meet one of the following:

  • Has a net worth that exceeds $1 million at the time of the purchase of the securities

  • Has assets of at least $1 million under management

• Individuals with incomes that exceed $200,000 in each of the two most recent tax return years and the upcoming year

• Spouses with a joint income that exceeds $300,000 in each of the two most recent tax return years and the upcoming year

Others that May Qualify as Accredited Investors

• Individuals who hold certain professional certifications, credentials, or designations from an accredited educational institution and are in good standing of Series 7, Series 65, and Series 82 licenses

• Knowledgeable employees of private funds

• Limited liability companies (LLCs) with at least $5 million in assets

• Rural business investment companies (RBICs), investment advisers, exempt reporting advisers registered with the state or the SEC

• Indian tribes, government bodies, funds, and entities organized under laws governing foreign countries that meet the following:

  • Not founded to buy unregistered securities

  • Has investments that exceed $5 million as defined in Rule 2a51-1(b) of the Investment Company Act

• Family offices that meet the following:

  • Has at least $5 million in assets under management

  • Family clients that meet the stipulation of the Investment Advisers Act

• Spousal equivalents within the meaning of accredited investor definition pooling their finances

How to Become an Accredited Investor?

The terms accredited and non-accredited investors can be misleading. For one thing, there are no official procedures for becoming an accredited investor. In other words, no government or independent institutions provide licenses or certifications.

Without a licensing or certifying body, the burden of determining an investor’s status rests on the investment firm. It is up to them to exercise due diligence in ensuring the investors meet the qualifications. These include income, network, professional certifications, and being knowledgeable.

To determine the investor’s suitability for accreditation, funds and investment firms use a questionnaire. Furthermore, they will ask for copies of financial documents and others.

1. Income and Net Worth

The Securities Act of 1933, Regulation D, Rule 501 contains the accredited investor definition. Among them are two that pertain to income and net worth. To become accredited, an investor only needs to satisfy one of two criteria.

• Income. Individuals whose pre-tax income exceeds $200,000. Spouses may also qualify if their pre-tax income exceeds $300,000. Their two most recent tax return years and upcoming year must meet the income requirements in both cases.

• Net Worth. Individuals and spouses with at least $1 million net worth. Not included in the computation is the value of their primary residence.

2. Professional Certifications

There is no certification stating one is an accredited investor. But there are also other professional credentials qualifying them to carry out investments on behalf of others. Registered brokers and investment advisers, for example, are acceptable as accredited investors.

SEC and state-registered investment advisors can qualify as accredited investors. Likewise, those with credentials issued by accredited educational institutions may also be eligible.

3. Knowledgeable Employee of Private Funds

Not everyone working in private funds qualifies as an accredited investor. Those who do are executive officers, directors, trustees, and general partners. In general, they serve as the capacity of an affiliate management person or a private fund. In essence, they actively participated in investment activities for at least 12 months.

4. Required Documents

Before companies or investment managers qualify any investor as accredited, they will ask for legal documents. These are to substantiate your financial status and professional credentials, such as:

• Financial statements

• Credit report of net worth (value of the primary home not included in computation)

• Tax returns

• Documents that indicate earnings, such as W-2 forms

• Letters from certified public accountants, tax lawyers, brokers, and investment advisers

• Professional credentials, designations, and certifications administered by the Financial Industry Regulatory Authority (FINRA)

• A knowledgeable employee of private funds

After meeting all the accredited investor requirements, the successful candidate can proceed to invest in unregistered securities. Usually, the accreditation validity lasts one year.

What Are the Pros and Cons of Being an Accredited Investor?

As you will see, accredited investors have more options. At the same time, you should be aware of the downsides.

Advantages

• Financial Advantage. As an accredited investor, you can invest in more opportunities that others with less wealth cannot access. As such, you have more options in growing your wealth.

• High ROI. Accredited investors can invest in hedge funds. The returns can be considerable despite the high minimum investment amounts and risks.

• Increased Diversification. Seasoned investors know the importance of keeping a diversified investment portfolio. As an accredited investor, there are more choices regarding the type of investments you can make.

Disadvantages

• Higher Minimum Investment Amounts. On the one hand, the typical investment amounts for unregistered securities are higher than registered securities. Usually, the figures range from tens of thousands to over a million. But then again, accredited do have higher income and net worth.

• Increased Risk. Companies do not register securities with the SEC. Hence, some of them may not disclose a complete set of information allowing investors to make wiser decisions. The lack of oversight compounds the risk associated with substantial investment amounts.

• Longer Capital Lock-up Period. Investing in unregistered securities lessens liquidity. If the accredited investors need funds, they may not sell those shares – not until after the lock-up time. For hedge funds, this period may last from 1 to 5 years.

• Expensive Performance Fees. Hedge fund managers can make a fortune. One reason is that they charge higher performance fees. In general, investment managers charge more on high-risk securities. More or less, the rates range from 15% to 20%.

The Accredited Investor Status

Being an accredited investor status brings forth so much more opportunities. However, becoming one is a matter of meeting the qualifications stipulated by the SEC.

As you learned, accreditation is largely determined by income or net worth. Suffice to say, getting accredited is only for those with considerable wealth. Not only that, but they also need to be financially sophisticated.

Unregistered securities are risky – far riskier than publicly-traded shares. It is why the SEC does not allow those who cannot fend for themselves and less financially-capable investors to buy those stocks.

As for the accredited investors, it is their choice to dip into those riskier investments. They are savvy enough to weigh the pros and cons at their level.