An accredited investor has insider knowledge of the investment world that most people don’t have. You might not believe it, but most investors lack access to and might not even be aware of the most lucrative opportunities for investments available.
Becoming an accredited investor is associated with numerous benefits you would never get to enjoy otherwise.
What Is an Accredited Investor?
In the most basic sense, an accredited investor is a savvy and wealthy company or individual. They buy securities—usually bonds or stocks—in a company for investment instead of resale. Accredited investors must meet some standards of wealth. Good examples of an accredited investor include the following:
- A partnership or corporation with over $5 million worth of assets
- A charitable organization with over $5 million worth of assets
- A business investment company, insurance company, or bank
- An individual with a $1 million net worth
- Any executive director, director, or general partner of the company that sells the securities
- A household with more than $300,000 worth of income for each of the past two years
- An individual with more than $200,000 worth of income for each of the past two years
- A business with equity owners that are accredited investors based on the above definition
- A trust with more than $5 million worth of assets that wasn’t formed specifically to buy the securities being offered
What Qualifies You as an Accredited Investor?
The definition of an accredited investor according to the SEC is indicated in Regulation D’s Rule 501. Below are the key points of this definition or the qualifications of accredited investors in Rule 501:
- A business development company as defined in Investment Company Act of 1940’s section 2(a)(48) or an investment company registered under that Act
- Any insurance company as defined in Securities Exchange Act of 1934’s section 2(a)(13) or a bank or any dealer or broker registered pursuant to the Act’s section 15
- A plan formed and retained by a state, its political subdivisions, or any instrumentality or agency of a state or its political subdivisions for its employees’ benefits if the plan has overall assets of more than $5,000,000
- A Small Business Investment Company with a license from the U.S. Small Business Administration under the Small Business Investment Act of 1958’s section 301(c) or (d)
- An employee benefit plan that is within the meaning of Employee Retirement Income Security Act of 1974 in case a plan fiduciary made the investment decision as defined by the act’s section 3(21), which is either a loan and savings association, a bank, registered investment adviser, or insurance company, or if this employee benefit plan has overall assets of more than $5,000,000 or if it is a self-directed plan wherein investment decisions are made exclusively by individuals who are accredited investors
Simply put, an accredited investor can be a brokerage, bank, some trusts, some retirement plans sponsored by the employer, or a registered investment adviser (RIA).
How Do You Become an Accredited Investor?
The only way for an individual to become an accredited investor is to meet one or more of the requirements stated above.
It is all a matter of whether your net worth or salary is high enough.
No aptitude test, course of study, or process will help you get there. If your wealth is not enough, then you won’t be able to become an accredited investor.
What Are the Benefits of Being an Accredited Investor?
Being an accredited investor allows you to experience and enjoy the following benefits:
Higher returns (also higher risk)
Probably the number one reason to invest is to generate higher returns, but it is important to remember that not every private placement investment can create high profits.
Certain hard money debt deals have only 7% returns.
Compare this to the average 8% return in the stock market, and the effort might not be worth it.
Meanwhile, some development and value-add deals that come with more risks can return 15% to 25% IRR.
An opportunistic investment that verges on speculation can create higher returns.
An investor expects higher returns in order to take on additional illiquidity and risk.
Yield Higher Than Most Other Investments
A lot of investors chase after higher yields, yet they are often limited to REITS, bones, and dividend-paying stocks.
An accredited investor can invest in a private offering that has higher yields.
For instance, a stabilized commercial property like an industrial building or apartment building pays a preferred return of 8% or higher, depending on the property’s yearly cash flow.
Real estate debt funds can have returns of 8% to 12.5%, which depend on the usage of leverage.
Accredited Investors Are Able to Have Good Diversification
Diversification is another reason for investing in private deals.
With the stock market being relatively volatile, an accredited investor hopes to diversify their investment portfolio through investing in those assets that have less or no correlation to the market.
In the event that the market tanks, other unrelated investments can buffer the losses.
Commercial real estate like industrial buildings, apartment buildings, and mobile home parks don’t rise and fall in accordance with bonds and stocks. But they are sensitive to the conditions of the local market and the broader economic cycle.
Some other examples like life settlement and law settlement investments don’t have any correlation to the market, but they have their unique risk profile.
How Do You Prove That You Are an Accredited Investor?
You can prove that you are an accredited investor through any of the following ways:
Net worth method
Investors may opt to prove that they are accredited investors because they are a natural person with an individual net worth of more than $1 million or a joint net worth with their spouse.
With this method, the investor is required to disclose their liabilities and assets to calculate the net worth.
Keep in mind that the positive value of the primary residence of the investor is not included in the net worth for accredited investor verification purposes.
However, incurred debt for the past 60 days against this primary residence together with debt in excess of the primary residence’s value is subtracted from the net worth for accredited investor verification purposes.
This can be an easy method for an investor with only one large bank account and no liabilities, but it can be time-consuming and complicated for an investor with multiple liabilities or assets.
The three main components of this method of net worth verification include the following:
- The investor’s credit report together with that of his or her spouse
- Disclosure of the assets of the investor
- Disclosure of the liabilities of the investor
- Investors can prove that they are an accredited investor since they are a natural person with more than $200,000 in income in each of the past two years
- or a joint income with a spouse of more than $300,000 for these years
- a reasonable expectation of a similar level of income in the present year.
As proof, it is recommended for the investor to provide official or government records showing their income like pay stubs or tax filings.
If not, the investor may try obtaining a letter from the employer or account that confirms that the yearly wages or income. The income must exceeded these amounts for the past two years and will continue to exceed it in the present year.
An investor must also create an affirmative statement that the expected income in the present year will meet the level of minimum income.
Investors can be considered as an accredited investor if they are an executive officer, director, general partner, or issuer of sold or offered securities or if they are an executive officer, a director, or a general partner of the issuer’s general partner.
Evidence of this position could be evidence through providing incumbency, resolutions, governing documents, or any other certificates.
There are instances when evidence is available to the public like research reports, securities filings, or any other information that reliable third-party sources provide.
Only a few accredited investors are going to qualify using this method, yet once they do, it is probably the easiest verification method.
Professional letter method
Investors may request a written confirmation of their accredidation from:
- an investment adviser that is registered with the SEC
- a registered broker-dealer
- certified public accountant in good standing
- duly registered under the laws of the area of his principal office or residence
- licensed attorney in good standing under the laws of jurisdictions where he is allowed to practice law.
The provided written confirmation should certify that there were reasonable steps taken for verifying that an investor is an accredited investor within the past three months, and it was determined that the investor is indeed an accredited investor.
It is a useful method when the investor has a lawyer or accountant who can offer a statement that certifies that he is an accredited investor for no or little cost on the part of the investor.
There might be an associated cost to obtain this letter, and many accountants or lawyers won’t feel comfortable giving this letter, particularly if they are not intimately familiar with securities’ laws.
Qualified vs. Accredited Investor
A qualified investor is also commonly called an accredited investor.
It is an individual or entity that the Securities and Exchange Commission legally permits to invest in venture capital funds, hedge funds, private equity offerings, and other private placements.
A qualified investor must demonstrate enough net worth or income before they can buy unregistered securities.
For now, a qualified investor is the same as an accredited investor. “Qualified investor” is a term usually used interchangeably with “accredited investor” to pertain to an individual or entity that is allowed to buy unregistered securities.
These refer to high income or high net worth individuals or entities that has enough financial sophistication to accept and understand all the risks associated with investments that may not be understood or accepted by the general population.
Before Dodd-Frank reforms, the terms qualified investor and accredited investor had a small difference.
During net worth calculation to identify the status of an accredited investor, the value of a person’s primary residence could be included in the past, but it could not when determining the status of a qualified investor.
But this is not the case anymore these days.
The two calculations ignore the value of the primary residence of the investor, which makes the criteria for qualification for the two classifications the same.
Qualified investor has another meaning as added by the Gramm-Leach-Bliley Act in the Securities Exchange Act of 1934.
“Qualified investor” is the term used to allow institutions to work with you:
- Banks to sell securities to other entities like individuals
- Registered investment companies
- Other banks that invest a minimum of $25 million
- Governments with investments of more than $50 million with no need to register as a broker-dealer.
The Bottom Line
There are many excellent opportunities available out there, but most of the regular and ordinary investors don’t get the chance to access the available alternative investments, real estate projects, and hedge funds.
If you have successfully grown your net worth and want to learn and try some unregistered investments, there is a big chance for you to become an accredited investor yourself.
If you do, you will enjoy numerous benefits that others may not know of.
However, you need to remember that being an accredited investor may mean that you will have to take on more responsibilities and risks.
Be careful in considering where you will put your hard-earned money and ensure that it suits both your financial situation and your portfolio.