This content is created by AP Buyline in accordance with AP’s editorial guidelines and supervised and edited by AP staff. Our evaluations and opinions are not influenced by our advertising relationships, but we may earn commissions from our partners’ links in this content. Learn more about AP Buyline here.
In a nutshell
If you want to invest in hedge funds, real estate syndications, or start-ups, you might need to be an “accredited investor.”
- An accredited investor is a person or entity (i.e. a business) that’s eligible to invest in certain opportunities that regular investors are prohibited from.
- While not every single investing opportunity requires you to be an accredited investor, it’s good to know your options and whether or not you should work towards this qualification.
What is an accredited investor?
An accredited investor is a benchmark requirement that demonstrates a person or an entity is financially solvent enough to risk a sizable amount of capital in a more risky or illiquid investment. Venture capital firms and investment bankers are required to limit their fundraising to accredited investors to protect individuals or institutions from financial hardship if the investment fails.
To put it another way, having the designation of an accredited investor is like having a badge showing you legitimately have money to invest in various opportunities. When companies only allow accredited investors to be a part of an opportunity, they’re adding a safeguard to a riskier type of investment.
Where does the term “accredited investor” come from?
In 1929, the U.S. experienced a catastrophic stock market crash, which led to the Great Depression. Congress, to prevent future crashes, created the Securities Act of 1933. The point of this Act was to require more transparency when it came to investments to prevent fraud.
However, this Act only applied to investments registered with the SEC. If an investor doesn’t want to register with the SEC, they can be exempt if they meet certain criteria. One aspect of that criteria is Regulation D Rule 501. This regulation states that if companies want to qualify for certain exemptions, they can only sell securities to accredited investors. This rule created the initial definition and qualifications of accredited investors.
What are the requirements to become an accredited investor?
Becoming an accredited investor isn’t like becoming a chartered accountant or passing the bar exam. Rather, it is a verification process set up by companies to check if your financial situation and/or experience qualifies you to participate in their funding round.
Usually, you’ll have to release financial statements to them, including W-2s, tax returns, brokerage statements, and more. Or, if you’re qualifying because of your experience, you’ll likely need to show evidence of your licenses, such as a Series 7, Series 65, or Series 82 license.
Who can be an accredited investor?
There are two sets of criteria that investors must meet in order to be considered accredited.
Financial criteria
- Have a net worth of $1 million or more individually (or combined with a live-in significant other), excluding the value of your primary residence.
- Have an income of $200,000 or more ($300,000 if combined with a significant other) during each of the last two years. You must also prove you’ll likely make this amount again the next year.
Professional criteria
- Have a Series 7, 65, or 82 license.
- Be an officer, partner, or director of the company that is selling the securities.
- Be a “knowledgeable employee” of the fund looking for investors.
- Be a “family client” of a “family office” that qualifies as an accredited investor entity.
Entities that qualify as accredited investors
There are many types of entities (versus individual investors) that can qualify as accredited investors. Here are some examples:
- Corporations, limited liability companies, trusts, partnerships, 501(c)(3) organizations, employee benefit plans, “family offices” and “family clients” of that office, as long as these entities have assets over $5 million.
- Entities that own investments over $5 million.
- Entities where every one of the owners are accredited investors.
- SEC-registered broker-dealers, SEC- or state-registered investment advisors, and exempt reporting advisors.
- Registered investment companies, small business investment companies, rural business investment companies, business development companies, banks, and savings and loan associations.
Should you be an accredited investor?
Here are a few advantages to becoming an accreditation as an investor.
Greater selection of investment opportunities
This is the main advantage of being an accredited investor. You get a lot more access to opportunities and early-stage offers. Since many of these investments are only available to accredited investors, becoming one means you have the advantage of gaining access to many otherwise inaccessible opportunities.
Potentially higher returns
With these higher-risk investments, there is both a higher chance of failure and a higher chance of outsized returns. Imagine being an early investor in Walmart, Amazon, or Google. Early investors’ returns will be much greater than those who invested after their initial public stock offering (IPOs). Of course, like anything, returns are not guaranteed, and this is why many of these companies require their investors to have advanced financial knowledge and experience.
Increased diversification
Diversification is important when it comes to your investment portfolio. Being an accredited investor gives you access to more opportunities to invest broadly.
On the other hand, there are reasons why you may not be able to or may not want to seek accreditation status.
High minimum investment amounts
You often have to tie up a substantial amount of money to invest in these opportunities. Because an investor is making a significant financial decision, they either need to have a high net worth or sophisticated financial knowledge.
High-performance fees
Due to the attention to detail needed for these more select investments, they often have performance fees. In some cases, these can range as high as 20%, eating up a big portion of your initial investment and returns.
Long capital lock-up periods
Finally, many of these investments might be long-term. With stocks, you can sell anytime the market is open. However, this might not be the case with some of these private investment opportunities. For example, if you are an early investor in a start-up company, you may not be able to see a return on investment until the company’s IPO, which could be years — or never.
Accredited investor rules changes
In the past, to qualify as an accredited investor you had to meet certain criteria including having a net worth of more than $1 million and an income of over $200,000 individually (and more for a couple).
However, in August 2020, the SEC updated the definition of an accredited investor. Now, more types of entities can qualify as accredited investors, including banks, investment advisors, and more.
Additionally, the SEC updated the criteria so that people who are financial professionals with specific certifications are eligible. Furthermore, employees of the company raising funds are eligible as well.
By updating the rules of who qualifies as an accredited investor, the SEC made investment deals more accessible to people who have enough financial knowledge to confidently invest but may not have as high a net worth or income as other accredited investors.
What types of investments require investors to be accredited?
The types of investments that require accreditation are high-risk, low-liquidity ones, such as the following:
- Private equity: When a private equity firm is seeking capital, it will do rounds of fundraising from limited partners. Limited partners put up the capital, and the private equity fund invests it.
- Hedge funds: Since hedge funds specialize in higher-risk, more speculative investments, most only accept accredited investors.
- Startups: When startups need venture capital, they will go to accredited investors to get the money.
The AP Buyline roundup
Being an accredited investor opens doors to exclusive, potentially high-return investment opportunities, such as private equity, hedge funds, and early-stage start-ups. However, it’s important to remember the risks involved. You’ll likely have to put up more capital, you may not see a return for years, and many of these investments come with higher fees.
Frequently asked questions (FAQs)
Here are some frequently asked questions about accredited investors.
What qualifies you as an accredited investor?
You qualify as an accredited investor when you meet one of the following: First, your income exceeds $200,000 (or $300,000 with a spouse) for the last two years. Second, you have a net worth exceeding $1 million, either individually or with a spouse, excluding the value of your primary residence. (Your net worth is your assets including cash, investments, real estate that’s not your primary residence and vehicles) minus your liabilities. Finally, you have certain professional certifications recognized by the SEC, or you are considered a knowledgeable employee of the fund.
How do I prove I am an accredited investor?
Usually, you’ll provide financial documentation to prove either your income or your net worth or both. This can include tax returns, W-2 forms, pay stubs, and other financial statements. Verification is usually done through a platform set up by the company you are investing in.
Can an LLC be an accredited investor?
Yes, if the LLC meets the accreditation requirements, which include having assets exceeding $5M. The SEC has more detailed information on what type of entities qualify as accredited investors.
Can I invest without being an accredited investor?
Yes, there are many investments you can make without being an accredited investor. These include stocks, bonds, precious metals, commodities, mutual funds, and ETFs. Only private opportunities like private equity rounds, hedge funds, and startups are restricted to accredited investors.
Where do accredited investors put their money?
Accredited investors have access to all investments the ordinary public has access to, plus private equity funding rounds, startup funding, and hedge fund investment. Accredited investors can put their money in any assortment of these options.
What happens if you lie about being an accredited investor?
You shouldn’t lie about being an accredited investor. Typically, it’s the fundraising entity’s responsibility to certify accredited investors before moving forward. However, if a firm doesn’t do this, they could be liable for violating SEC rules. If you lie about being an accredited investor and want to get your money back, you will likely have to hire legal help, which can be more expensive than becoming accredited. Ultimately, it’s not worth participating in an investment deal that requires you to be an accredited investor unless you are one.
This content is created by AP Buyline in accordance with AP’s editorial guidelines and supervised and edited by AP staff. Our evaluations and opinions are not influenced by our advertising relationships, but we may earn commissions from our partners’ links in this content. Learn more about AP Buyline here.
