An accredited investor — also called a qualified investor — is a designation that allows certain investors access to unique investment opportunities that retail investors and the general public cannot access. These opportunities can be illiquid and high-risk, yet they are more plentiful than ever due to the number of investors looking for alternatives to diversify their portfolios. Many investments are only available to accredited investors due to the inherent risks.
Though the risks with these investments can be higher, so can the rewards. Knowing the requirements of an accredited investor in terms of process and qualifications could help you gain privileged access to appealing opportunities.
What Is an Accredited Investor?
An accredited investor is a person or entity with a net worth or earning capacity high enough to deal, trade and invest in alternative assets and absorb financial losses in case of a poor investment. Entities that can be accredited investors include:
- Investment broker-dealers
- Charitable organizations
- Businesses and corporations
- Insurance companies
These investment vehicles can sell unregistered, private securities to accredited investors:
- Venture capital firms: These firms invest in young startup companies, and since their investments could be inherently risky, they require accredited investors.
- Hedge fund investments: Since hedge funds usually make more speculative investments, they only work with qualified investors.
- Private equity funds: Most forms of private equity investing need accredited investor status.
- Real estate investment platforms: Real estate investment providers such as 1031 Crowdfunding offer some investments that are only available to qualified investors.
These private funds will decide what information they want to include in their prospectus, the document that describes the investment to potential investors. Accredited investor opportunities are exclusively available to credentialed investors to ensure they adequately understand this information.
While registered offerings come with some level of risk protection through disclosure and reporting requirements, accredited investor opportunities typically do not. This lower need for protection from risk is why many funds prefer to work with accredited investors rather than retail investors.
The assumption is that the investors will undertake due diligence by using their investment and financial expertise to evaluate the investment's merits. If they make a poor investment decision, they have the financial means to absorb the loss better than retail investors. Though investors cannot sell private securities right away in most cases, most accredited investors can afford to have some of their assets tied up in an illiquid investment.
Accredited Investor Requirements
The U.S. Securities and Exchange Commission (SEC) guides and defines the accredited investor qualifications for people, trusts and entities.
A "natural person" becomes an accredited investor by meeting at least one of the accredited investor criteria.
According to the SEC, the accredited investor financial qualifications include:
- Net worth qualification: Your a) individual net worth or b) joint net worth with your spouse or spousal equivalent must exceed $1 million when you make the investment.
- Earned income qualification: For the last two tax return years, you must have had a) an annual pre-tax income over $200,000 or b) a joint pre-tax income with your spouse over $300,000. There must also be a realistic expectation of the same or higher income for the current year.
Besides these financial tests, you can have certain professional credentials, certifications and designations to be qualified as an accredited investor, including:
- Licensure qualification: You must hold a Series 7, Series 65 or Series 82 license in good standing from the Financial Industry Regulatory Authority (FINRA).
- Knowledgeable private fund employee qualification: You must be an executive officer, director or similar position of the private fund or an employee of the private fund who has participated in its investment activities for the last year.
Trusts and Entities
Rule 501 also establishes accredited investor rules for trusts and entities. Qualified investors in this category include:
- A trust with total assets of $5 million or more directed by a sophisticated person — a person who has the knowledge and experience in finance and business necessary to evaluate the value and risks of a potential investment — and formed to make purchases beyond the subject securities.
- An entity with over $5 million in total investments where a) all owners are accredited investors and b) the entity was formed to make purchases beyond the subject securities.
Rule 501(a) of Regulation D of the Securities Exchange Act of 1933 established the definition and requirements for accredited investors. These parameters may change in the future if new laws are passed.
How to Calculate Your Net Worth
You must have a net worth of $1 million or more to pass the net worth test and become a Regulation D-accredited investor. You can calculate your net worth alone or with your spouse or spousal equivalent at the time of the securities sale. For joint net worth, you and your spouse may hold properties individually and purchase your securities individually or jointly.
You can calculate your net worth by adding your assets together, then subtracting your liabilities. Here are some examples of assets you can include in your net worth calculation:
- Bank accounts
- 401(k) plans
- IRA accounts
- Car value
- Vacation and investment properties value
- Student loans.
- Car loans.
- The balance on your home equity line within the past 60 days.
- The portion of your mortgage that is underwater.
Some exceptions for what is considered an asset or liability include:
- Home value: The Dodd-Frank Act of 2010 excludes the value of your primary residence as an asset for net worth calculation. This rule is excepted if you were an accredited investor and purchased your primary residence before July 20, 2010.
- Loans on the primary residence: Debts secured by a primary residence — like mortgages or loans — are excluded from your liabilities up to the residence's fair market value. If the loan is more than the fair market value, the difference between these two figures counts as a liability.
- Home equity line of credit: While home equity lines of credit and outstanding balances on the home equity line are not liabilities, any increase in the loan amount in the 60 days before you purchase securities does count as a liability. This standard prevents artificially inflating the net worth by converting home equity into other assets.
How to Prove You're an Accredited Investor
Often, you can prove you are an accredited investor through self-proclamation — there is no verification requirement for securities offered under Rule 506(b) of Regulation D. However, due to the fact that there is no official certification, all organizations offering investment opportunities are responsible for ensuring you fit the qualified investor criteria. Therefore, you will need to prove you are an accredited investor if asked.
If an issuer is making a securities offering under Rule 506(c) of Regulation D, they must verify their investors hold the necessary qualifications. These groups may ask you for documents that illustrate your net worth or income to prove your accredited investor status, such as:
- Financial and bank statements
- W-2 forms
- Tax returns
- Brokerage account statements
- Credit report to disclose liabilities
- Third-party statements from acceptable institutions, like your financial advisor, broker, attorney or certified public accountant (CPA)
- Business ownership documentation, like an operating agreement and tax filings
- Proof of professional credentials, certifications and designations
The Benefits of Accredited Investor-Exclusive Deals
The accredited investor status allows individuals to invest in exclusive deals, which bring these benefits:
- Unique investment opportunities: Accredited investors can put money into potentially lucrative investments the general public cannot access, such as hedge funds.
- High returns: Accredited investor opportunities could offer more diversified options and have higher return rates than other investments so that you can build more wealth in less time.
- Hassle-free real estate investments: Qualified investors can invest in profitable real estate opportunities without becoming landlords or flipping properties themselves.
- Significant financial resources: For an investor to become accredited, they must have a substantial net worth or income. Their financial state means they can afford to take a loss if an investment gives a poor return.
What Happens if You're Not an Accredited Investor?
While accredited investors have access to exclusive funds, investment opportunities are also available to help nonaccredited investors grow their wealth. Many firms allow accredited and nonaccredited investors to invest in various alternative asset classes. Adults with a brokerage account, 401(k) or individual retirement account can invest in the following assets:
- Publicly traded stocks.
- Mutual funds.
- Publicly traded real estate investment trusts.
Why Does the SEC Restrict Certain Investments?
The SEC restricts some investments to accredited investors in order to:
- Protect investors: The requirement to become an accredited investor ensures that investors understand the risks of their potential investment, have the finances to protect themselves in the event of a significant monetary loss and do not invest beyond their means. Qualified investors are usually more financially sophisticated and can afford to do without the protection a novice investor would require.
- Exempt some companies from registration: Companies must register the securities they sell to protect investors. In some cases, meeting the requirements for registering securities can be a financial burden. When a security is only offered to accredited investors, it is exempt from SEC registration. In these cases, the SEC presumes qualified investors possess the knowledge to evaluate and are prepared for the risks of their investments.
What Should I Do as an Accredited Investor?
Some steps an accredited investor should take before their first investment are:
- Gain investment experience: Have some general investment experience before investing in private securities. Learn about industries you want to invest in and practice conducting due diligence.
- Know the costs: Most private investments have substantial fees, lockup periods and limited to no liquidity. Be aware of the terms before you invest.
- Conduct due diligence: Review application documents like offering documents and the private placement memorandum before signing, partner with a reputable broker or fiduciary, and do everything needed to ensure you are conducting due diligence with your investments.
See More Investment Opportunities for Accredited Investors With 1031 Crowdfunding
Real estate has become an increasingly popular investment for accredited investors in recent years. You can build wealth through real estate while diversifying your portfolio from traditional investments. The first step toward real estate investment is Joining the Crowd at 1031 Crowdfunding.
Once you have established yourself as an accredited investor, you can begin investing in alternative assets. If you are an investor in a 1031 exchange, you may want to consider a Delaware Statutory Trust, a turnkey solution available through 1031 Crowdfunding. We are a leading real estate investment platform with an online marketplace of vetted real estate properties. We offer all the documentation you'll need to conduct your due diligence. You can close your deal in as little as three to five days for a stress-free 1031 exchange.
Connect with 1031 Crowdfunding to see our exclusive opportunities for qualified investors. Join the crowd by registering for an account today.