What is an Accredited Investor?
An accredited investor refers to an individual or institutional investor who has met certain requirements set by the U.S. Securities and Exchange Commission (SEC) in the US. Accredited investors are allowed to repurchase securities that are not available to other investors and that have not been registered with the appropriate regulatory authority.
The SEC requires such an investor to meet certain requirements, which include asset size, net worth, annual income, or professional experience. Typically, accredited investors include high-net-worth individuals, investment banks, brokers, insurance companies, etc.
In the United States, securities must be registered with the SEC before they can be offered for sale to the public. The SEC provides an exemption to certain securities that the issuers plan to sell to accredited investors. Such securities are unregistered, and the issuer must verify that the potential accredited investors meet the requirements set by the SEC.
The registration process for securities is usually expensive, and by being exempted from the registration process, the companies save a lot of money. Due to the high risk involving unregistered private placements, financial authorities like the SEC must verify such transactions and ensure investors are experienced and financially stable to engage in such investments.
Requirements to Become an Accredited Investor
The specific requirements for an individual or institution to become an accredited investor vary from one country to the other. For example, the United States, Canada, the United Kingdom, Brazil, Australia, Israel, etc. all impose different requirements for accredited investors.
The requirements are determined by the local financial regulator. In the United States, the SEC is responsible for setting the requirements, which are outlined in Rule 501 of Regulation D.
The requirements for becoming an accredited investor in the United States are as follows:
1. Annual Income
A person must have an annual income that exceeds $200,000 or $300,000 for joint incomes for the last two years. The individual must also expect the same or higher revenue in the current financial year. The requirement covers an individual who has earned the income alone or with a spouse during the last two years.
2. Net Worth
A person must have a net worth of $1 million or higher, either alone as an individual or jointly (if married) at the time of purchase. The valuation of net worth excludes the value of the primary residence of that individual or married couple. An individual who is a general partner, director, or executive officer for the issuer of the unregistered securities may also be considered as an accredited investor.
3. Entity Net Worth
An entity may also be accredited if it is an organization with assets valued at $5 million or higher. The entity may also be considered an accredited investor if its owners are accredited investors.
However, an entity may not be allowed to become an accredited investor if it was formed for the sole reason of purchasing unregistered securities. The definition of an accredited investor was modified by the US Congress in 2016 to include investment advisors and brokers.
How to Become An Accredited Investor?
There is no formal process that an individual or institution can follow in order to become an accredited investor. Instead, the task of verifying whether an individual or institution is an accredited investor lies in the hands of the seller of unregistered securities.
The seller is required to verify the status of any individuals or institutions that are interested in buying the securities as accredited investors. In September 2013, the SEC made it mandatory for issuers of securities to take several steps to verify the status of individuals who want to buy the securities as accredited investors.
Generally, an investor is required to fill a questionnaire that requires various details such as annual income, address, net worth, etc. They are also required to attach supporting documents such as financial statements for the last two years, account information, tax returns, and salary slips.
Also, some issuers of securities may require additional information such as the latest credit reports and letters of reviews from financial advisors and attorneys that support the information they have declared in the questionnaire.
Regulation of Accredited Investors
One of the reasons why financial regulators set requirements for accredited investors is to protect investors who may not be familiar with the investments they are investing in and, therefore, subject themselves to high risks of losing their money.
By setting such strict requirements, the regulator ensures that the investors who earn the coveted accredited investor title are those who are knowledgeable about high-risk investments and financially stable to absorb any losses resulting from unregulated securities. In simple terms, the rules are aimed at protecting the investors rather than the issuers of unregulated securities.
Regulators require accredited investors to meet specific stringent qualifications as a way of promoting risky but high potential securities that can become successful in the future. Instead of limiting the trading of risky securities, regulators set limitations to allow only the most qualified and financially stable investors to invest in unregistered securities. Such investors can make huge returns when the securities become successful, and still absolve losses if the securities fail to yield the expected returns.
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