- An accredited investor is an individual or institution that’s earned special status to invest in unregulated securities such as hedge funds.
- To qualify as an accredited investor, you must meet certain qualifications, such as being a high earner or having a net worth of $1 million.
- Unregistered securities are inherently risky but often offer higher rates of return, allowing accredited investors to build wealth quickly.
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If you’ve ever come across an investment available only to so-called accredited investors, you’ve likely wondered what the term meant.
The label can apply to entities ranging from massive banking institutions and wealthy Fortune 500 companies, all the way down to high-earning households and even individuals. What they all have in common is a combination of access and risk. Access to exclusive investment products like hedge and venture capital funds, and risk in the form of fewer investor protections.
It also happens to be a pool that’s rapidly expanding. So whether you’re hoping to join the rarefied group yourself, or simply interested in the importance of accreditation, read on for everything you need to know about accredited investors.
What is an accredited investor?
An accredited investor is an institution or an individual considered sophisticated enough to purchase unregistered securities and operate outside the regulations that protect the average investor.
Under current finance law, any company that wishes to offer up its securities has two options. It can either register with the Securities and Exchange Commission (SEC), operating as a publicly traded entity with a required quarterly earnings report to be made available to both shareholders and the public. Or it can bypass those regulations, remaining privately owned but continuing to trade by through an exemption.
Selling to accredited investors is just one of those exemptions, covered by SEC Rule 501 under Regulation D of the Securities Act of 1933. The rule was drafted as a government response to the Great Depression, granting market access to smaller companies that might otherwise be crushed under the costs accompanying SEC registration.
The accredited investor exemption was extended in 1982 in order to include individuals as well as institutions, provided the former could prove a net worth high enough to cushion against losses that the average investor is shielded from by SEC regulations.
Accredited investor requirements
According to the SEC, an accredited investor can be anyone who has:
- An individual or joint net worth in excess of $1 million, excluding your main residence
- An individual income above $200,000 for each of the two previous years, or joint income with a spouse or spousal equivalent above $300,000 – with an expectation that you’ll continue earning at or above those levels
For those who don’t meet the income or net worth requirements, there are still options, assuming you can prove that you:
- Are employed at a fund that distributes private investments
- Hold in good standing a Series 7, 65, or 82 license, which are certifications for finance professionals that require an exam to obtain
In 1982, just 1.8% of American households met these qualifications. But as of 2020, that number has ballooned to 13.85%, because of income minimums remaining static even as definitions and exceptions have expanded. For example, licensed brokers and investment advisors joined the list in 2016, and accredited finance professionals were added as recently as 2020.
Rounding out the list of accredited investors are institutions like banks, brokerage firms, insurance companies, employer-sponsored retirement plans, and even trusts, provided all of the above can claim assets in excess of $5 million.
Why accreditation is important
While many are mostly familiar with the SEC’s consumer protection efforts, the regulatory authority’s obligations are actually twofold. In addition to safeguarding investors, it’s also responsible for capital formation – essentially, helping the market accumulate capital. To ensure that those two efforts aren’t in conflict, it’s sometimes necessary for the SEC to match up high-risk, high-reward opportunities with suitable investors.
That’s where accredited investors come in.
Private ventures like angel investing and other speculative entrepreneurial activities have a high likelihood of failure, which could mean a loss of the entire initial investment. Instead of choking off funding by insuring and regulating these ventures, the SEC cuts through its own red tape by demarcating a class of investors that it finds qualified to assess those risks independently – and remain solvent if the worst happens.
The assumption is that accredited investors are set loose on a choppy sea, equipped with either an oar or a boat – representing knowledge and wealth, respectively. One helps navigate the unregulated market, and the other will float you to safety should the waves threaten. Meanwhile, the average investor is safe on the beach or paddling in the shallows, safe under the watchful gaze of the lifeguard (i.e., the SEC).
How do firms determine whether you’re accredited?
In the absence of SEC regulation, the onus is on individual firms to confirm accredited investor status before giving an individual the green light to purchase securities. To prove your status, you’ll likely have to fill out a questionnaire that will ask you to provide variations on the following documents:
- Financial statements. These will show where your money is held and invested, how much of it is there, and how long has it been there.
- Credit report. This will provide a snapshot of your individual net worth.
- Tax forms and returns. This is to confirm your earnings, so remember that you’ll need to present three years’ worth of documents for either you solo, or you and your spouse.
- Professional credentials. This includes any certifications or designations issued by the Financial Industry Regulatory Authority (FINRA), but specifically Series 7, 65, or 82 licenses.
Once you’ve furnished this information and been cleared by your chosen firm, you can invest in unregistered securities that aren’t available to the general public.
Investment opportunities for accredited investors
Investors without accreditation can manage the full breadth of registered securities like stocks, bonds, and mutual funds. They can also accumulate wealth, purchase real estate, build retirement portfolios, take risks, and reap rewards – the biggest difference is in the scale of these endeavors.
But once you become accredited, it “unlocks” access to products not available to the general public, such as hedge funds, venture capital funds, private equity funds, and angel investing. This gap in access can be explained by the way that the SEC views each unique product. For example, the SEC considers hedge funds a more “flexible” investment strategy than something like mutual funds, because hedge funds use speculative practices like leverage and short-selling.
Since these complex products require extra research and understanding, investors need to demonstrate that they comprehend the risks involved in these types of investments before the SEC is comfortable with them diving in.
The financial takeaway
An accredited investor is a person or institution that has met certain SEC qualifications that allow them to trade securities that aren’t available to the public. These regulations are put in place by the SEC and exist to protect the average investor, not just limit them.
If you want to become an accredited investor, that path is only becoming more accessible as the years pass. Talk to your financial adviser to see whether your net worth is approaching the minimums, or consider the licensing exams referenced above. Just know that with the added potential for reward comes attendant risk and increased responsibilities.
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