It’s only a Matter of Time Before you Hear the Word “Accredited Investor”
If you’ve recently begun learning how to invest, you’ll then wonder what this word entails, how to become an accredited investor, and what the disadvantages and benefits are. In this guide, we’ll go over all of that and more, including accredited investor criteria and real-world examples. Let us begin with the description.
What Exactly Is An Accredited Investor?
An accredited investor is a person or organization permitted to purchase or invest in securities that have not been registered with financial regulatory agencies. The Securities and Exchange Commission is the primary financial oversight agency in the United States (SEC).
The definition is derived from the word “accredited.” This means that the person or organization must meet the appropriate criteria to be accredited. Accredited investors meet asset size, net worth, and income requirements. The standards for business organizations are also dependent on governance.
In a moment, we’ll go over the basic requirements for being an accredited investor in the United States. It should be noted that the SEC recently extended the concept of accredited investors in 2020. Individuals with unique professional certifications or who are “knowledgeable employees” of a private fund are now included in the concept of an accredited investor.
Requirements for Accredited Investors
The qualifications for being an accredited investor vary depending on where you live. The regulations are defined by the Security Exchange Commission (SEC) in the United States, but they are also decided by local financial regulatory bodies.
You can find the key requirements for being an accredited investor in Regulation D, Rule 501 of the Securities Act of 1933. These regulations are available in the Electronic Code of Federal Regulations.
The following is a rundown of the requirements:
- A salary of more than $200,000. A joint benefit with a partner must be greater than $300,000 per year.
- An individual or couple with a net worth greater than $1 million, except the value of their primary residence.
- Businesses with a value of more than $5 million.
- Earned a professional credential or has been designated as a “Knowledgeable Employee” by a private fund.
You may be thinking, “Why are there so many laws and restrictions?” As a precautionary measure, the accredited investor criteria are very stringent. The SEC does not want inexperienced investors to gamble with their capital. These provisions were enacted to restrict massive, risky investments to those with the financial resources to bear substantial risk and loss. Furthermore, by the time you reach the status of certified, you should be a competent and knowledgeable investor.
An Example of a Qualified Investor
If you’re still unsure whether you’re an accredited investor or not, maybe an example would be useful. Let’s look at how an individual investor can compute their net worth.
Establish a balance sheet that includes all of your assets and liabilities. Next, the total all of your assets, including bank account balances, retirement account balances (such as a 401(k) or IRA), the value of other savings, and tangible assets like your vehicle.
Do not include the value of your primary residence in your list of properties. Remember that one of the qualifications for qualified investors is net worth, which does not include the value of the home in which they reside. Other assets that you own but do not live in can be used.
Then put all of your liabilities together. Student loans, car loans, and credit card debt are common examples of liabilities. Finally, to calculate your net worth, deduct your total liabilities from your total assets. If your total is more than $1 million, you are an accredited investor. Should your net worth be less than $1 million, you would not be considered an accredited investor. If the latter is the case, this knowledge would still be useful to you. At the very least, you now know how far you are from being an accredited investor!
What Would an Accredited Investor Do?
You’re probably thinking about what kind of unique abilities you’d gain as an accredited investor. Companies are required by law to report their investment options, or shares, with the SEC. There are, however, a few notable exceptions. Selling unregistered investments to accredited investors is one of these exceptions. Companies get encouragement to do so because it saves them the hassle of registering their shares with the SEC.
As an accredited investor, you will be able to make the following investments:
- Hedge funds are a form of mutual fund that invests
- Crowdfunding for real estate
- Funds for venture capital
- Funds for private equity
- Investment by an angel
You can invest in stocks, bonds, and mutual funds as an “ordinary” investor. Accreditation as an investor can be thought of as a “promotion”. You will gain access to previously unavailable investment opportunities. However, bear in mind that while these investments can yield higher returns, they can also carry considerable risk. It’s always a good idea to proceed with caution.
Who Is Qualified to Become an Accredited Investor?
So far, we’ve looked at investor accreditation through the eyes of an individual. However, as previously mentioned, financial and corporate organizations may also be included in this group.
The SEC states in Regulation D, Section 501, that the following business organizations can also gain accredited investor status:
- Banking Institutions
- Brokerage services
- Employer-sponsored pension plans
- Firms that provide registered investment advice
- LLCs with a minimum asset value of $5 million
- SEC-registered investment advisory firms
- Companies that invest in rural businesses
- Tribal governments in Native America
Advantages of Being an Accredited Investor
As previously mentioned, the primary advantage of gaining accredited investor status is immediate access to a plethora of new investment opportunities. If you’re serious about investing, this is a big move forward. In certain ways, you’re receiving compensation for reaching a certain degree of net worth and profits.
You will most likely be able to earn higher rates of return with these new investment opportunities. In other words, you will continue to accumulate money, but at a faster pace.
Finally, new investment options are an excellent way to diversify the portfolio. You might, for example, put your money into a hedge fund or take part in large-scale real estate crowdfunding ventures.
The Drawbacks of Being An Accredited Investor
It should come as no surprise that higher-yielding investment opportunities often indicate a higher level of risk. Furthermore, these types of investments usually necessitate a large initial investment. We’re not talking for a few hundred or even a few thousand dollars. We’re talking tens of thousands to hundreds of thousands of dollars at stake. You will lose a lot of money if your investment fails.
Finally, accredited investment opportunities provide higher performance and management fees, ranging from 15% to 20%. Your investment capital can also be locked up for long periods of time.
How to Become a Qualified Investor
After considering the pros and cons, do you believe you are able to become an accredited investor? Remember that only because you are an accredited investor does not obligate you to engage in investment opportunities in which you are not happy.
To become an accredited investor, follow these steps:
- Determine Your Net Worth
In our example section, we explained exactly how to measure your net worth. To summarize, you simply deduct your total liabilities from your total assets. If you included the value of your primary residence, make sure to deduct it as well, according to SEC regulations.
2. Compile Financial Documentation
Following that, you’ll need to collect the records that will help you prove the net worth you estimated earlier. This includes obtaining duplicates of the tax returns, credit reports, bank statements, and retirement and other investment account statements.
3. Obtain verification
Last but not least, it’s time to have yourself tested! When companies issue unregistered shares, the SEC needs them to collect investor questionnaires. You will be required to complete these questionnaires as a means of verification for each organization in which you wish to invest. Prepare to provide personal and financial details, as well as the documents gathered in the previous phase, as evidence.
Finally, to complete the process, you can sign the questionnaire paper. Remember to save a copy for yourself!
If you’ve been wondering how to become an accredited investor, we hope this guide has been useful. The process of becoming an accredited investor is extremely simple. The difficult part is meeting the SEC conditions to obtain the status. However, knowing your net worth is still a good idea. Use this as an opportunity to measure your net worth and see if you are eligible. If not, you’ll know how much more money you’ll need to amass!
Can you see the benefit of being an accredited investor? What types of shares or funds would you invest in if someone could grantee this exclusive status, and why? Please share your thoughts in the comments below!