Becoming an Accredited Investor: A Guide
Many investors are interested in opportunities outside traditional investments. However, they may be discouraged to find that not all investment opportunities are open to them. Many private investment options, such as hedge funds or private equity, aren’t registered with the Securities and Exchange Commission (SEC), often because they’re riskier and less liquid. As a result, SEC regulations restrict these opportunities to ‘‘accredited investors’’ under regulations such as Regulation D Rule 506(c).
This article will explain what it means to be an accredited investor, different ways to become accredited, and the benefits of being accredited.
What is an Accredited Investor?
The Securities and Exchange Commission (SEC) defines an accredited investor in several ways, primarily focusing on income, net worth, and professional qualifications. According to SEC regulations, an accredited investor is:
A natural person who has:
Earned income exceeding $200,000 in each of the last two years (or $300,000 together with a spouse or spousal equivalent) and reasonably expects to maintain the same income level in the current year or
A net worth exceeding $1 million, excluding the value of the person's primary residence.
Investment professionals with specific licenses in good standing (e.g., Series 7, Series 65, or Series 82).
Directors, executive officers, or general partners of the company selling the securities.
A "knowledgeable employee" of the issuer of particular securities, as defined in rule 3c-5(a)(4) under the Investment Company Act, of the issuer of securities where that issuer is a 3(c)(1) or 3(c)(7) private fund.
Specific family clients of a family office that qualifies as an accredited investor.
SEC-registered broker-dealers or SEC-or state- registered investment advisers, or exempt reporting adviser.
While entities can qualify as accredited investors, this article primarily focuses on individual investors.
How to Become an Accredited Investor
There are several ways to qualify as an accredited investor, depending on income, net worth, or professional credentials. Here are the primary routes to becoming accredited:
Meeting Income Requirements
Many high-income professionals-like executives, doctors, and lawyers-already qualify based on their annual earnings. However, many people who have tenure in their company or work in high demand fields are also meeting these income levels when combined with a spouse’s income. Fund sponsors will require documentation to confirm that a prospective investor meets the accredited investor definition and is suitable to be included in the investment opportunity. They will ask potential investors to have tax documents that show income at these levels. For those who are not quite earning or have only started earning those required levels, it is important to consider whether their or their spouse’s current employment situation allows for growth into these ranges or would it take more time or possibly more education to get to those income levels. A question to consider is whether it is possible to get certificates, licenses, or degrees for increased earning potential through promotions or better paying jobs? Many times, future accredited investors are closer on the income qualification than they realize.
Some wage earners have additional time on their hands and seek additional income streams. Before starting a new endeavor, it is important to consider the time and the capability of having a side business or additional job. The income would need to be sustainable for at least two years and beyond to meet the income requirement related to the accredited investor definition. Many professionals have set up coaching or consulting businesses that don’t conflict with their primary job. Others have considered creating content, design work, administrative work, or other consulting work through sites like Fiverr and upwork. Many professionals who work shifts have found that they can do other work on their days off. With technology, it is more possible than ever to fit in additional income streams.
2. Building Net Worth
Another route to accreditation is through net worth. Net worth is defined as assets minus liabilities. It is recommended to review net worth at least quarterly. As factors change, it is a best practice to review and look for fraud or areas of concern that may need adjusting.
According to the SEC definition of ‘accredited investor’ when factoring net worth, a person’s primary residence does not count in the equation unless the mortgage is more than the value of the home and then it would negatively impact the net worth. Since a primary residence doesn’t factor into the net worth equation, those that are nearing retirement may opt to sell their home turning that equity into liquidity. Speaking with a tax professional and financial planner about ways to reduce expenses and taxes while maximizing income and net worth potential is helpful.
Those who are decades from retirement may not think about their retirement accounts counting towards their net worth. It is important to understand what the employer match is, what the plan is allocated to, how much of the funds in the account would be available to be liquidated, and plans that are available within the employer’s plan. Usually, employer plan custodians have educational resources and tools to help employees understand their options and the risk and benefits associated with their plan’s offerings. Many financial advisers will review the plans as part of a financial planning session and make recommendations on maxing out the employer’s matching percentage which has potential tax savings benefits as well.
As time passes, people tend to acquire art, jewelry, pay off vehicles, and acquire or inherit other valuable assets. It is important to know the value of these assets. If they are appraised or insured, there is documentation to back inclusion in a net worth equation. Any debt on the assets will still need to be subtracted from the value of the asset. Second homes with positive equity also count towards net worth.
3. Employment as a "Knowledgeable Employee"
Another path to being an accredited investor is working for the issuer of the security as a knowledgeable employee and then, if allowed, they would be able to invest in their company’s fund as an accredited investor. There are specific definitions as to what being a knowledgeable employee entails.
This term is defined in rule 3c-5(a)(4) under the Investment Company Act of 1940 (17 CFR 270.3c-5(a)(4)) as “an Executive Officer, director, trustee, general partner, advisory board member, or person serving in a similar capacity, of the Covered Company or an Affiliated Management Person of the Covered Company; or. (ii) An employee of the Covered Company or an Affiliated Management Person of the Covered Company (other than an employee performing solely clerical, secretarial or administrative functions with regard to such company or its investments) who, in connection with his or her regular functions or duties, participates in the investment activities of such Covered Company, other Covered Companies, or investment companies the investment activities of which are managed by such Affiliated Management Person of the Covered Company, provided that such employee has been performing such functions and duties for or on behalf of the Covered Company or the Affiliated Management Person of the Covered Company, or substantially similar functions or duties for or on behalf of another company for at least 12 months.
4. Obtaining Financial Licenses
Obtaining specific financial licenses can provide another route to becoming accredited for those without the necessary income or net worth levels. The licenses include:
Series 7 (General Securities Representative License)
Series 65 (Investment Adviser Representative License)
Series 82 (Private Securities Offerings Representative License)
More than simply passing the exams is required; license holders must be in good standing and demonstrate knowledge and experience in financial and business matters to evaluate the merit and risks of a prospective investment. These license holders must be able to be found on a publicly available, relevant self-regulatory organization or other industry body website.
Benefits of Being an Accredited Investor
Accredited investors have access to a wide range of privately held investment opportunities, including:
Hedge Funds
Private Equity Funds
Venture Capital Funds
Private Real Estate Investment Funds
Private Placements
Fund-of-Funds
Direct Offerings of Private Companies
These investment vehicles often offer higher returns than traditional investments but come with more significant risks and less regulatory oversight. Accredited investors typically work with financial advisers to help balance these higher-risk investments within a diversified portfolio.
In addition to potentially higher returns, accredited investors can benefit from tax advantages and other unique opportunities unavailable to non-accredited investors.
Final Tips for Prospective Accredited Investors
If you're considering becoming an accredited investor, here are a few key steps to get started:
Take Stock of Your Financial Situation: Review your income, assets, liabilities, and investments to determine your status in relation to the accredited investor criteria.
Educate Yourself: Understand the investment opportunities available to accredited investors. Attend seminars and webinars or read materials on financial markets and private investments.
Consult a Financial Adviser: Align your investment strategies with your financial goals. A financial adviser can help you assess your eligibility and ensure your portfolio is well-balanced.
Conclusion
Becoming an accredited investor opens doors to investment opportunities that are typically out of reach for most individuals. Whether you're looking to build wealth through private equity, venture capital, or hedge funds, the journey to accreditation starts with understanding your financial position, gaining the proper credentials, and working with trusted professionals to guide your strategy.
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Important Disclaimer
This blog is intended to be educational and based on reliable information sources. However, nothing in this blog should be considered legal, tax, financial, or any other type of professional advice. All investors should consult with their own financial, tax, legal, and other advisors to determine whether an investment suits their situation.
