While everyone can invest, not all securities are accessible to every investor in the market. For example, unregistered investments like private equity, venture capital funds, startup companies, and some real estate ventures are not available for all investors.
You first need to be an accredited investor to access those investments. To become one, you need to have either the income or knowledge to handle the bigger risks associated with unregistered investments. Here’s what you need to know about being an accredited investor.
Accredited Investor Explained
An accredited investor is an individual or company eligible to put money into assets not regulated by the Securities and Exchange Commission (SEC).
Such unregistered securities tend to have a high-profit potential. However, they are riskier and can be pretty complicated, which is why they are only offered to sophisticated, high net worth investors such as:
- Hedge Funds
- Private Equity Firms
- Angel Investors
- Venture Capital Funds
- Shares of Startups
- Real Estate Crowdfunding Vehicles
There are two reasons security needs to be registered with the SEC. First, to ensure an investor’s safety from fraud.
Second, to ensure that he receives full disclosure regarding the assets and issuers. Complete financial disclosure allows investors to stay posted about the crucial things that can significantly affect their investment decisions.
Criteria for Becoming an Accredited Investor
Individuals or companies may qualify as accredited investors based on their income or wealth. In addition, they need to be financially well-versed to grasp complicated, unregistered securities and have the financial capabilities to remain on stable grounds after a complete loss of the invested capital.
However, you don’t go through an official process to become an accredited investor. There is also no government agency or independent body that qualifies a person or entity as an accredited investor.
Instead, firms and financial institutions that offer unregistered investments are given the task of confirming whether their investors are accredited through due diligence before selling their securities.
To learn more about what makes an individual or company an accredited investor, here’s a further look into the criteria. Keep in mind that a person or couples who fall under one of the following criteria are considered accredited investors:
Individuals with income of $200,000 or higher and couples with income of $300,000 and higher for two straight years can qualify as accredited investors. They also need to show that their income source is the same every year, and there should be a realistic forecast of equal or more income in the next year.
Under the net worth category, an accreditor investor is someone with a net worth of $1 million and above, either as an individual or a couple, when the securities were sold. The value of an investor’s primary residence has been excluded from the net worth calculation.
Individual investors with particular professional designations can also be considered accredited investors. These credentials require specific licenses from the Financial Industry Regulatory Authority (FINRA), such as Series 7, Series 65, and Series 82.
Knowledgeable Employee Status
People working for a firm that issues unregistered securities are known as “knowledgeable employees.” They qualify as accredited investors for investments in the company, and the status can extend to their spouses for the joint investments they made in the firm.
Being Recognized as an Accredited Investor
Being recognized as an accredited investor is a process that involves the seller (i.e., company or financial institution) of the unregistered assets and buyer.
Sellers usually take the following steps to verify that the potential investors are accredited investors in terms of their income or net worth:
Step #1: Provide potential investors with detailed questionnaires.
Step #2: Get confirmation through financial statements, tax returns, or other financial information to ensure that the income or net worth requirements have been met.
Step #3: Review the credit report to confirm the net worth and identify any outstanding liabilities.
Step #4: Ask for an attestation letter from a financial advisor, certified public accountant (CPA), or tax attorney.
If you’re looking to become an accredited investor as a knowledgeable employee, you need proof of your position as a director, general partner, or executive at the issuing company. Governing documents, resolutions, or other supporting credentials can be accepted as proof.
On the other hand, if you’re trying to qualify via professional designations, you can provide verification of securities licenses from FINRA.
Reasons to Become an Accredited Investor
Perhaps the most significant benefit of becoming an accredited investor is that it allows you to invest in assets with higher profit potential even though a higher risk is involved. Plus, the returns generated by unregistered securities are less correlated to traditional securities and the overall market.
Moreover, being an accredited investor grants access to a broader range of investment opportunities, private funds, and unique assets that can help enhance your portfolio diversification.
The Problem with Being an Accredited Investor
While unregistered investments can yield higher returns, you, as an accredited investor, will be dealing with the possibility that you would either go home with some or no capital at all.
In addition, private equity funds, hedge funds, and other similar investment vehicles usually require investors to make an initial investment of $100,000 or higher.
Those types of investments also have a lock-up period, a specific timeframe that keeps investors from redeeming or selling their shares of the investment. Therefore, you should be ready for less liquidity.
Lastly, being an accredited investor also means you need to take care of high fees. Hedge funds usually use the two and twenty fee structure, which involves a 2% annual management fee and a 20% performance fee charged on profits.
Wrapping It All Up
The path of an accredited investor is not for everyone to take. Wealth is the most critical standard, with some exceptions. It is believed that high-net-worth individuals are more familiar with the financial world and have the financial capabilities to withstand considerable losses.
However, individuals who fit in SEC’s requirements may find opportunities in the broad investing space and the potential for bigger profits. Overall, being an accredited investor who can put money into unregistered securities can take your wealth-building further.