What Is an Accredited Investor?
An accredited investor is an individual or a business that is allowed to buy and sell securities that are not registered with financial authorities, such as shares in new businesses that have not yet gone public.
Accredited investors get this designation by satisfying at least one requirement regarding income, net worth, asset size, governance status, or professional experience. In the U.S., the term is used by the Securities and Exchange Commission (SEC) under Regulation D to refer to investors who are financially sophisticated and have a reduced need for the protection provided by regulatory disclosure filings.
Accredited investors include high-net-worth individuals, banks, insurance companies, brokers, and trusts.
Key Takeaways
- Accredited investors are defined by the SEC as qualified to invest in complex or sophisticated types of securities that are not closely regulated.
- Certain criteria must be met, such as having an average yearly income over $200,000 ($300,000 with a spouse or domestic partner) or working in the financial industry.
- Sellers of unregistered securities are allowed to sell only to accredited investors, who are deemed able to bear the risks.
- Unregistered securities are inherently riskier because they lack the normal disclosure requirements that come with SEC registration.
Investopedia / Katie Kerpel
Duties of an Accredited Investor
Accredited investors have privileged access to pre-IPO companies, venture capital companies, hedge funds, angel investments, and various deals involving complex and higher-risk investments and instruments.
A company that is seeking to raise a round of funding may decide to directly approach accredited investors. An example might be a young technology company that has a product in the late development stages and needs more money to launch the product on the market. It is not a public company but hopes to launch an initial public offering (IPO) in the near future.
Such a company might decide to offer securities to accredited investors directly. This type of share offering is referred to as a private placement.
For accredited investors, there is a high potential for risk or reward. The SEC wants to ensure that they are financially stable, experienced, and knowledgeable about their risky ventures.
Requirements for Accredited Investors
The regulations for accredited investors vary among jurisdictions. In the U.S, the definition of an accredited investor is put forth by the SEC in Rule 501 of Regulation D.
To be an accredited investor, a person must have an annual income exceeding $200,000 ($300,000 for joint income) for the last two years with the expectation of earning the same or a higher income in the current year. The income test cannot be satisfied by showing one year of an individual’s income and the next two years of joint income with a spouse.
An accredited investor should have a net worth exceeding $1 million, either individually or jointly with a spouse. This amount cannot include a primary residence.
The SEC also considers applicants to be accredited investors if they are general partners, executive officers, or directors of a company that is issuing unregistered securities.
An entity is considered an accredited investor if it is a private business development company or an organization with assets exceeding $5 million.
Also, if an entity consists of equity owners who are accredited investors, the entity itself is an accredited investor. However, an organization cannot be formed with the sole purpose of purchasing specific securities.
A person can qualify as an accredited investor by demonstrating sufficient education or job experience in the financial industry.
Recent Changes to the Accredited Investor Definition
The U.S. Congress modified the definition of an accredited investor in 2020 to include registered brokers and investment advisors.
According to the SEC’s press release, the amendments “allow investors to qualify as accredited investors based on defined measures of professional knowledge, experience or certifications in addition to the existing tests for income or net worth. The amendments also expand the list of entities that may qualify as accredited investors, including by allowing any entity that meets an investments test to qualify.”
Among other categories, the SEC now defines accredited investors to include the following: individuals who have certain professional certifications, designations, or credentials; individuals who are “knowledgeable employees” of a private fund; and SEC- and state-registered investment advisors.
How to Become an Accredited Investor
People who want to be accredited investors don’t apply to the SEC for the designation. Rather, it is the responsibility of the company offering a private placement to make sure that all of those approached are accredited investors.
Individuals or parties who want to be accredited investors can approach the issuer of the unregistered securities. The issuer may ask the applicant to fill out a questionnaire and provide financial documents.
The required documentation may include account information, financial statements, and a balance sheet. It may extend to tax returns, W-2 forms, salary slips, and even letters from CPAs, tax attorneys, investment brokers, or advisors.
The company may check the applicant’s credit report as part of the assessment.
Most participants in private placements do not have to go through this process. People with certain financial accreditations, managers of hedge funds, and partners in private equity firms are among those who don’t have to prove their credentials to buy unregistered securities.
Example of an Accredited Investor
For example, suppose there is an individual whose income was $150,000 for the last three years. They reported a primary residence value of $1 million (with a mortgage of $200,000), a car worth $100,000 (with an outstanding loan of $50,000), a 401(k) account with $500,000, and a savings account with $450,000.
While this individual fails the income test, they are an accredited investor according to the test on net worth, which cannot include the value of an individual’s primary residence. Net worth is calculated as assets minus liabilities.
This person’s net worth is exactly $1 million. This involves a calculation of their assets (other than their primary residence) of $1,050,000 ($100,000 + $500,000 + $450,000) less a car loan equaling $50,000. Since they meet the net worth requirement, they qualify to be an accredited investor.
Who Qualifies to Be an Accredited Investor?
The SEC defines an accredited investor as either:
- An individual with gross income exceeding $200,000 in each of the two most recent years or joint income with a spouse or partner exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year.
- A person whose individual net worth, or joint net worth with that person’s spouse or partner, exceeds $1,000,000, excluding the person’s primary residence.
Are There Any Other Ways of Becoming an Accredited Investor?
Under certain circumstances, an accredited investor designation may be assigned to a firm’s directors, executive officers, or general partners if that firm is the issuer of the securities being offered or sold. In some instances, a financial professional holding a FINRA Series 7, 65, or 82 can act as an accredited investor.
There are a few less common qualifications, such as managing a trust with more than $5 million in assets.
What Privileges Do Accredited Investors Receive That Others Don’t?
Under federal securities laws, only those who are accredited investors may participate in certain securities offerings. These may include shares in private placements, structured products, and private equity or hedge funds, among others.
Why Do You Need to Be Accredited to Invest in Complex Financial Products?
Accredited investors hear pitches for investments that are not regulated by the government and are not subject to the same disclosure rules that public companies are required to follow.
The regulators want to be certain that participants in these highly risky and complex investments can fend for themselves and judge the risks in the absence of government protection.
The Bottom Line
The accredited investor rules are designed to protect potential investors with limited financial knowledge from risky ventures and losses they may be ill equipped to withstand.
On the flip side, it gives people who already have substantial financial assets a major advantage over those with more modest assets.