Accredited Investor Requirements and Options
- November 30, 2023
- by Michael
A special class of investments are only open to what are known as “accredited investors”. How does a person become an accredited investor and what can they invest in that ordinary people cannot? Do they get higher returns more easily? Does it require paperwork? What are the requirements to become an accredited investor? You will get answers to these and other questions in this article.
What is an accredited investor?
An accredited investor is a person who is allowed to invest in securities that aren't registered with the Securities and Exchange Commission (SEC). This opens up the door to many types of securities, funds, and deals that regular people do not have access to. This is with good reason though, as these investments come with more risk since unregistered securities work differently, sometimes uniquely, compared to publicly traded stocks. Oftentimes accredited investor only deals are advertised with high returns, but you have to read the fine print and understand what is going on to be sure it is a solid investment.
To be an accredited investor any of the following can be met:
If any of these conditions are met, congratulations - you are automatically an accredited investor!
1) Net Worth Requirement
The first way to be an accredited investor is based on income. Individuals must have an income greater than $200,000. For married couples their combined income must be above $300,000. The minimum must be met in each of the last two years. There must also be a reasonable expectation of maintaining that level of income in the current year.
2) Income Requirement
Another way to be an accredited investor is based on net worth. An individual or married couple must have a net worth of over one million dollars excluding the value of their person's primary residence. So based on Wealth Meta’s definition of Net Worth, this would be “Investable Net Worth” plus any emergency fund.
There is always debate about whether home equity should be included in net worth calculations. To clear this up for the purposes of accredited investor status, in 2010 a law was passed that subtracted equity in the primary residence from the net worth calculation.
3) Other Pathways
In some cases financial professionals and business entities can meet criteria regardless of income or net worth. The SEC has guidance for attaining accredited investor status for financial professionals and entities.
What kinds of investments can an accredited investor get into?
Accredited investors are able invest directly in the following types of investment vehicles:
- Hedge funds - a pooled investment vehicle that uses a wide range of investment techniques to generate astronomical rates of return. Hedge funds are usually limited liability companies or limited partnerships.
- Venture capital funds - a pool of money that investors commit to investing in early-stage companies. Investors who supply the fund with money are designated as limited partners. The person who manages the fund is called the general partner.
- Private equity deals - investments representing an equity stake in a private company. Any business that is not a public company is part of a substantial universe of private companies, including millions of U.S. businesses. For comparison there are only a few thousand publicly traded companies.
- Equity crowdfunding - trading cash for a stake in a company. Individual investors provide funds to businesses through crowdfunding platforms.
- Angel investment - an angel investor is an early stage investor in a company who gives money to a startup to help it get up and running. Typically, angel investors will receive either convertible debt or an equity stake in the company in exchange for their investment. Sometimes an angel investor will be the first to invest in a new idea. In general, angel investment is made under conditions that are more favorable to the business than later rounds of investment.
- Other private placements - this could be anything for real estate deals, loans, complex derivatives, etc.
- Access to online alternative investment platforms:
- Loans / Equity:
- Real Estate:
What are the downsides of unregistered investments?
Lack of liquidity is one big downside. Your money may not be readily available if you want it back or change your mind. There could be a predefined term (like a loan) where your investment plus interest comes back to you after a given number of months or years. Or the investment term could be indefinite depending on if or when there is a liquidation event (such as selling a property or business).
Complexity and lack of transparency is another big issue. When you put your money in a hedge fund you are handing it over to be managed by the hedge fund manager. They structure it so they have a lot of leeway in what they can do, including taking on hidden risk, using leverage, etc. Of course they want those risks to pay off so everybody wins. The problem is if things go poorly the investors bear the brunt of the losses while the hedge fund manager continues to collect their salary. Each fund is structured differently of course, but ideally the manager has skin in the game.
What is the process to become an accredited investor?
Turns out there is no process - once you meet one of the requirements above, poof - you are an accredited investor. The name accredited sounds like there is some formal process that has to be met, but there isn’t one. If you want to become an accredited investor, you don't need to do any paperwork. When making an investment in one of the unregistered securities above the broker will verify your status independently. But there is no need to tell the Securities and Exchange Commission (SEC).
Conclusion: Accredited investors have access to a much wider array of investments, but investing at this level is complex. It involves additional risk but can come with higher reward.