Every investment has some level of risk, whether it’s in cryptocurrency or the S&P 500. And in most cases, investors can make the decision for themselves whether they’re willing to accept that risk. But when it comes to some high-risk investment opportunities, the Securities and Exchange Commission (SEC) imposes restrictions on who can invest due to the high level of risk and speculation.
The way to get around these restrictions is by becoming an accredited investor. Accredited investors have access to a wider variety of investment opportunities. And the good news is there’s no formal process to become accredited—you simply have to meet the income and net worth requirements in place.
Are you wondering how being an accredited investor could benefit you? Keep reading to learn how to become an accredited investor, what an accredited investor is, what types of investment opportunities are available to accredited investors, and more.
What is an Accredited Investor?
An accredited investor is a person or institution that meets certain requirements to purchase investment reserved for sophisticated investors. The requirements to become an accredited investor can be met through one’s income, net worth, or line of work.
These requirements help the SEC determine who might have a deep enough understanding of financial and investment matters to make rational decisions, especially in the case of high-risk investments.
The investment opportunities that are only available to accredited investors include unregistered securities, also known as private placements as well as hedge funds, venture capital, and more. The burden lies on the investment firm to ensure their investors.
What is a Qualified Purchaser vs. an Accredited Investor?
You may hear the term accredited investor used interchangeably with the term qualified purchaser. Both are someone who is allowed to make investments not available to most investors, but they are two different things.
Qualified purchasers must be one of the following:
- An individual or family-owned business with more than $5 million investments
- A trust sponsored and managed by qualified purchasers
- An individual or entity that investors at least $25 million on their own behalf or on behalf of others
- Any entity where all owners are qualified purchasers
As you’ll learn below, these requirements for being a qualified purchaser are significantly stricter than the requirements to be considered an accredited investor.
Requirements for Accredited Investors
To achieve accredited investor status and gain access to investment opportunities in unregistered securities and other similar investments, there are several requirements you can meet. It’s important to note that you don’t have to meet all of the accredited investor requirements—just one is sufficient.
Accredited investors must meet one of the following requirements:
- Have an earned income of at least $200,000 (or $300,000 joint income with a spouse) in the previous two years and reasonably expect to continue to maintain that income
- Have a net worth of at least $1 million alone or jointly with a spouse
- Hold a Series 7, 65, or 82 license in good standing
Under the latest definition of an accredited investor, you also qualify based on certain professional certifications, designations, credentials, or professions. For example, you can be considered an accredited investor if you’re employed by a private fund and are considered a knowledgeable employee of the fund. You may also qualify if you're an SEC or state-registered investment advisor.
It’s not just individuals who can be accredited investors. Institutions can also qualify. To be an accredited investor, an institution must be:
- A trust with total assets of at least $5 million that was not formed specifically to purchase securities as long as the investments are purchased by a sophisticated person
- A certain entity with at least $5 million in investments that was not formed specifically to purchase securities
- Any entity where all of the equity owners are accredited investors
For the purpose of an entity qualifying as an accredited investor, the sophisticated person in charge of purchases must be someone the entity offering the funds believes has sufficient knowledge and experience to evaluate the risks and benefits of prospective investments.
How to Become an Accredited Investor?
Many people assume there’s a formal process in place to become an accredited investor or that there’s a certification or other form of documentation that proves your status. However, you become an accredited investor simply by meeting one of the basic requirements.
That means you can qualify if you earn an income of $200,000 (or a combined income of $300,000 with a spouse), have a net worth of $1 million (again, either individually or jointly with a spouse), or reach accredited investor status through your job.
Because there’s no official accreditation process beyond meeting proving your income or net worth, you might already be an accredited investor without realizing it. To see if you qualify, start by looking at your annual income over the past two years (you can refer to your previous tax returns or W-2 statements for you and your spouse) or can also simply look at your net worth (that is, the difference between your assets and your expenses. Note that your primary residence doesn’t count as part of your net worth; nor does a mortgage or debt secured by your primary residence count as a liability for this purpose).
If you’re debt-free and have considerable assets in your investment portfolio, then you may very well qualify.
Further Reading: IPO Investment: Should You Invest in an IPO?
Investment Opportunities for Accredited Investors
The benefit of becoming an accredited investor is that you have access to many investments that aren’t accessible to other investors. The reason the SEC requires someone to be an accredited investor to participate in these opportunities is that they require a certain amount of knowledge.
Suppose you had an investment opportunity in a startup through venture capital or angel investing. These firms aren’t public, meaning they don’t have to meet the disclosure requirements of a public company. They are also high-risk and speculative investments since the companies haven’t proven themselves yet.
A few of other investment vehicles available to accredited investors are:
- Unregistered securities (known as private placements)
- Hedge funds
- Private equity funds
- Venture capital
- Angel investments
- Private real estate investment funds
An individual investor who isn’t accredited may not fully grasp what they’re getting themselves into with these investments. They also may not understand the risks or liquidity restrictions when applicable.
However, through the eyes of the SEC, an accredited investor is sophisticated enough to weigh the risk and benefits of investments—even if the company or fund isn’t required to make the same disclosures that a public company would have to.
How Do Firms Determine if You're an Accredited Investor?
At this point, you might be wondering: If there’s no professional certification or other documentation to prove your accredited status, how do investment firms ensure you qualify? There are a few guidelines in place that companies can follow to verify an investor's accreditation status.
First, the investment fund is likely to use a screening process and ask a series of questions to help determine whether an investor meets the necessary requirements. The fund may also ask for certain documentation from the investor, including:
- Tax returns
- W-2 forms
- Bank and brokerage statements
- Credit report
- Professional certifications, designations, or credentials
Ultimately, the burden lies on the fund to ensure that its investors meet the accreditation requirements. The fund will likely ask for documents to prove your accredited status. But it usually takes the blame if a non-accredited investor ends up investing in their fund. And if a non-accredited investor does invest, they generally have the right of rescission, which allows them to take their money out at any time.
Pros and Cons of Becoming an Accredited Investor
There are both advantages and drawbacks to the investment opportunities available to accredited investors. Of course, these pros and cons only only apply if you actually choose to take advantage of the additional investment opportunities afforded to you. You might have the income and net worth to qualify as an accredited investor, but if you don’t choose to invest in otherwise restricted companies or funds, none of the below apply to you.
- Access to restricted investments
- The potential for higher investment returns
- Greater portfolio diversification
- Easy to meet the requirements as long as you have sufficient income or net worth
- Higher risk of investment loss
- Potentially high investment fees
- Longer lock-up periods for investments
- High minimum investment amounts
- Unsophisticated investors could still qualify as accredited investors
Remember that with great power comes great responsibility. Once you meet the requirements of an accredited investor, you’ll have access to a wider selection of investments. That may include hedge funds, venture capital, private placements, and more. But while those investments could have higher potential returns, they are also likely to have higher risk, investment minimums, and fees.
The good news is that you don’t have to be an accredited investor to invest and get good returns. There are a seemingly countless number of investments available to any investor, many of which have a historical return that keeps up with certain restricted investments.
Further Reading: How to Invest 50k
Disclaimer: The content presented is for informational purposes only and does not constitute financial, investment, tax, legal, or professional advice. If any securities were mentioned in the content, the author may hold positions in the mentioned securities. The content is provided ‘as is’ without any representations or warranties, express or implied.