April 7, 2023

How to become an accredited investor

A step-by-step guide to become an accredited investor

Achieving accredited investor status is a highly coveted goal for many aspiring investors, as it offers access to exclusive investment opportunities that are off-limits to the general public. To become an accredited investor in the United States, you need to meet certain financial benchmarks set by the Securities and Exchange Commission (SEC), such as net worth or annual income.

the SEC has recently updated their regulations on accredited investors, making it possible for individuals with specific knowledge, professional experience, or other credentials to also qualify for accreditation. These new rules went into effect on December 8, 2020, and have opened up new doors for investors who previously didn't meet the financial thresholds.

In this article, we'll guide you through the steps to become an accredited investor, explaining the requirements, benefits, and verification process. By following these steps, you can enhance your investment portfolio and potentially boost your financial returns.

Accredited investor - who is it?

An "accredited investor" refers to an individual or entity who is authorized to invest in investment funds or securities not registered with the SEC, which typically include high-risk investments like hedge funds and venture capital opportunities.

To safeguard inexperienced investors from such high-risk investments, the SEC defines the "accredited investor" term in Rule 501 of Regulation D, determining who is allowed to invest in unregistered securities. Accredited investors are deemed to possess more financial acumen than non-accredited investors and better equipped to endure potential losses on an investment.

The SEC has a duty under the Securities Act of 1933 to shield retail investors from the risk of loss. Therefore, the accredited investor classification pertains to individuals who the SEC believes may have less reliance on the protective measures provided by the Securities Act.

The eligibility criteria for becoming an accredited investor can be generally categorized into two groups:

Individual Investors (Natural Persons)

The SEC has outlined three distinct criteria that a prospective investor can utilize to ascertain their accredited status:

  • Annual Income. - If an investor earned more than $200,000 in the last two calendar years and anticipates earning a comparable income level in the current year, they qualify as an accredited investor Spouses or domestic partners can also qualify if their combined annual income exceeds $300,2es an individual from being an accredited investor, even if they earned more than $200,000 as an individual in the first year and over $300,000 in joint income the following year without hitting the same $200,000 threshold individually For example, suppose an individual earned $299,000 in 2018 while their spouse did not earn any additional income. The next year, their spouse earns $275,000, and they earn $175,000, crossing the $300,000 joint qualification threshold. In that case, they and their spouse are not considered accredited investors because they did not satisfy either of the mandatory thresholds in each of the two required years.
  • Net Worth. - Accreditation status is granted to individuals if their individual net worth (or joint net worth with a spouse or domestic partner) is above $1 million at the time of appraisal, disregarding the value of their primary residence. Similarly, any mortgage linked to the primary residence is not considered a liability if: 1. The mortgage was obtained over 60 days ago, and 2. The fair market value of the primary residence exceeds the mortgage value. It is essential to remember that the $1 million threshold is a net worth assessment, implying that an individual must subtract their liabilities from their assets and achieve a figure greater than $1 million.
  • Experience and Qualifications. - On August 26, 2020, the SEC unveiled a series of revisions to Rule 501(a) of Regulation D that expanded the definition of an accredited investor. These updated regulations came into effect on December 8, 2020, and established new categories of accredited investors based on professional qualifications. Individuals possessing particular professional certifications, designations, or credentials granted by an SEC-approved accredited educational institution may also be eligible for accredited investor status under the new criteria. Currently, the SEC accepts Series 7, Series 65, and Series 82 licenses certified by the Financial Industry Regulatory Authority (FINRA) as initial certifications for determining accredited investor status. However, individuals holding these licenses must remain in good standing with their FINRA-member firm to qualify. The licensing criteria could potentially expand over time, as the SEC keeps updating the list. Moreover, a private fund can also acknowledge certain "knowledgeable employees" as accredited investors, allowing certain fund employees with responsibility for making investment decisions to make private investments in the funds they work for. To be considered a "knowledgeable employee," the individual must be either an affiliated management person or directly involved in the fund's investment activities and have at least 12 months of direct engagement with the fund.
  • Entities (A Group Of Investors Or A Firm). - In order for a business entity to qualify as an accredited investor, it must meet specific and stringent requirements. The two most common methods for an entity to qualify are by being exclusively owned by accredited investors or by maintaining a total asset or investment value of more than $5 million. However, certain types of entities may be eligible for accreditation based on their business type, such as mutual funds, certain banks or other financial institutions specializing in savings and loans, tribal authorities, and registered entities. With the new amendments to Rule 501(a) of Regulation D, the definition of institutional accredited investors has been broadened to include more entity types. Family offices with over $5 million in assets under management and any limited liability company can now be regarded as a qualified institutional buyer. However, the entity cannot be formed solely for the purpose of investing in securities, which is similar to the restriction placed on investment companies.

Where Can Accredited Investors Invest?

In the world of private securities, most investment opportunities are restricted to accredited investors in order to reduce the amount of disclosure required by the issuer to sell securities to a broader audience. These private offerings typically include venture capital and private equity funds, which allow accredited investors to pool their capital to invest in high-risk/high-reward opportunities like startups and small-to-medium-sized businesses with strong growth potential.

Hedge funds are another example of private securities typically reserved for accredited investors. These funds also use pooled funds to employ proprietary investment strategies with the goal of earning higher-than-market returns for investors.

While some real estate crowdfunding platforms are open to the general public, most real estate investments are considered high-risk and are available only to accredited investors. Additionally, accredited investors may have access to specialty investment funds that invest in assets like cryptocurrency or other alternative investments. This could include any portfolio investment in asset classes that are considered insulated from broader market trends, such as artwork, collectibles, and other commodities.

How Can You Confirm You Are An Accredited Investor?

The Securities and Exchange Commission (SEC) mandates that issuers must verify the accredited investor status of every participant in a private placement that employs general solicitation and advertising. The SEC prohibits self-attestations, representations, and other cursory methods of verifying investor status.
Let's delve into the various documents necessary for verifying accredited investor status.

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Individual Verification

To establish accreditation, investors have three options: income, net worth, or professional qualifications.

To demonstrate annual income, investors can provide IRS forms reporting their income for the previous two years, such as Form W-2, Form 1099, Schedule K-1 to Form 1065, and Form 1040.

Net worth can be verified by presenting proof of assets such as bank statements, brokerage statements, deposit certificates, tax assessments, and other relevant value statements. The SEC mandates a $1 million net worth test, requiring investors to provide a credit report listing all outstanding liabilities. The sum of assets minus the liabilities listed on the credit report must exceed $1 million to pass the net worth test. All net worth documentation must be dated within 90 days of purchasing the security to comply with SEC regulations.

The issuer may also ask investors for documents validating the qualifications, credentials, or certifications needed to be considered an accredited investor. For the initial FINRA license categories, investors can easily provide their CRD number, which can be verified on BrokerCheck.

Entity Verification

There are a couple of ways for entity investors to qualify as accredited: total assets and investments or accreditation status of entity owners.

To verify assets, investments, or assets under management, entity investors can provide bank or brokerage statements that demonstrate account balances exceeding the necessary threshold. Just like individual net worth verification, all documentation must be no more than ninety days old.

Alternatively, each owner of the entity (or grantor, in the case of a trust) can confirm their status as an accredited individual by submitting a document that confirms their identity, followed by going through one of the individual verification processes outlined earlier.