What is an accredited investor
An accredited investor is a person or a business entity authorized to trade in securities which cannot be registered with the financial authorities. They are entitled to such privileged access if they meet one (or more) requirements relating to income, net worth, asset size, governance status or professional experience. In the United States, 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 information documents. Accredited investors include wealthy individuals (HNWI), banks, insurance companies, brokers and trusts.
DISTRIBUTE Accredited investor
The term comes from the English word “accredited” which literally means a person who has received a special authority or sanction if he meets certain recognized standards. Accredited investors are the most popular for buying securities that are not registered with regulatory authorities like the SEC. Since the capital raising exercise involves a complex and costly process, including regulatory filings, many companies offer securities directly to accredited investors. Companies are exempt from registering securities with the SEC, which saves them a lot of costs, and are allowed to sell the shares to qualified accredited investors. Participants in such types of private placements run the risk of losing their entire investment, and authorities should therefore ensure that they are financially stable, experienced and informed of their risky businesses.
The role of regulatory authorities in such transactions is limited to verifying or providing the necessary guidelines to establish benchmarks so that an individual or entity can qualify as an accredited investor – that is, say that the applicant must have the financial means and the knowledge to take the risks. involved in investments in these unregistered securities. Other areas to which accredited investors have privileged access are venture capital, hedge funds, angel investments and transactions involving complex and higher risk investments and instruments.
Requirements for accredited investors
The regulations for accredited investors vary from jurisdiction to jurisdiction and are often defined by the local market regulator or a competent authority. In the United States, the definition of accredited investor is proposed by the SEC in Rule 501 of Regulation D.
To be a certified investor, a person must have annual income greater than $ 200,000, or $ 300,000 for joint income, in the past two years in the hope of earning the same or more income over the course of the current year. An individual must have earned income above the thresholds, alone or with a spouse in the past two years. The income test cannot be met by showing one year of individual income and the next two years of joint income with a spouse. The exception to this rule is when a person is married during the period of carrying out a test.
A person is also considered an accredited investor if their net worth exceeds $ 1 million, individually or jointly with their spouse. The SEC also considers a person to be a qualified investor if it is a general partner, an executive officer, a director or a related combination thereof for the issuer of non-registered securities.
An entity is an accredited investor if it is a private business development enterprise or an organization with assets exceeding $ 5 million. In addition, if an entity is made up of equity owners who are accredited investors, the entity itself is an accredited investor. However, an organization cannot be formed for the sole purpose of purchasing specific securities.
In 2020, the United States Congress changed the definition of accredited investor to include registered dealers and investment advisers. In addition, if a person can demonstrate sufficient education or professional experience demonstrating his professional knowledge of unregistered securities, he can also be considered as an approved investor.
Purpose of requirements for accredited investors
Any market regulatory authority must strike a fine balance between promoting investment and safeguarding investors.
On the one hand, regulators must promote investments in risky businesses and entrepreneurial activities that may have the potential to emerge as multi-baggers in the future. Such initiatives are risky, may focus on purely conceptual research and development without any marketable product, and may have a high risk of failure. If these companies succeed, they offer a big return to their investors. However, they also have a high probability of failure, which carries the risk that investors will lose all of their investments.
On the other hand, regulators need to protect common individual investors, often less knowledgeable, who may not have the financial cushion to absorb high losses or understand where they are spending their hard-earned money. Therefore, a balanced approach is taken through the provision of accredited investors, who are financially sound as well as knowledgeable and experienced to adapt to the task of being allowed to invest in these non-registered securities and investments.
How to become an accredited investor?
There is no formal agency or process to guarantee the coveted status of an accredited investor. No registration, form filling or request is required, and no certificate is issued by an agency indicating that one is now an accredited investor for this year. Instead, it is the responsibility of the sellers of these securities to take a number of different steps to verify the status of entities or individuals who wish to be treated as accredited investors.
Persons or parties wishing to apply for an accredited investor can contact the issuer of the unregistered securities, who may ask the applicant to complete a questionnaire to determine whether the applicant qualifies as an accredited investor. The questionnaire may need to be accompanied by various attachments, such as account information, financial statements and the balance sheet to verify qualification. The list of attachments can extend to tax returns, W-2 forms, salary statements and even letters from CPA revisions, tax advisers, investment dealers or advisers. In addition, issuers can also assess a person’s credit report for further assessment.
Example of accredited investor
Consider an individual who has earned $ 150,000 in individual income in the past three years and has declared a principal residence value of $ 1 million on a mortgage of $ 200,000, a car worth $ 100,000 with a $ 50,000 unpaid loan, a $ 500,000 401 (k) account and a savings account with $ 450,000. Although this person fails the income test, he is an accredited investor under the net worth test, which cannot include the value of the principal residence and is calculated as assets minus liabilities. The person’s net worth is exactly $ 1 million, which corresponds to their assets of $ 1,050,000 ($ 100,000 plus $ 500,000 plus $ 450,000) minus a car loan of $ 50,000. Since he meets the net worth requirement, he qualifies to be an accredited investor.
The Bottom Line
Money can only be used to the best with appropriate knowledge. It can be tempting for the super rich to earn the coveted title of an accredited investor and to have the opportunity to invest in unregistered investments that are provided by companies such as private equity funds, hedge funds and venture capital companies. While hundreds of commercial enterprises are eagerly awaiting the capital funding of these accredited investors, it is those with deep pockets who should remain aware of the high risks associated with such enterprises. The qualification criteria defined by agencies like SEC are designed to ensure that only the right candidate (s) choose the path of high risk reward.