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- An accredited investor is a person or institution that can invest in unregulated securities.
- To qualify as an accredited investor, you must meet certain qualifications.
- Unregistered securities are inherently risky but often offer higher rates of return.
If you've ever come across an investment available only to so-called accredited investors, you've likely wondered what the term meant.
The label can apply to entities ranging from massive banking institutions and wealthy Fortune 500 companies, all the way down to high-earning households and even individuals. Whether you're seeking more information on how to become an accredited investor, or simply interested in what that would mean, read on for everything you need to know about accredited investors.
Defining an accredited investor
A more sophisticated investor
An accredited investor is an institution or an individual considered sophisticated enough to invest in opportunities that are not available to more regular investors.
Under current finance law, any company that wishes to offer up its securities has two options. It can register with the Securities and Exchange Commission (SEC), operating as a publicly traded entity with a required quarterly earnings report to be made available to both shareholders and the public. Alternatively, it can bypass those regulations, remaining privately owned but continuing to trade through an exemption.
Selling to accredited investors is just one of those exemptions, covered by SEC Rule 501 under Regulation D of the Securities Act of 1933. The rule was drafted as a government response to the Great Depression, granting market access to smaller companies that might otherwise be crushed under the costs accompanying SEC registration.
The accredited investor exemption was extended in 1982 in order to include individuals as well as institutions, provided the former could prove a net worth high enough to cushion against losses that the average investor is shielded from by SEC regulations.
Broader access
Investors without accreditation can manage the full breadth of registered securities like stocks, bonds, and mutual funds. They can also accumulate wealth, purchase real estate, build retirement portfolios, take risks, and reap rewards — the biggest difference is in the scale of these endeavors.
One of the benefits of being an accredited investor is that once you attain this status, it "unlocks" access to products not available to the general public, such as hedge funds, venture capital funds, private equity funds, and angel investing.
This gap in access can be explained by the way that the SEC views each unique product. For example, the SEC considers hedge funds a more "flexible" investment strategy than something like mutual funds, because hedge funds use speculative practices like leverage and short selling.
Since these complex products require extra research and understanding, investors need to demonstrate that they comprehend the risks involved in these types of investments before the SEC is comfortable with them diving in.
How to qualify as an accredited investor
Financial criteria
The US federal government has provided specific accredited investor requirements. According to the SEC, an accredited investor can be anyone who meets one of the following criteria:
Income
An individual with income above $200,000 for each of the two previous years, or joint income with a spouse or spousal equivalent above $300,000 — with an expectation that you'll continue earning at or above those levels, qualifies.
Net worth
An individual or married couple with a net worth in excess of $1 million, excluding their primary residence, also qualifies.
Other
For those who don't meet the income or net worth requirements, there are still options, assuming you can prove that you are a partner, director, or officer at a fund that distributes private investments or hold in good standing a Series 7, 65, or 82 license, which are for financial professionals and require passing an exam.
In 1982, just 1.8% of American households met these qualifications. As of 2020, that number has ballooned to 13.85%, because of income minimums remaining static even as definitions and exceptions have expanded. For example, licensed brokers and investment advisors joined the list in 2016, and accredited finance professionals were added as recently as 2020.
Rounding out the list of accredited investors are institutions like banks, brokerage firms, insurance companies, employer-sponsored retirement plans, and even trusts, provided all of the above can claim assets in excess of $5 million.
An organization can also qualify as an accredited investor if all of its equity owners are accredited investors.
Why it matters
While many are mostly familiar with the SEC's consumer protection efforts, the regulatory authority's obligations are actually twofold. In addition to safeguarding investors, it's also responsible for capital formation — essentially, helping the market accumulate capital. To ensure that those two efforts aren't in conflict, it's sometimes necessary for the SEC to match up high-risk, high-reward opportunities with suitable investors.
That's where accredited investors come in.
Investment access
Private ventures like angel investing and other speculative entrepreneurial activities have a high likelihood of failure, which could mean a loss of the entire initial investment. Instead of choking off funding by insuring and regulating these ventures, the SEC cuts through its own red tape by demarcating a class of investors that it finds qualified to assess those risks independently — and remain solvent if the worst happens.
The assumption is that accredited investors are set loose on a choppy sea, equipped with either an oar or a boat — representing knowledge and wealth, respectively. One helps navigate the unregulated market, and the other will float you to safety should the waves threaten. Meanwhile, the average investor is safe on the beach or paddling in the shallows, safe under the watchful gaze of the lifeguard (i.e., the SEC).
Less regulation
Securities that are available to accredited investors are supplied through private offerings, which may come with fewer regulations than securities offered to more regular investors.
The rationale behind this is that if an individual qualifies as an accredited investor, they have the ability to incur the additional risk associated with these opportunities, because of their substantial assets, investor sophistication, or both.
FAQs
There are certainly risks associated with the unregulated securities that accredited investors can buy.
Yes, you can potentially lose your accredited investor status if you no longer meet the criteria needed to qualify.
You can prove you meet the criteria by providing documentation to the organization offering unregistered securities.
No, accredited investors are not always wealthy. An individual can qualify as an accredited investor by meeting specific income requirements, being an insider or meeting specific licensing requirements.
Hedge funds, private equity firms, investment banks, and venture capital firms all offer investments available only to accredited investors.
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