A step-by-step guide to become an accredited investor
Accredited investors are a special classification under United States securities law for investors that meet specific financial benchmarks of net worth, annual income or other qualifications set by the Securities and Exchange Commission (the “SEC”).
The SEC recently introduced new rules that came into effect on December 8, 2020. These expand the accredited investor definition to include individuals with specific knowledge, professional experience, or other credentials specified by the SEC.
In this article, we’ll explain how to become an accredited investor. We’ll tell you about the conditions associated with accreditation, the benefits of acquiring an accredited investor status and how to get yourself verified.
Here’s What We’ll Cover In This Post:
- What Is An Accredited Investor?
- Where Can Accredited Investors Invest?
- How Can You Confirm You Are An Accredited Investor?
- Frequently Asked Questions Regarding Accreditation
- Verify Your Accredited Investor Status Through Parallel Markets
Disclaimer: The content in this article is provided only for informational purposes. It should not be considered legal or financial advice on any subject matter included or excluded from this article. Please consult with legal or financial experts, an investment advisor or other professionals before acting based on any information contained in this article.
What Is An Accredited Investor?
An “accredited investor” is an individual or entity permitted to invest in investment funds or other securities that are not registered with the SEC.
These investments, like a hedge fund and other venture capital opportunities, often have fewer regulatory disclosures and are considered to carry a higher degree of risk.
In an effort to protect laypersons from any such high-risk investment, the SEC defines the term “accredited investor” under Rule 501 of Regulation D to determine who is permitted to invest in any unregistered security.
Accredited investors are considered to have more financial sophistication than non-accredited investors and better able to withstand the risk of loss on an investment.
The SEC has a mandate under the United States Securities Act of 1933 (the “Securities Act”) to protect retail investors from such risk of loss, so the accredited investor definition applies to those individuals the SEC deems the protections of the Securities Act to be less important.
Curious to know how an accredited investor is different from a non-accredited one? Check out our article on What is a Non-Accredited Investor? Definitions and Examples.
The qualifications to become an accredited investor can be broadly divided into two categories:
A. Individual Investors (Natural Persons)
The SEC has determined three distinct criteria that can be used by a potential investor to confirm accreditation status:
1. Annual Income
An investor is considered accredited if they’ve earned more than $200,000 in the past two calendar years and reasonably expect to earn a similar level of income in the current year.
Spouses or spousal equivalents qualify if their combined annual income is over $300,000 in each of the two prior calendar years with a reasonable expectation of earning a similar level of income in the current year.
It is essential to note that you need to meet the required income threshold in the same manner for both years. You are not considered an accredited investor if you earned more than $200,000 as an individual for year one but make over $300,000 as joint income for year two without hitting the same $200,000 threshold individually.
For example, suppose you earned $299,000 in 2018 while your spouse did not earn any additional income. The next year, your spouse earns $275,000, and you earn $175,000 (which crosses the $300,000 threshold for joint qualification). You and your spouse are not considered accredited investors because you did not meet either of the requisite thresholds in each of the years required.
2. Net Worth
Individuals qualify for accreditation if their individual net worth (or their joint net worth with a spouse or spousal equivalent) exceeds $1 million at the time of evaluation, excluding the value of their primary residence.
Any mortgage attached to a primary residence similarly does not count against a person’s liabilities so long as:
- It was taken out over 60 days ago and;
- The fair market value of the primary residence exceeds the value of the mortgage.
Remember, the $1 million threshold is a net worth test, which means you have to subtract your liabilities from your assets and get to a number above $1 million.
3. Experience and Qualifications
On August 26, 2020, the SEC announced a series of amendments to Rule 501(a) of Regulation D. These new rules went effective on December 8, 2020, and they effectively expand the definition of an accredited investor.
The new definition permits entirely new categories of accredited investors on the basis of professional credentials. Any natural person possessing specific professional certifications, designations, or credentials issued by an SEC-approved accredited educational institution can also qualify as an accredited investor.
The initial certifications the SEC accepts for determining accredited investor status are the Series 7, Series 65, Series 82 licenses certified by the Financial Industry Regulatory Authority (FINRA) licenses. Any individual holding the requisite license must remain in good standing with their FINRA-member firm to qualify. The licensing requirements may expand over time, but we will see!
A private fund can also recognize certain “knowledgeable employees” as accredited investors - essentially allowing certain fund employees with responsibility for making investment decisions to make private investments in the funds they work for.
Specifically, “knowledgeable employees” must be either an affiliated management person or someone directly involved in the fund’s investment activities, with at least 12 months of direct involvement with the fund.
B. Entities (A Group Of Investors Or A Firm)
Business entities similarly have very stringent accredited investor requirements in order to qualify.
The two most prevalent ways for entities to qualify as institutional accredited investors are:
- To be owned exclusively by accredited investors; or
- Maintain a total asset or investment value of over $5 million.
Certain types of entities qualify as an accredited investor on the basis of their business type - for example, a mutual fund, certain banks or any other financial institution specializing in savings and loans, tribal authorities or other registered entities.
The new rules broadened the entity types that may be considered as an accredited institutional investor. Family offices that meet a $5 million in assets under management threshold and any limited liability company can now be regarded as a qualified institutional buyer.
The main restriction for entity accreditation aside from financial metrics is a prohibition against forming the entity for the specific purpose of investing in securities - similar to an investment company.
Where Can Accredited Investors Invest?
Almost every investment opportunity in the private securities market is reserved for only accredited investors to minimize the amount of disclosure that would be otherwise required of the issuer to sell securities more broadly. The categories of private offerings typically limited to accredited investors include:
- Venture Capital & Private Equity Funds In a venture capital or private equity fund, accredited investors pool capital to invest in high-risk/high-reward opportunities like startups and SMBs with strong growth potential.
- Hedge Fund A hedge fund similarly uses pooled funds to employ proprietary investment strategies in an effort to earn higher-than-market returns for investors.
- Real Estate Crowdfunding While certain 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.
- Specialty Investment Funds Accredited investors also have access to any special fund that invests in assets like cryptocurrency.
- Other Alternative Investments This includes any portfolio investment in asset classes considered insulated from broader market trends, like artwork, collectibles, and other commodities.
How Can You Confirm You Are An Accredited Investor?
For a private placement that utilizes general solicitation and advertising, the SEC requires issuers to proactively verify that each investor participating in the offering is accredited.
Self-attestations, representations, and other “check-the-box” exercises are not permitted.
Instead, investors should use Parallel Markets to confirm their status as an accredited investor. Below we’ll discuss the types of documentation required to verify accredited investor status.
1. Individual Verification
As mentioned above, there are three ways for an individual investor to be accredited: income, net worth or professional credentials.
- Verification of Annual Income Annual income can be demonstrated by providing any Internal Revenue Service (IRS) forms that report the investor’s income for each of the last two years. Acceptable IRS forms include Form W-2, Form 1099, Schedule K-1 to Form 1065 and Form 1040.
- Verification of Net Worth Net worth can be demonstrated by providing proof of assets like bank statements, brokerage statements, deposit certificates, tax assessments and other relevant statements of value. Again, the $1 million threshold is a net worth test, so the SEC requires investors to provide a credit report that lists all outstanding liabilities as well. The total proof of assets less the liabilities on the credit report must be greater than $1 million to pass the net worth test. Per SEC rules, all documentation relating to the net worth test must be dated within ninety days prior to purchasing the security.
- Verification of Educational/Professional Qualifications The issuer can request the investor for documents that verify they have obtained the necessary designations, credentials or certifications deemed acceptable by the SEC that identify them as a qualified investor for accreditation purposes. For the initial FINRA license categories, the investor can simply provide their CRD number, which is easily verified on BrokerCheck.
2. Entity Verification
As mentioned above, there are two primary ways for entity investors to be accredited: total assets and investments or accreditation status of entity owners.
- Verification of Assets/Investments/Assets Under Management Assets, investments, or assets under management can be verified by providing bank or brokerage statements that confirm the entity maintains account balances in excess of the necessary threshold. Similar to individual net worth accreditation, all documentation must be dated within the prior ninety days.
- Verification of Entity Owner Accreditation Status An alternative verification method is to have each entity owner (or grantor if a trust) confirm their investor status as an accredited individual. This involves providing a document that confirms the identity of each owner of the entity and then having those individual owners go through one of the individual processes listed above.
Note: You may come across another term - Qualified Purchaser. Find out more about this term in Qualified Purchaser: Is It Different From An Accredited Investor?
Frequently Asked Questions Regarding Accreditation
Now that it’s clear how to verify your accreditation status, let’s take a look at some commonly asked questions regarding accreditation:
1. Can I Receive A Certificate That Verifies My Accreditation Status?
Yes! The SEC permits certain third parties to evaluate an investor’s accreditation status and issue a letter attesting that they have taken reasonable steps to verify that investor. That letter can be used by the investor to access investment deals limited to accredited investors. Parallel Markets provides you with an easy-to-use solution that’s quick and portable. You can use Parallel Markets’ Parallel Passport product to verify your accreditation status across a number of partner websites.
2. How Long Does It Take To Verify My Status As An Accredited Investor?
Since there’s no set procedure for confirming investor status, an external issuer or broker/dealer can take up to several days to verify you as an accredited investor. However - with Parallel Markets, it’ll only take you a single business day (and often less time than that!) to verify your accreditation status.
Verify Your Accredited Investor Status Through Parallel Markets
To confirm your investor status, Parallel Markets provides an easier solution - digital verification within 5 hours on average!
Parallel Passport, Parallel Market’s portable identity solution, provides accreditation status easily. The application takes a couple of minutes to complete, and the Parallel Passport can be used anywhere where accreditation is necessary. With Parallel Passport, investors can log in to each partner website to positively assert their identity and accreditation status.
If you’re an issuer, you can use Parallel Passport to simplify the investor validation process. The software halves your onboarding times and eliminates the need to collect sensitive documents from investors over email.
Even accrediting hundreds of investors will be a breeze with the help of Parallel Markets.
Ready to streamline your investment with a simple, portable investor accreditation tool?
Disclaimer The information contained in this article is provided for informational purposes only and should not be construed as legal advice on any subject matter. You should not act or refrain from acting on the basis of any content included in this article without seeking legal or other professional advice.