Explore the definitions and differences across investor types.
An “accredited investor” is an individual or institutional investor that meets the regulatory net worth, annual income or other standards set by the Securities and Exchange Commission (“SEC”).
The SEC recently promulgated final rules that went into effect on December 8, 2020. These new rules expand the accredited investor definition to include new categories based on knowledge, professional experience or other credentials. Non-accredited investors are people or entities who do not meet any of these requirements.
Non-accredited investors are restricted to limited investment opportunities by the United States Securities Act of 1933 (the “Securities Act”) and the United States Securities Exchange Act of 1934.
But why does the SEC prevent these persons or entities from investing in specific securities?
In this article, we’ll discuss the answer to that question and take a look at how non-accredited investors differ from accredited investors. We’ll also show you what investments are permitted for non-accredited investors - and how to get yourself verified as an accredited investor.
Here’s what we’ll cover in this post:
- What is an Accredited Investor?
- What is a Non-Accredited Investor?
- Where Can Non-Accredited Investors Invest?
- Demonstrate Accredited Investor Status to Access Broader Investment Opportunities
- Get Your Accredited Investor Status Verified With Parallel Markets
What is an Accredited Investor?
SEC rules delineate between “accredited investors” and “non-accredited investors.” “Accredited investors” are permitted to purchase securities that may not be registered with the regulatory authorities, while “non-accredited” investors are more restricted in their investment opportunities.
Note - Platforms will sometimes use the terms “accredited investor” and “sophisticated investor” interchangeably, but they actually mean two different things. A “sophisticated investor” is related to a subjective standard about whether a person has “enough knowledge and experience in business matters to evaluate the risks and merits of an investment.” An “accredited investor,” by contrast, looks more stringently at specific financial metrics to determine whether the investor can afford the risk of loss in a particular investment
Regulation D (“Reg D”) under the Securities Act is an exemption from registration for sales of securities to persons that have a lesser need for the protections provided by the United States’ disclosure regime.
Specifically, Reg D and United States case law focuses on exempting individuals (accredited investors) that “possess sufficient financial sophistication and ability to sustain the risk of loss of their investment or to fend for themselves to render the protections of the Securities Act’s registration process unnecessary.”
There are several criteria an individual or firm can meet to be classified as an accredited investor.
Individuals are considered an accredited investor if they have either:
- Earned an annual income of $200,000 individually (or $300,000 in joint income for spouses and spousal equivalents) or more for the last two fiscal years and reasonably expect to meet the same income threshold for the current fiscal year.
- A net worth of over $1 million (alone or together with a spouse) excluding the value of any primary residence.
The SEC’s new accreditation definition permits additional exemptions based on financial sophistication, but these two are the most common accreditation benchmarks.
Entities have several methods of being qualified as institutional accredited investors. The two most common ways are:
- Maintaining total assets worth over $5 million.
- Being owned entirely by accredited investors.
Note: The entity must not be formed exclusively to make an investment in a fund.
Since an accredited investor has virtually no restrictions on where they can invest, they can choose to make an investment in a range of assets including:
- Hedge Funds
- Private Equity Funds
- Venture Capital Funds
- Other assets in the private capital markets
- Real estate
- Equity crowdfunding platforms, and more.
To raise capital efficiently, oftentimes these platforms will solely accept investment from accredited investors with minimum investment thresholds set at a high level.
Don’t know the difference between an accredited investor and a qualified purchaser? Check out our article on qualified purchasers to get a quick overview.
What is a Non-Accredited Investor?
A “non-accredited investor” simply refers to someone who does not meet the income or net worth requirements kept in place to qualify accredited investors.
Therefore, a non accredited investor is someone who:
- Earned less than $200,000 a year for the last two fiscal years ($300,000 if joint income is considered);
- Has a net worth of less than $1 million when their primary residence is excluded; and
- Does not meet any of the other potential categories for accredited investors.
The SEC deems these income and wealth limits as necessary safeguards to protect an unaccredited investor from making an investment in risky assets they may not fully understand and from suffering losses the non accredited investor may not be able to afford.
Given the high financial thresholds to qualify as an accredited investor, it is not surprising that non accredited investors comprise the vast majority of total investors in the world.
Oftentimes, you will see the people or platforms refer to “retail investors” when they really mean non-accredited investors. This is a common misconception, and the term retail investor simply refers to anyone who’s not an institutional investor (accredited or non-accredited).
Where Can Non-Accredited Investors Invest?
Investments open to non-accredited investors are highly regulated by the SEC in various ways, including mandating certain disclosure levels or capping the amount of investment a non accredited investor can make. Companies offering an investment opportunity to non-accredited investors must only do so under strict conditions.
For example, Rule 506(b) of Regulation D states that a “private placement” (a non-public/ private offering of securities by a private company) can raise unlimited funds from an unlimited number of accredited investors.
However, issuers relying on this Rule 506 offering may only sell securities to up to 35 non accredited investors. Each non-accredited investor must possess sufficient knowledge and experience in financial and business matters to evaluate the merits and risks of the prospective investment. What’s more, issuers are required to provide the non-accredited investors with a substantial set of regulatorily-mandated financial data, including audited financial statements and qualitative disclosures about the business.
Similarly, Regulation A+ defines two tiers of investments for equity crowdfunding platforms - Tier 1 permits non-accredited investors to invest freely in the crowdfunding platform, but Tier 2 limits the investment of non-accredited investors to 10% of their annual income or net worth - whichever is greater.
To qualify for the Reg A exempt offering, a company must conduct a process akin to a mini-IPO and file financial and other information with the SEC.
The SEC recently increased the funding limits under Reg A+. Companies can now obtain $75 million from a Tier 2 securities offering in a capital raise, up from $50 million. The SEC also raised the maximum securities offering for secondary sales under Tier 2 from $15 million to $22.5 million.
Companies compliant with Regulation Crowdfunding can also raise capital from non-accredited investors. After the SEC’s new amendments, they can raise a maximum amount of $5,000,000 through crowdfunding within 12 months.
However, there are limitations on how much non accredited investors can invest. If the annual income or net worth of an unaccredited investor is less than $107,000, they can make an investment of up to $2,200 or 5% of their income or net worth, whichever is greater.
But if their annual income and net worth are greater than $107,000 - they can make an investment of up to 10% of whichever is greater from their net worth and annual income.
It’s important to remember that non-accredited investors aren’t limited by investment vehicles like a REIT or real estate crowdfunding platforms, but by regulations in place by the SEC. For example, a non-accredited, potential investor can invest in commercial real estate and public equity investment platforms - but they can’t invest in a securities offering of a private company without an exemption.
Similarly, non accredited investors can also invest in an investment option like equity crowdfunding, mutual fund platforms, and real estate - but only if they function under an exemption.
Does The New Accredited Investor Definition Affect Retail Investors?
On August 26, 2020, the SEC published a press release amending the definition of an accredited investor. The amendments revise Rule 501(a), Rule 215, and Rule 144A of the Securities Act.
While this amendment provides entities like Indian tribes and family offices with access to a broader range of investments, it also includes additions that affect retail investors.
According to the updated definition, any natural person can qualify as an accredited investor if they possess specific professional certifications, designations or credentials, or other credentials issued by an accredited educational institution designated by the SEC.
These qualifications should be able to display their level of financial sophistication accurately.
As of the final rule, the initial categories the SEC will adopt for accredited investors are the Financial Industry Regulatory Authority (FINRA) Series 7, Series 65, and Series 82 licenses.
A potential investor who is considered to be a “knowledgeable employee” of a private fund can also be considered an accredited investor - but only to make an investment in the fund of the same private company.
This knowledgeable employee has to be an affiliated management person or an employee who directly participates in the fund’s investment activities.
How Do I Prove Accredited Investor Status To Access More Opportunities?
As we’ve mentioned, every potential investor needs to be an accredited investor to make an investment with companies or funds that aren’t subject to reporting requirements mandated by the SEC.
But how do you verify yourself as an accredited investor?
Well, there are two ways you can verify your status as an accredited investor to qualify for a prospective investment:
- Accreditation Verification Letter: You can ask your lawyer, CPA, or investment adviser to write a letter that verifies your status as an accredited investor under Regulation D Rule 501; or
- You can use Parallel Markets.
How To Get Your Accredited Investor Status Verified With Parallel Markets
Using Parallel Markets is the easiest way to get your accreditation status verified to qualify for a prospective investment. You can verify your status with Parallel Markets in a number of ways, including:
- Income Verification: You can present tax returns, W-2, K-1, or 1099 forms that show your income to be greater than $200,000 for the last two fiscal years ($300,000 if it’s joint income with a spouse).
- Net Worth Verification: You can present documents that showcase all your assets and liabilities to prove your net worth to be above $1M, excluding the value of your primary residence.
Assets can be presented through bank statements, real estate appraisals (excluding the primary residence), and brokerage statements. Liabilities are usually presented through a credit report. The documents must have been obtained within the last 90 days.
If you need to verify accredited status through an SEC-approved license, simply provide your Central Registration Depository (CRD) number to the Parallel Markets team.
Why Should Investors Choose Parallel Markets?
Parallel Markets provides an easy accreditation service that retail investors and entities can use to validate and share their status with third parties.
Parallel Markets boasts an investor onboarding and verification platform known as Parallel Passport - which provides a secure, end-to-end investor identification solution.
Investors can use Parallel Passport to log in at partner websites and confirm their accredited investor status and identity in a single click.
Parallel Passport can cut down the hours you might have to spend on inconvenient approval processes and give you more time to evaluate investment decisions.
Why Should Issuers Choose Parallel Markets?
Issuers can use Parallel Passport to simplify the validation of investors.
Parallel can handle your beneficial ownership mapping, Anti-Money Laundering (AML) checks, Know-Your-Customer (KYC) process, and even your accreditation checks.
The Parallel Passport tool can help you cut down investor onboarding times by over 90%, reduce compliance costs by up to 60% - and do all this while eliminating the need to collect sensitive client documents through email.
Dealing with hundreds of investors at the same time? Not a problem.
With the Parallel Passport software, you can keep track of all investor records automatically.
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.