The essential guide to becoming an accredited investor

Is it your first time looking for information on how to become an accredited investor in the U.S., but not sure where to start? Here we’ll cover the accredited investor definition, which has recently changed as part of a new SEC ruling to expand the universe of eligible investors. The effective date of the new rules was December 8, 2020. We will also look at the history behind accreditation, how you can qualify as an accredited investor, and the unique types of investments available to accredited investors.

Before we begin, let’s first clarify that becoming an accredited investor is not part of a larger submission or the application process. Put simply, it’s not like applying for a bank loan or a mortgage. To be deemed an accredited investor, individual investors, spouses, or investment companies, must simply meet one of the eligibility criteria laid out by the SEC. Under Federal Legislation regulated by the SEC, an accredited investor is classified as an individual or business entity that can legally trade in securities. 

Regulators have strict guidelines on who can be considered an accredited investor. Under new legislation, individuals can now qualify as an accredited investor “based on measures of professional knowledge, experience or certifications in addition to the existing tests for income or net worth.”

Who is considered an accredited investor? 

To be considered an accredited investor, individuals will need to provide substantial proof that personal net worth exceeds the $1 million threshold. Additionally, accredited investors can also be people who are legally married and have a joint net worth that meets SEC standards. Total net worth should include all current assets that exceed the greater of $1 million. And these assets exclude the primary residence and the value thereof.

What is the purpose of becoming an accredited investor?

The purpose of governmental bodies like the SEC’s rules for investor accreditation is to provide protection to investors. The accreditation requirement seeks to ensure that investors have sufficient knowledge to understand the risks of the prospective investment or the finances to protect against the risk of monetary loss. For these reasons, it’s important to understand the accredited investor definition and what qualifies an investor.

What makes someone an accredited investor?

To be deemed an individual accredited investor, the SEC defines multiple tests for which a natural person now only needs to pass one:

1. Income
2. Net worth
3. Professional certifications or designations
4. Knowledgeable employees of private funds

The income and net worth thresholds can be considered financial tests, while professional certifications or designations and knowledgeable employees can be considered knowledge tests.

Financial tests to become an accredited investor

Income test

The first way an individual can become an accredited investor is with a pre-tax income exceeding $200,000 in each of the two most recent tax return years. There must also be a reasonable expectation that they will earn the same or more in the current calendar year and the coming year.

Individual net worth

The second way an individual can become an accredited investor is to have a net worth exceeding $1M. This excludes the value of their primary residence.

How an individual becomes an accredited investor with their spouse or spousal equivalent

Similar to becoming an individual accredited investor, an individual together with their spouse or spousal equivalent (which means a cohabitant occupying a relationship generally equivalent to that of a spouse) can jointly become accredited investors. Again, this is done either via income or via net worth financial statements.

Income

An individual together with their spouse or spousal equivalent will be deemed accredited investors if they have a pre-tax joint income of at least $300,000 for the two previous years. They must also be on track to make the same amount (or more) in the upcoming year.

Net worth

Spouses or spousal equivalents can also qualify if their joint net worth exceeds $1M at the time they are making an investment. As with becoming an accredited investor individually, this net worth must exclude the value of your primary residence.

Knowledge tests

Professional certifications or designations test

One of the new ways that an individual can become an accredited investor is by having certain professional certifications, designations or other credentials issued by an accredited educational institution. Examples of the requisite designations include individuals in good standing with the Series 7, Series 65, or Series 82 licenses. In addition, the SEC has provided itself the flexibility to reevaluate or add certifications, designations, or credentials in the future.

Knowledgeable employees of private funds

The last of the main ways that an individual can be deemed an accredited investor is to be a knowledgeable employee of a private fund. Knowledgeable employees are defined as:

• An executive officer, director, trustee, general partner, advisory board member, or person serving in a similar capacity, of the private fund or an affiliated management person.
• An employee of the private fund or an affiliated management person of the private fund who participates in the investment activities of such private fund, other private funds, or investment companies for at least 12 months.

Other types of accredited investors

The following can also qualify as accredited investors:

• Financial institutions.
• A corporation or LLC, not formed for the specific purpose of acquiring the securities offered, with total assets in excess of $5M.
• Knowledgeable employees of private funds.
• Certain types of insurance companies.

For a detailed breakdown of the various types of accredited investors, please see the definitions and terms used in Regulation D.

Now that you have a general idea of the criteria and requirements, let’s take a look at the history behind the accredited investor concept.

Accredited investor legislation: past, present, future

In the 1930s, federal lawmakers were seeking a way to protect investors while also spurring new business growth. The Securities Act of 1933 was enacted to regulate offers and sales of securities in the United States.

The idea was to do so by requiring companies to register a statement with a variety of information. This would include information about itself, its securities, and the specific offering with the SEC. The registration needed to be deemed effective before it could be offered to investors.

However, regulators needed to ensure that only experienced investors with sufficient resources were participating for securities that were not registered. These opportunities do not fall under federal or state securities laws. As a result, Regulation D of the Securities Act of 1933 was developed and the term accredited investor was born.

The SEC wanted to create a standard of knowledgeable qualified investors with financial merits. Only investors who qualified as such would be able to participate in private securities and private investment offerings. By doing so, they wanted to strike a balance that would stimulate business growth and also protect less experienced qualified investors from riskier investments. As these rules continue to evolve, the knowledge and qualifications requirements become more and more important. This recent ruling could have a large impact on the pool of potential investors.

Dodd-Frank Wall Street Reform and Protection Act

On the heels of the 2008 financial crisis, President Obama signed the Dodd-Frank Wall Street Reform and Protection Act (the Dodd-Frank Act, for short) into law in 2010. It amended the eligibility requirements for investors, specifically, as a result of the Dodd-Frank Act, the value of a primary residence was no longer permitted to be included as part of the net worth of an individual.

Determining accredited investor eligibility

We’ve titled this post, “How to Become an Accredited Investor.” However, there isn’t an official move to bullet application process to become an accredited investor. If you are interested in investing in opportunities that are only open to accredited investors, there are a few steps you will have to take. If a securities offering is being made under Rule 506(c) of Regulation D, the firm managing the investment opportunity must verify that you meet the requirements. They either verify net worth or income based on rules set forth under Regulation D.

You will be required to provide documentation that demonstrates your accreditation status. This includes the following:

• Bank statements
• W-2s
• Brokerage accounts
• Your credit report to disclose liabilities
• Business ownership documentation such as tax filings along with an operating agreement
• Certain third-party statements from acceptable institutions
• Proof of knowledge or professional certifications

Remember, the value of a primary residence or primary home can’t be included as part of your net worth. However, vacation and investment properties can be included in your net worth. You must submit proof of ownership and proper valuation.

Once your documentation has been submitted, the managing firm will review it. They will then accept or reject your accredited investor status. If approved, your accreditation is typically valid for one year or until the next tax day (if you verify via income). You will then be able to invest.

Investment opportunities for accredited investors

Accredited investors have access to investment opportunities that are offered privately under Regulation D of the Securities Act. These are not publicly offered opportunities available to the general investing public. Typically, these investments could be riskier, but they offer the opportunity for potentially higher returns.

Historically, the SEC distinction was to designate individuals that are considered to be more sophisticated investors. These are individuals that do not require the same layers of protection as novice investors with less wealth and less investment knowledge and experience.

What are the benefits of becoming an accredited investor?

Private companies can offer securities for investment that are not available to the general public.

These securities products can include:

• Venture Capital Funds (VC)
• Angel Investing
• Hedge Funds
• Private Equity Opportunities
• Equity Crowdfunding

There are also additional private investment securities that can be accessed by accredited investors.

Changing the definition of an accredited investor and investor sophistication

The definition and requirements of this type of investor accreditation have remained top of mind since its inception in the 1930s. The specific purpose of the SEC’s requirements, the Securities Exchange Act, and federal laws surrounding investor accreditation is to provide protection. These requirements are intended to ensure that investors are knowledgeable enough to understand the risks of these investment opportunities. They also work to ensure that potential investors have enough wealth to protect against monetary loss from riskier investments.

Today, the parameters for accredited investors continue to be a hot topic. Many believe that the requirements are too stringent, while some insist they are too loose. Others believe that accredited status should be based on their investing acumen. Or rather, a combination of such knowledge and wealth instead of being just wealth or income-based.

Even though these parameters have recently changed, there are some who wish for the requirements to lessen even further. This will continue to be a hotly debated topic amongst the financial crowd.

Michael Piwowar, the former Commissioner of the Securities and Exchange Commission, stated in 2017 that the current accreditation standards “don’t serve their intended purpose of protecting those people from the potential risks of putting money into higher-risk investments.”

Taking the debate a step further, SEC commissioners have highlighted geographic disparity and inflation in their arguments for and against changing requirements for investor accreditation.

Accredited Investor Definition

With all the information and details that we provided above, let’s have a clear definition of the term “accredited investor”.

An accredited investor is a designation granted by the SEC to individuals or entities who can participate in private securities offerings, qualified either through financial criteria ($1M net worth or $200K individual/$300K joint annual income) or professional credentials (such as Series 7 certification), demonstrating their capacity to understand and withstand sophisticated investment risks.

Disclaimer:

Investors should carefully consider the investment objectives, risks, charges and expenses of the Willow Wealth Alternative Income Fund before investing. The prospectus for the Willow Wealth Alternative Income Fund contains this and other information about the Fund and can be obtained by referring to yieldstreetalternativeincomefund.com.

The prospectus should be read carefully before investing in the Fund.Investments in the Fund are not bank deposits (and thus not insured by the FDIC or by any other federal governmental agency) and are not guaranteed by Willow Wealth or any other party. The securities described in the prospectus are not offered for sale in the states of Nebraska, Texas or North Dakota or to persons resident or located in such states. No subscription for the sale of Fund shares will be accepted from any person resident or located in Nebraska or North Dakota.

This communication and the information contained in this article are provided for general informational purposes only and should neither be construed nor intended to be a recommendation to purchase, sell or hold any security or otherwise to be investment, tax, financial, accounting, legal, regulatory or compliance advice. Any link to a third-party website (or article contained therein) is not an endorsement, authorization or representation of our affiliation with that third party (or article). We do not exercise control over third-party websites, and we are not responsible or liable for the accuracy, legality, appropriateness or any other aspect of such website (or article contained therein).