At some point in your financial journey, you will likely come across the term “accredited investor” when exploring potential investments. Here is a brief primer on what accredited investor status means and how it impacts investment opportunities.
What does it mean to be an accredited investor?
The U.S. Securities and Exchange Commission (SEC) defines an accredited investor as an individual who:
has earned income of $200,000 individually—or $300,000 combined with a partner or spouse—in each of the past two years, and reasonably expects to earn at least this amount in the current year;
has a net worth of at least $1 million—either individually or combined with a partner or spouse—not including the value of a primary residence; or
is a financial professional with a Series 7 (general securities representative), Series 65 (investment advisor representative), or Series 82 (private security offerings representative) license.
Additional “professional criteria” may also qualify an individual as an accredited investor.
Entities may also qualify for accredited investor status under certain conditions:
all owners are accredited investors;
investments exceeding $5 million;
certain entity types with total assets exceeding $5 million;
investment advisor firms; or
financial firms.
Legislation working its way through Congress could expand the definition of accredited investor, but this is current as of writing.
Why designate accredited investors?
Certain investments are limited to accredited investors. You will typically encounter these when exploring additional investments beyond tax-advantaged accounts and regular brokerage accounts. Investments requiring accredited investor status include hedge fund investments, private equity investments (including venture capital and angel investing), and online real estate investment providers (such as CrowdStreet or certain Fundrise offerings).
High-net worth individuals and entities are more likely to have the means and sophistication to invest in potentially riskier investments and withstand any losses. According to the SEC:
For companies raising capital, the accredited investor definition largely determines who is in their pool of potential investors, and for investors whether they are eligible to invest in many early-stage companies. Many of the offering exemptions under the federal securities laws limit participation to accredited investors or contain restrictions on participation by non-accredited investors.
In other words, the SEC set guidelines to prevent individuals from investing significant proportions of their net worth in risky investments in an effort to limit detrimental losses. If an angel investor with a $3 million net worth chooses to invest $100,000 in a startup with a high risk of failure but the potential for sizable returns, a 100% loss is not a financial emergency for that investor. Meanwhile, an investor with only $200,000 would lose half of their wealth. Investors with higher net worths have the means to be riskier with some of their money because they have enough other assets to ensure financial wellbeing if a risky investment has a poor outcome.
Becoming an accredited investor can impact your financial portfolio because it opens the door to investment opportunities with the highest possible returns. More of these investments fail than succeed, but investing in ten startups where nine fail and one succeeds can often lead to returns significantly higher than market averages. While this kind of investing is imprudent for building baseline financial security, it can be a worthwhile way to attempt to build significant wealth with a small proportion of your portfolio. Accredited investors who invest up to 10% of their net worth in risky investments with high rewards increase their chances of significant wealth accumulation.
How do I prove that I am an accredited investor?
There is no clearinghouse or uniform method to demonstrate your accredited investor status. Because the SEC merely requires that issuers of investments take “reasonable steps” to verify accredited investor status, each issuer will have its own procedures.
You will typically need to submit financial documentation (such as W-2s and/or tax returns) or certification by a licensed professional (generally a CPA, attorney, or securities advisor). The certification itself may be a form provided by the issuer, but often there is no form. As an attorney, I have completed forms verifying accredited investor status on multiple occasions. I have also provided an open-ended, generic verification letter for individuals exploring multiple accredited-investor-only options.
If you need help verifying your accredited investor status, or simply want to discuss whether certain investments might be right for you, reach out to me today!
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