Accredited Investor: Duties and Requirements

What Is an Accredited Investor?

An accredited investor is an individual or entity permitted by financial authorities, especially the U.S. Securities and Exchange Commission (SEC), to engage in trading of unregistered securities. These investors, who include high-net-worth individuals, banks, insurance companies, brokers, and trusts, meet specific financial criteria established under SEC's Regulation D. Typically, they demonstrate financial sophistication through their income, net worth, asset size, or professional experience, thereby not requiring the regulatory protections designed for less experienced investors. Understanding the role and criteria for accredited investors can aid in navigating high-risk and high-reward investment opportunities.

Responsibilities and Opportunities for Accredited Investors

Accredited investors have privileged access to pre-IPO companies, venture capital companies, hedge funds, angel investments, and various deals involving complex and higher-risk investments and instruments.

Companies seeking funding might directly approach accredited investors. An example might be a young technology company that has a product in the late development stages and needs more money to launch the product on the market. It is not a public company but hopes to launch an initial public offering (IPO) in the near future.

Such a company might decide to offer securities to accredited investors directly. This type of share offering is referred to as a private placement.

Accredited investors face high potential risks and rewards. The SEC wants to ensure that they are financially stable, experienced, and knowledgeable about their risky ventures.

Criteria to Qualify as an Accredited Investor

Accredited investor regulations differ by location. In the U.S, the definition of an accredited investor is put forth by the SEC in Rule 501 of Regulation D.

To be an accredited investor, a person must have an annual income exceeding $200,000 ($300,000 for joint income) for the last two years with the expectation of earning the same or a higher income in the current year. The income test cannot be satisfied by showing one year of an individual's income and the next two years of joint income with a spouse.

An accredited investor should have a net worth exceeding $1 million, either individually or jointly with a spouse. This amount cannot include a primary residence.

The SEC also considers applicants to be accredited investors if they are general partners, executive officers, or directors of a company that is issuing unregistered securities.

An entity qualifies as an accredited investor if it's a private business development company or has assets over $5 million.

Also, if an entity consists of equity owners who are accredited investors, the entity itself is an accredited investor. However, an organization cannot be formed with the sole purpose of purchasing specific securities.

Latest Updates to Accredited Investor Criteria

The U.S. Congress modified the definition of an accredited investor in 2020 to include registered brokers and investment advisors.

A SEC press release states that the amendments let investors qualify as accredited investors through professional knowledge, experience, or certifications, in addition to income or net worth tests. The amendments also expand the list of entities that may qualify as accredited investors, including by allowing any entity that meets an investments test to qualify."

Among other categories, the SEC now defines accredited investors to include the following: individuals who have certain professional certifications, designations, or credentials; individuals who are “knowledgeable employees” of a private fund; and SEC- and state-registered investment advisors.

Steps to Becoming an Accredited Investor 

People who want to be accredited investors don't apply to the SEC for the designation. Rather, it is the responsibility of the company offering a private placement to make sure that all of those approached are accredited investors.

Individuals or parties who want to be accredited investors can approach the issuer of the unregistered securities. The issuer may ask the applicant to fill out a questionnaire and provide financial documents.

The required documentation may include account information, financial statements, and a balance sheet. It may extend to tax returns, W-2 forms, salary slips, and even letters from CPAs, tax attorneys, investment brokers, or advisors.

The company may check the applicant's credit report as part of the assessment.

Most participants in private placements do not have to go through this process. People with certain financial accreditations, managers of hedge funds, and partners in private equity firms are among those who don't have to prove their credentials to buy unregistered securities.

Example of an Accredited Investor

For example, suppose there is an individual whose income was $150,000 for the last three years. They reported a primary residence value of $1 million (with a mortgage of $200,000), a car worth $100,000 (with an outstanding loan of $50,000), a 401(k) account with $500,000, and a savings account with $450,000.

While this individual fails the income test, they are an accredited investor according to the test on net worth, which cannot include the value of an individual's primary residence. Net worth is calculated as assets minus liabilities.

This person's net worth is exactly $1 million. This involves a calculation of their assets (other than their primary residence) of $1,050,000 ($100,000 + $500,000 + $450,000) less a car loan equaling $50,000. Since they meet the net worth requirement, they qualify to be an accredited investor.

The Bottom Line

The accredited investor rules are designed to protect potential investors with limited financial knowledge from risky ventures and losses they may be ill equipped to withstand.

On the flip side, it gives people who already have substantial financial assets a major advantage over those with more modest assets.