Your average retail or institutional investor will only be allowed to procure securities on the markets once they have gone public. This is actually a formality that can be avoided if you are an accredited investor.
Becoming an accredited investor requires the individual or entity to meet certain requirements before they are able to access unregistered securities. These requirements are set out by the SEC and are the main hurdles that stand between these investors.
What Is an Accredited Investor?
An accredited investor is, simply put, a retail or institutional investor that has met certain regulations set out by the U.S. Securities and Exchange Commission (SEC). These accredited investors have access to securities that will not be available to other investors who have not been regulated by the SEC or another regulatory body yet. The securities themselves that they have access to may not be registered with financial authorities.
Provided that the accredited investor has met at least one of the requirements of the SEC, they will be able to access these securities. These requirements include a number of factors (that we will touch on later) that include things like net worth, annual income or professional experience. Should they fulfil any of these requirements, they will be provided the privilege of accessing these unregistered securities. (1)U.S. Securities and Exchange Commission."Accredited Investors – Updated Investor Bulletin."
Accredited Investors and how they operate
An accredited investor is legally authorised by the SEC to acquire securities that are not registered with a financial authority. Companies will offer securities to accredited investors because it ultimately saves them a lot of money.
How does it save them money? Well, the registration process for getting your security to go public costs a lot of money. By offering securities to an accredited investor, these companies forgo these expenses, making the whole situation a win-win for both the company offering the security and the accredited investor who is accessing these securities first.
As we already mentioned, an accredited investor needs to tick off certain boxes before they can achieve this accreditation status. This is largely due to the fact that purchasing these unregistered securities carries with it a significant degree of risk. As such, the SEC needs to make sure that an accredited investor is financially stable, knowledgeable and experienced.
The SEC plays a big role in finance in the US but when it comes to accredited investors, all they can really do is issue guidelines to the investors to help them avoid large scale risks from unregistered securities. All the SEC can really do is make sure that an accredited investor has the means both financially and with regards to their knowledge to combat any of these risks.
What it takes to be an Accredited Investor
In order to become an accredited investor in this day and age, a retail or institutional investor needs to hit certain marks that satisfy the SEC guidelines. It’s worth noting that other countries have varying requirements for this status. Here are the key requirements to become an accredited investor. (1)Electronic Code of Federal Regulations."§230.501 Definitions and Terms Used in Regulation D."
In order for a retail investor to become an accredited investor, they would need to have a net worth of at least $1 million. This can also include a joint (spousal) net worth of $1 million as well. Unfortunately, your net worth does not include your residence.
In order to become an accredited investor an individual needs to have an annual income of at least $200,000 for the period of 2 years. Joint annual income (like wth your spouse) would need to be a combined $300,000 per year.
Entity net worth
If you are trying to register your company (entity) as an accredited investor, you will need to show assets to the value of at least $5 million. If the owners of the company are accredited investors, the entity itself will then be seen as an accredited investor as well.
An important note here is that an entity will not be considered for accredited investor status if the company was formed for the sole purpose of purchasing unregistered securities. The SEC regulation rigorously checks for this.
Regulating accredited investors
It’s clear that the SEC sets out strict guidelines for entities and individuals who are looking to become accredited investors. The main reason for this is that the SEC is looking to protect the investors themselves. This holds particularly true for retail (individual) investors who are unfamiliar with the securities they are investing in. The guidelines are there to help investors to avoid major capital losses on their investments.
By setting such rigid regulations for gaining the accredited inverter status, the SEC is making sure that those who acquire the title are not only knowledgeable about high risk investments but that they are also financially stable enough to take the hit from any potential losses on unregistered securities investments.
While it may seem as though these guidelines are in place to make it difficult for retail and institutional investors to earn the accredited title, they are actually there to protect the investors and not the companies who are issuing unregistered securities.
An example of accredited investing
Let’s take a look at a fairly basic example of what it might take for you to become an accredited investor. Let’s say an individual makes $100,000 a year for the last 3 years, they have a property that is valued at $1,2 million and a mortgage worth $220,000. Their car is worth $150,000, their 401k is worth $400,000 and they have a savings account with roughly $500,000 in it. While we know that this person does not achieve the guideline of earning at least $200,000 annually, they do in fact achieve the net worth guideline.
In a basic sum, we can see that the value of the individual’s net worth currently sits at a little over $1 million. Even without the value of the person’s residence taken into account, they have still achieved the net worth value required to be considered as an accredited investor.
The SEC amends certain accredited investor guidelines
It’s important to note here that the SEC has made changes to the actual definition of an accredited investor. These changes were made in 2020 on August the 26th. The changes to the definition of an accredited investor were done in such a way that included knowledge and expertise and not just financial stability. (2)U.S. Securities and Exchange Commission."SEC Modernizes the Accredited Investor Definition."
The amendments to the definition have essentially allowed investors to qualify as accredited investors provided that they meet certain measures of knowledge, qualifications and certifications. These are simply added to the already pre existing definitions of net worth and annual income. As we saw earlier, if an individual serves as an executive or owner of an entity, that entity will also be an accredited investor, provided that the executive or owners are accredited investors themselves.
The SEC defines this knowledge and experience as individuals who are employees of private funds or state registered investment advisors. This basically just reaffirms the notion that you can become an accredited investor if you have certain certifications/qualifications and that you work within the field of investments.
FAQs about accredited investors
There are a couple of frequently asked questions about accredited investors and how it all works. Let’s take a look at some of these questions and what the subsequent answers are.
Can anyone become an accredited investor?
Yes, in theory anyone can become an accredited investor. Whether you are a retail (individual) investor or working with institutional investors, you can become an accredited investor. For the retail investor, you need to meet requirements with regards to your annual income or with your overall net worth. An entity will have the same requirements but they will need to meet larger financial parameters. (1)U.S. Securities and Exchange Commission."Accredited Investors – Updated Investor Bulletin."
Is accredited investing safe to do?
The SEC has set guidelines for investors to meet precisely because they are trying to protect the interests of the investors themselves. With that being said, there are still risks to purchasing unregistered securities. This is expressly stated by the SEC. With that being said, should you meet the guidelines that have been set out and if you are knowledgeable about investments, you can mitigate your risks to a significant degree.
What else does the SEC do to protect investors?
At this time, there is not much else that the SEC can do to protect investors aside from setting out the guidelines that investors will need to meet to become accredited investors in the first place. However, the SEC is the regulatory body that deals with unethical practices in finance so you can rest assured that they are on top of anything and everything that may be deemed unethical or fraudulent when it comes to the companies selling these unregistered securities.
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