At the most basic level, accredited investors are people and institutions that meet qualifications to invest in venture capital, private placements, hedge funds and private equity. By purchasing securities from a business, they give that business a better opportunity to expand its reach, develop new technology, and invest in other forms of growth. Ideally, accredited investors receive a portion of the company’s profits in return for purchasing securities.
Accredited investors, however, must meet at least one of several qualifications established by the Security Exchange Commission (SEC). The average person will not meet these qualifications. Individuals, families, and institutions that have significant assets are more likely to meet accreditation qualifications.
Qualifications for Accredited Investors
Companies that aren’t sure how to define accredited investor status should turn to Rule 501 of Regulation D. There are also some amendments in the Dodd-Frank Wall Street Reform and Consumer Protection Act that adjust the definition of what is an accredited investor. While the details can get somewhat complicated, most accredited investors fall into one of eight categories.
Some of the most popular types of accredited investors include:
- Financial companies, such as banks, registered investment companies, small business investment companies, business development companies, and even insurance companies.
- Employee benefit plans. There are a couple caveats to this type of accredited investor, though. Either the employee benefit plan must have over $5 million in assets, or it must be managed by a registered investment adviser, insurance company, or banking institution.
- Corporations, partnerships, and charitable organizations that have over $5 million in assets.
- Manage personnel of the company selling the securities, including the company’s director, executive officer, and general partners.
- Any business exclusively owned by accredited investors.
- A person with a net worth of $1 million or more. This can also include spouses with a combined net worth over $1 million or anyone with managed assets worth $1 million or more. Only natural persons can qualify. That means no organizations, including corporations, can qualify as this type of accredited investor.
- A person who has earned at least $200,000 of income for the last two consecutive years. Spouses must earn a combined income of $300,000 or more. Organizations cannot qualify as this type of accredited investor.
- A trust that includes assets of at least $5 million. The trust cannot be formed specifically to purchase securities from the company. It must exist independently.
These qualifications can seem a bit confusing to some. The simplest way to answer what is accredited investor qualifications is to state the minimum requirements. Individuals must either have $1 million or earn $200,000 per year. Organizations and trusts typically need to have at least $5 million in assets.
If someone doesn’t fit those requirements, it’s unlikely that they can qualify as accredited investors.
How Companies Can Benefit From Accredited Investors
Companies are required to verify that their accredited investors meet SEC qualifications. Companies that fail to verify accredit investor status can face serious penalties that may include jail time, fines, and losing licenses.
Considering the hassle of verification and the penalties for not following the rules, many companies might wonder whether they even need accredited investors, especially since Rule 506 of Regulation D lets companies recruit up to 35 non-accredited investors.
That might seem like a smart idea at first, but there are several reasons successful companies usually focus on accredited investors.
The primary reason is that companies have to disclose large amounts of information to non-accredited investors. In an attempt to protect inexperienced investors who might get duped by unscrupulous companies, the SEC requires companies to give non-accredited investors discloser documents that inform them of how securities work and the risks they face by purchasing them. Providing and explaining these documents to inexperienced investors can take more time than verifying an accredited investor. By only choosing accredited investors, businesses have to disclose far less information. That helps businesses save time.
Accredited investors are also likely to spend larger amounts of money. At the very least, an accredited investor has $1 million in assets. That gives companies an opportunity to sell large securities to the investor. By accessing that money, companies can accumulate the funds they need to expand their services, products, and stores.
Non-accredited investors, by definition, do not have $1 million. That means they can’t invest as much money. A business could simply sell more securities to a larger number of non-accredited investors, but this is a hassle that few owners or managers want to undertake. When it comes to increasing the business’s capital as quickly as possible, accredited investors offer advantages that non-accredited investors simply cannot.
Accredited Investors Have More Flexibility Than Non-Accredited Investors
From a financial perspective, accredited investors can offer more benefits to the companies they invest in. Since these individuals, families, and organizations have access to significant wealth, they may choose to purchase more securities from companies they believe will grow and produce healthy profits.
Accredited investors also have the opportunity to invest in securities that have not been officially registered with the SEC. As long as a company only sells securities to accredited investors, it does not need to disclose as much information to them. According to the SEC, accredited investors are presumably savvy enough to understand the risks of investing in companies, private funds, hedge funds, and similar opportunities. This lets accredited investors and the companies they invest in act more quickly.
Companies that meet certain specifics under Regulation D can also advertise directly to accredited investors without providing extensive disclosure forms. This helps businesses attract more money that can make them successful while earning profits that increase the wealth of investors.
Creating a Criteria That Regulates Securities and Accredited Investors
The SEC created investor accreditation under authority of the Securities Act of 1933, which was passed by the U.S. Congress after a stock market crash led to the Great Depression. By creating the SEC to oversee securities regulations, Congress hoped to avoid future economic depressions. The strategy has been largely effective, although the country’s economy has experienced several recessions since 1933, often after periods of deregulation that weaken the SEC’s ability to control the industry.
Regulation D, which details requirements for organizations that sell securities, includes several rules that protect potential investors while encouraging the industry to follow responsible guidelines. When creating Regulation D, lawmakers considered how much money investors needed to have before they were considered experienced investors. While having $1 million doesn’t qualify every person as an experienced investor, it does indicate that the investor is likely to have this experience. The Supreme Court of the United States upheld the perspective that investors with $1 million or more are probably sophisticated enough to choose their own investment strategies. Investors with $1 million can also absorb losses more easily than investors who have less money. The regulations remained untouched for over 80 years.
Regulation D was revised in April 2012, when President Obama signed the Jumpstart Our Business Startups Act (JOBS) into law. The JOBS Act relaxes some regulatory requirements so companies have more opportunities to sell securities to accredited and non-accredited investors. Since Regulation D sets different requirements for selling securities to accredited and non-accredited investors, though, many businesses find that it is easier to focus on accredited investors who have more money and require fewer disclosures.
According to Forbes contributor Devin Thorpe, the SEC may alter regulations in the near future to make crowdfunding a more attractive option for businesses and small investors. These changes would likely let people qualify as accredited investors according to how much education and experience they have in finance and related subjects. This would let people without $1 million or $200,000 per year incomes qualify as accredited investors who can make sophisticated decisions without requiring businesses to give disclose excessive information. In other words, the changes would let people become accredited according to skill rather than wealth.
Accredited investors are a real boon to companies that sell securities. Current regulations make it relatively easy for businesses to find investors who have enough assets to make a lasting difference in their success. Without accredited investors, it’s unlikely that today’s small to medium businesses could find the capital they need to expand operations or introduce new products and services to the world without jeopardizing their own financial stability. Of course, buying securities from companies with successful strategies also gives people an opportunity to make more money from their investments. If you need a list of accredited investors to expand your business or fund your private investment offering, contact us and we would be happy to build you a collection of qualified prospects.