It is possible for anyone to invest in stocks, bonds, and mutual funds; however, there is a vast array of assets that cannot be purchased by ordinary investors.
Some examples of these assets include start-up businesses, particularly real estate ventures, private equity funds, and venture capital funds.
To be able to put your money into unregulated assets, you are required to have an accredited investor status. To be considered an accredited investor, you must either have the financial resources or the knowledge to be able to handle the higher levels of risk that are involved. The following criteria must be met before you can call yourself an accredited investor.
Who Is an Accredited Investor and What Do They Do?
An accredited investor is a person who is authorized by the Securities and Exchange Commission (SEC) to invest in securities that have not been registered with the SEC (SEC).
Because of the high levels of risk and complexity associated with these kinds of assets, only sophisticated investors who have a significant amount of capital are eligible to purchase them.
Despite the potential for large returns, investing in these kinds of assets is not for everyone. They are as follows:
- Firms that invest in private equity
- Hedge funds
- Platforms for crowdsourcing investments in real estate
- Stocks in newly established businesses
- Venture capital funds
- Angel investment
Under the terms of the Securities Act of 1933, any and all securities that are to be offered for sale to the general public are required to be registered, and comprehensive financial and business information must be provided to the Securities and Exchange Commission (SEC).
Registration has two different functions. Its purpose is to shield investors from being deceived or misled in any way, as well as to guarantee that investors are provided with complete financial disclosure regarding issuers and the securities they purchase.
Investors are provided with all of the information that is essential to support an informed investment decision when full disclosure is provided.
Who Can Become an Accredited Investor?
The idea that people who have sufficient income or wealth are financially savvy enough to understand complex, unregistered investments and have the financial strength to withstand the complete loss of the capital invested is the reasoning that underpins the accredited investor rules. Accredited investors must have either sufficient income or sufficient wealth.
Regrettably, there is no one set procedure that must be followed in order for an individual to be considered an accredited investor.
Accredited investors cannot be certified by either a government agency or an independent board, as there is none of either.
Instead, firms and financial institutions that issue unregistered securities are required to verify that their investors are accredited before any sale of the securities can take place. This verification is accomplished through the process of performing diligence.
The following qualifications must be met in order for an individual to be deemed an accredited investor. Note that in order to be deemed accredited investors, individuals or couples must meet at least one of the following criteria:
- Income: In order to qualify as an accredited investor, an individual must have a yearly income of at least $200,000 (or a couple must make $300,000) for at least two years in a row. Couples must make at least $300,000. They need to be able to show that their income comes from the same source every year, and there needs to be a reasonable expectation that their revenue will remain the same or increase over the course of the following year.
- Net Worth: An individual or couple with a net worth of at least $1 million at the time of investment, excluding the value of a primary dwelling. • Income: An individual or couple with an annual income of at least $200,000 per year. Before the Dodd-Frank Act was passed in 2010, a primary property had the potential to be factored into a person’s net worth; however, after its enactment, primary residences are no longer considered when calculating net worth.
- Professional credentials: Individuals who have particular professional designations may also be eligible for the status of accredited investor provided they meet the requirements of this category. Among these prerequisites are a number of licenses issued by the Financial Industry Regulatory Authority (FINRA), such as the Series 7, Series 65, and Series 82.
- Insider status: Individuals who work for a company that provides unregistered investments are considered to have insider status. They are known as “knowledgeable individuals” in the industry.
How to Become an Accredited Investor
The buyer of an unregistered investment asset and a corporation or financial institution that is selling the investment together go through the steps necessary to determine whether or not the buyer meets the criteria to be considered an accredited investor.
The following is an example of the standard procedure that a seller may follow in order to ascertain whether or not a prospective buyer meets the requirements to be considered an accredited investor in terms of their income or net worth. The buyer may also:
- You should present the potential investor with a comprehensive questionnaire for them to fill out.
- In order to assess whether or not the required levels of income or net worth are met, you should request verification of the information regarding your finances in the form of financial statements, tax returns, or other papers.
- Verify your net worth by analyzing a credit report and determining whether or not there are any outstanding liabilities that have not been declared.
- Make sure that you ask a certified public accountant (CPA), a tax attorney, or a financial counselor for a letter of attestation.
In order to be considered an accredited investor, a knowledgeable individual, or an insider, the buyer would have to request evidence of the buyer’s status as a director, general partner, or executive at a company that sells unregistered securities. This would allow the buyer to meet the requirements necessary to become an accredited investor. Documents such as governing documents, resolutions, and other supporting documents could be included in this evidence.
If potential investor wants to qualify based on their professional certificates, they can provide FINRA with evidence of their securities licenses.
Advantages of Being an Accredited investor
There are many benefits to having an accredited investor status.
Being able to have access to investments that carry a higher degree of risk but potentially offer larger returns is the primary benefit of having investor accreditation. Additional advantages include the following:
- Higher returns that are not associated with the general success of the market as a whole
- Increased opportunities for diversification
- Possibility of participating in a wider variety of investment opportunities
Disadvantages of Being an Accredited Investor
Being an accredited investor comes with a number of drawbacks.
Unregistered securities are almost always high-risk investments, and buyers of these types of securities have a larger possibility of suffering a loss of some or all of the money they have put up as collateral.
However, investment minimums are typically quite high for hedge funds, private equity funds, and other similar types of funds. It is possible that participants may need to make an investment of at least one hundred thousand dollars to take part.
Lock-up periods are periods of time during which investors are unable to make withdrawals from certain sorts of assets. As a result, investors in these types of investments need to be prepared for reduced liquidity.
Last but not least, the costs are quite expensive. The most typical fee structure is known as the “standard two plus 20 arrangement,” which consists of a 2% yearly management fee in addition to a 20% performance fee depending on earnings.
Further Eligibility Needed to Become an Accredited Investor
Additional Criteria Have to Be Satisfied Before One Can Be Considered an Accredited Investor
You will be expected to produce paperwork in order to verify that you have achieved the desired level of certification. The following are included in this category:
- Bank statements
- Accounts with stockbrokers
- For your credit report to accurately reflect your obligations.
- Documentation regarding the ownership of the business, such as tax filings, in addition to an operating agreement
- Particular third-party assertions originating from respectable institutions
- Documentation of your expertise or professional qualifications
It is important to keep in mind that the value of your primary dwelling or primary home cannot be factored into your overall net worth. Nevertheless, vacation homes and investment properties are eligible for inclusion in one’s total net worth. You are required to provide evidence of ownership as well as an accurate value.
The management company will conduct an evaluation of your documentation once it has been handed in. They will next decide whether or not to accept your position as an accredited investor.
If you are accepted, your accreditation will normally be good for one year, or until the following tax day, whichever comes first (if you verify via income). After that, you will be able to make investments.
Summary on how to become an accredited investor
The position of accredited investor is not open to everyone. With a few notable exceptions, wealth is the primary criterion for admission.
It is common practice to make the assumption that those with a high net worth possess a higher level of monetary expertise, as well as the ability to withstand significant financial setbacks.
However, individuals who are able to satisfy the requirements of the SEC have a strong chance of reaping the benefits of a wider universe of investment options as well as the possibility of far better returns.
Having access to investments that are not registered enables those who are already wealthy to amass even more wealth.
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