Under the federal securities laws, a company may not offer or sell securities to investors without registration with the SEC. However, there are a number of registration exemptions that ultimately expand the universe of potential investors.
Many exemptions require that the investment offering be made only to persons who are accredited investors.
Definition of an Accredited Investor
As of 2021, the SEC defines an accredited investor as:
- An individual with a net worth, excluding the value of their primary residence, of $1 million or more
- An individual with an income of $200,000 or more in each of the two most recent years and who has a reasonable expectation of earning the same amount in the current year
- A married couple with a combined net worth of $1 million or more and an income of $300,000 or more in each of the two most recent years with a reasonable expectation of earning the same amount in the current year
- A bank, insurance company, registered investment company, business development company, or small business investment company
- An employee benefit plan, a charitable organization, a corporation, or a partnership with assets in excess of $5 million
- A trust with assets in excess of $5 million, not formed for the specific purpose of acquiring the securities offered
Benefits of Being an Accredited Investor
One of the key benefits of being an accredited investor is access to a wider range of investment opportunities. Accredited investors are eligible to participate in private placements, hedge funds, and other investment vehicles that are not available to the general public.
Additionally, accredited investors often receive more favorable terms and higher potential returns than what is available to the general public. This is because private placements and hedge funds are not required to comply with the same regulatory requirements as public offerings, allowing for more flexibility in terms of investment strategies and potential returns.
Unlike offerings registered with the SEC in which certain information is required to be disclosed, companies and private funds, such as a hedge fund or venture capital fund, engaging in these exempt offerings do not have to make prescribed disclosures to accredited investors.
One reason these security offerings are limited to accredited investors is to ensure that all participating investors are financially sophisticated and able to fend for themselves or sustain the risk of loss, thus rendering unnecessary the protections that come from a registered offering. Unlike security offerings registered with the SEC in which certain information is required to be disclosed, companies and private funds, such as a hedge fund or venture capital fund, engaging in these exempt offerings do not have to make prescribed disclosures to accredited investors.
Individuals as an Accredited Investor
An accredited investor, in the context of a natural person, includes anyone who:
- earned income that exceeded $200,000 (or $300,000 together with a spouse) in each of the prior two years, and reasonably expects the same for the current year, OR
- has a net worth over $1 million, either alone or together with a spouse (excluding the value of the person’s primary residence).
Income Test for Accredited Investor
The net worth test is relatively simple. Either you have a million dollars, or you don’t. However, on the income test, the person must satisfy the thresholds for the three years consistently either alone or with a spouse, and cannot, for example, satisfy one year based on individual income and the next two years based on joint income with a spouse. The only exception is if a person is married within this period, in which case the person may satisfy the threshold on the basis of joint income for the years during which the person was married and on the basis of individual income for the other years.
Corporate Entities, Trusts, as Accredited Investors
In addition, entities such as banks, partnerships, corporations, nonprofits, and trusts may be accredited investors. Of the entities that would be considered accredited investors and depending on your circumstances, the following may be relevant to you:
- any trust, with total assets in excess of $5 million, not formed to specifically purchase the subject securities, whose purchase is directed by a sophisticated person, or
- any entity in which all of the equity owners are accredited investors.
In this context, a sophisticated person, which is not the same as an accredited investor, means the person must have, or the company or private fund offering the securities reasonably believes that this person has, sufficient knowledge and experience in financial and business matters to evaluate the merits and risks of the prospective investment.
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