18 Oct What is an Accredited Investor?
Securities that are offered or sold by a company or private fund must register the transaction with the SEC, unless an exemption is made available. One example of how a securities offering can be exempt from registration is when that security is offered to – or bought by – an accredited investor.
But what, exactly, does it mean to be an accredited investor?
For starters, these exempt offerings made to accredited investors don’t have to endure the type of full disclosures required by offerings registered with the SEC. As a result, these offerings often carry a unique risk, because the investor isn’t provided certain data that could help him or her make a more informed decision.
As such, an accredited investor has to be able to bear the economic risk of investing in these risky, unregistered securities.
What it takes to be an accredited investor
The definition of an accredited investor is pretty cut and dry, and comes down to one of two parameters.
1. Either you have an income that’s exceeded $200,000 (or $300,000 when combined with a spouse) in each of the prior two years, and expect a similar income for the current year, OR
2. You have a net worth over $1 million (either alone or combined with a spouse), excluding the value of your primary residence.
In terms of #1, you have to be consistent on how you achieve the threshold. For example, you can’t have exceeded $200,000 in your first year, but then have to rely on joint income the following two years in order to make the grade.
The only exception is if you get married during this period. In that case, then you can satisfy the threshold via “joint income” for the years in which you were married, and on the basis of “individual income” for the other years where you were not married.
Calculating your net worth
If your net worth exceeds $1 million, then you are an accredited investor. Thus, it comes down to how you calculate your net worth.
If you’re calculating joint net worth with a spouse, it’s not required that all property be jointly held.
In order to calculate your net worth, you have to add up all of your assets (aside from your primary residence), and subtract your liabilities. The result is your net worth.
In addition to excluding your primary residence from the equation, you also benefit from not having to count any mortgage tied to that home as a liability … with a couple of exceptions.
1) If the loan is for more than the fair market value of your home, then that amount over the fair market value does count as a liability.
2) If there’s an increase in the loan amount in the 60 days prior to the purchase of any securities, then that amount counts as a liability as well (this is to prevent someone from falsely inflating their net worth by converting home equity into cash or other assets).
What changed after July 20, 2010?
The Dodd-Frank Act changed the rules of what it takes to become an accredited investor by excluding primary residences from the net worth test.
As a result some folks who were considered accredited investors prior to July 20, 2010 no longer meet the criteria. However, any purchase rights (preemptive rights or rights of first offer) related to securities they invested in prior to this date are grandfathered in.
When an accredited investor isn’t a person
An accredited investor does not need to be an individual person, either. Banks, corporations, nonprofits, trusts, and partnerships all can become accredited investors, if they meet either of these requirements:
1. It is a trust with total assets in excess of $5 million; the trust wasn’t formed for the purpose of purchasing the subject securities, and the purchase is directed by a sophisticated person (meaning they have sufficient knowledge and experience in financial and business matters), OR
2. Any entity where all of the equity owners are accredited investors.
Knowing the definition of an accredited investor, becoming one and/or finding one to invest in your business are three very different things.