What Is an Accredited Investor?
An accredited investor is an individual or a legal entity including high-net-worth individuals, banks, insurance companies, brokers, trusts, and investment funds that is allowed to invest in sophisticated high-risk investments such as venture capital, hedge funds, and angel investments.
Accredited investors are also allowed to trade illiquid securities such as Restricted Common Stock that may not be registered with securities agencies.
Which Individuals Qualify as Accredited Investors?
The securities agency of each country determines which individuals and entities qualify as accredited investors. Universally, this is determined by Income and Assets.
In the U.S., under Regulation D, the Securities and Exchange Commission (SEC) defines an accredited investor as:
– An individual with gross income exceeding $200,000 in each of the two most recent years or joint income with a spouse or partner exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year.
– A person whose individual net worth, or joint net worth with that person’s spouse or partner, exceeds $1,000,000, excluding the person’s primary residence.
Whether accurate or inaccurate, these investors are deemed to be financially sophisticated. Thus, they don’t need as much investment consumer protection as other less wealthy average investors that is provided in strict regulatory disclosures.
Which Entities Qualify as Accredited Investors?
In the U.S., under Regulation D, the Securities and Exchange Commission (SEC) defines an accredited investor as:
– A corporate or legal entity that is a private company or organization with assets worth at least $5 million.
– An entity that consists of owners who are accredited investors qualifies to be an accredited investor. However, an organization cannot be formed with the sole purpose of purchasing specific securities.
As such, accredited investors include private companies, banks, insurance companies, brokers, trusts, investment funds, registered brokers and investment advisors.
Private Placement
A private placement is an offering of securities (e.g. Shares) to investors in which the issuer does not have to register the shares with any securities agency nor file any strict regulatory disclosures. This reduces the time and costs associated with the offering.
Accredited investor status allows these investors to invest in the shares. The shares are offered directly to accredited investors. The shares are “placed privately” with these investors hence the name “private placement.”
These shares carry higher risk and are generally very illiquid. As such, only sophisticated accredited investors are allowed to invest in them.
And it is the issuer’s responsibility to determine that each investor qualifies as an accredited investor by verifying the investor’s income or assets and performing any other due diligence. Therefore securities agencies have a very minimal role in the offering and provide very little investor protection.
Due Diligence
Securities law requires that only accredited investors be allowed to participate in certain private placement investment offerings. Potential investors are generally required to fill out a questionnaire and provide any supporting documentation to prove their Income and Assets.
Documentation often includes bank financial statements, corporate or personal income tax returns, credit reports, and certified letters executed by a Certified Public Accountant (CPA) or tax attorney.
Other Unique Accredited Investor Designations
Under certain circumstances, an accredited investor designation may be assigned to:
– The officers, directors, shareholders, or partners of the issuer of the securities being offered or sold in the private placement. Accredited investor designation may even be assigned to the relatives and close business associates of these individuals.
The reason for this is it is deemed that these individuals have unique sophisticated knowledge of the issuer whose securities they are issuing and therefore do not need as much investor protection as the average unknowledgeable investor.
– Financial professionals with securities licenses can also be deemed accredited investors as they have sophisticated financial knowledge.
Detailed Criteria for Accredited Investors in U.S., Canada, and European Union
Below are the exact definitions of an accredited investors reprinted here from the securities agency publication of each country.
United States
In the United States, to be considered an accredited investor, one must have a net worth of at least $1,000,000, excluding the value of one’s primary residence, or have income at least $200,000 each year for the last two years (or $300,000 combined income if married) and have the expectation to make the same amount this year.
The term “accredited investor” is defined in Rule 501 of Regulation D of the U.S. Securities and Exchange Commission (SEC) as:
– a bank, insurance company, registered investment company, business development company, or small business investment company;
– an employee benefit plan, within the meaning of the Employee Retirement Income Security Act, if a bank, insurance company, or registered investment adviser makes the investment decisions, or if the plan has total assets in excess of $5 million;
– a charitable organization, corporation, or partnership with assets exceeding $5 million;
– a director, executive officer, or general partner of the company selling the securities;
– a business in which all the equity owners are accredited investors;
– a natural person who has individual net worth, or joint net worth with the person’s spouse, that exceeds $1 million at the time of the purchase, or has assets under management of $1 million or above, excluding the value of the individual’s primary residence;
– a natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year
– a trust with assets in excess of $5 million, not formed to acquire the securities offered, whose purchases a sophisticated person makes.
– a natural person who has certain professional certifications, designations or credentials or other credentials issued by an accredited educational institution, which the Commission may designate from time to time. Presently holders in good standing of the Series 7, Series 65, and Series 82 licenses.
– natural persons who are “knowledgeable employees” of a fund with respect to private investments.
– limited liability companies with $5 million in assets may be accredited investors.
– SEC and state-registered investment advisers, exempt reporting advisers, and rural business investment companies (RBICs) may qualify.
– Indian tribes, governmental bodies, funds, and entities organized under the laws of foreign countries, that own “investments”, as defined in Rule 2a51-1(b) under the Investment Company Act, in excess of $5 million and that was not formed for the specific purpose of investing in the securities offered.
– Family offices with at least $5 million in assets under management and their “family clients”, as each term is defined under the Investment Advisers Act.
– “Spousal equivalent” to the accredited investor definition, so that spousal equivalents may pool their finances for the purpose of qualifying as accredited investors.
Canada
As defined in National Instrument 45-106 by the Securities Commissions in Ontario, British Columbia, and other provinces, an accredited investor is:
– a person registered under the securities legislation of a jurisdiction of Canada, as an adviser or dealer, other than a person registered solely as a limited market dealer under one or both of the Securities Act (Ontario) or the Securities Act (Newfoundland and Labrador); or
– an individual registered or formerly registered under the securities legislation of a jurisdiction of Canada as a representative of a person referred to in paragraph (a); or
– an individual who, either alone or with a spouse, beneficially owns financial assets having an aggregate realizable value that before taxes, but net of any related liabilities, exceeds $1,000,000; or
– an individual whose net income before taxes exceeded $200,000 in each of the two most recent calendar years or whose net income before taxes combined with that of a spouse exceeded $300,000 in each of the two most recent calendar years and who, in either case, reasonably expects to exceed that net income level in the current calendar year; or
– an individual who, either alone or with a spouse, has net assets of at least $5,000,000; or
– a person, other than an individual or investment fund, that has net assets of at least $5,000,000 as shown on its most recently prepared financial statements; or
– a trust company or trust corporation registered or authorized to carry on business under the Trust and Loan Companies Act (Canada) or under comparable legislation in a jurisdiction of Canada or a foreign jurisdiction, acting on behalf of a fully managed account managed by the trust company or trust corporation, as the case may be; or
– an investment fund that distributes or has distributed its securities only to (i) a person that is or was an accredited investor at the time of the distribution, (ii) a person that acquires or acquired securities in the circumstances referred to in sections 2.10 of NI 45 106 [Minimum amount investment] or 2.19 of NI 45 106 [Additional investment in investment funds], or (iii) a person described in paragraph (i) or (ii) that acquires or acquired securities under section 2.18 of NI 45 106 [Investment fund reinvestment];
– a person acting on behalf of a fully managed account managed by that person, if that person is registered or authorized to carry on business as an adviser or the equivalent under the securities legislation of a jurisdiction of Canada or a foreign jurisdiction; or
– a person in respect of which all of the owners of interests, direct, indirect or beneficial, except the voting securities required by law to be owned by directors, are persons that are accredited investors (as defined in NI 45 106); or
– an investment fund that is advised by a person registered as an adviser or a person that is exempt from registration as an adviser.
European Union
Retail clients requesting treatment as ‘elective’ professional clients (as defined by Markets in Financial Instruments Directive (MiFID)) must satisfy at least two of the following quantitative criteria in assessing the client’s expertise, experience and knowledge:
– the client has carried out trade transactions, in significant size (at least €50,000), on the relevant market at an average frequency of 10 per quarter over the previous four quarters;
– the size of the client’s financial instrument portfolio, defined as including cash deposits and financial instruments, exceeds €500,000;
– the client works or has worked in the financial sector for at least one year in a professional position which requires knowledge of the transactions or services envisaged.