Most investments must be registered with the Securities and Exchange Commission, or SEC, before they can be offered for sale to investors. But there's an exception if the investment is only being sold to accredited investors.
Accredited investors, unlike the general public, qualify to invest in hedge funds, private equity deals, venture capital funds, and other private placements. Accredited investors must have a net worth exceeding $1 million or income that is above a certain level, either alone or with a spouse.
What is an accredited investor?
Under U.S. law, securities cannot be offered for sale unless they are either registered with the SEC or there is an exemption from registration. Only selling to accredited investors provides one such exemption.
An accredited investor can invest in certain unregistered investments, such as private equity, venture capital, and hedge funds.
Are you an accredited investor?
For an individual to qualify as an accredited investor, one of two conditions must be met:
- The individual must have earned income exceeding $200,000, or $300,000 when combined with a spouse, during each of the previous two full calendar years, and a reasonable expectation of the same for the current year. The same method (single or joint) must be applied to the income test in all three years.
- The individual must have a net worth greater than $1 million (either alone or combined with a spouse), excluding the person's primary residence. We have a net worth calculator that can help you determine yours -- just leave the "residence" input at zero for accredited investor purposes.
It's just not individuals that can be accredited investors. Banks, partnerships, corporations, nonprofits, and trusts can, too. For example, a trust with assets greater than $5 million or any entity whose owners are all accredited investors would qualify.
To be clear, the accredited investor rules are there to protect you as an investor, not the companies offering the investments. Also, there is no agency that verifies accredited investor status. In other words, you can't simply register somewhere as an accredited investor and then be free to invest in any hedge fund, venture capital fund, or private equity deal you want. Since 2013, under SEC rule 506(c), anyone selling investments that require "accredited investor" status must take steps to verify the status.
For this reason, if you attempt to invest in, say, a hedge fund, don't be surprised if the fund's management insists on thoroughly verifying your status as an accredited investor before letting you invest. And if you later try to invest in another such fund, expect to go through the verification process again.
Examples of accredited and non-accredited investors
To illustrate how this works, consider these two examples.
A married man with a net worth of $800,000 wants to invest in a hedge fund. He earned $250,000 two years ago, but his wife didn't work. Last year, he earned $160,000 and his wife earned $200,000, for a total of $360,000, and the couple expects about the same amount of earnings this year. Because the income test requires that investors use only one method (single or joint) to satisfy the income test, this investor would not meet the requirements of an accredited investor.
A retired married couple has about $2 million in investment assets, but since they no longer work, they have no earned income. However, since this couple has a net worth greater than $1 million, they would still qualify as accredited investors because of their net worth.
Could these requirements change?
It's entirely possible that the accredited investor definition will be significantly loosened over the coming years. For example, one change that was part of the Dodd-Frank reforms disallowed an investor's primary residence from being considered in the net-worth calculation. Since the current administration has made it a point to roll back financial regulations -- specifically Dodd-Frank -- it's possible that this could go away.