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Accredited investors consist of many people and entities, from banking giants to Fortune 100 companies down to hobby investors and families saving for college and retirement. It is also a rapidly expanding group of investors.

Whether you’re considering dabbling in the rarified group of investors or just curious about how it works, the article below outlines what to know about accredited investors.

What is an Accredited Investor?

An accredited investor is an individual or business entity with strong financial knowledge and high net worth. They are allowed to invest in securities, such as convertible notes and hedge funds. An accredited investor is not registered with the SEC and must satisfy specific criteria.

Finance laws created accredited investors to help companies bypass SEC public reporting requirements in response to the Great Depression to improve market capital access. Accredited investors remain privately-owned but trade under an exemption in the law, and accredited investor sales fall under these exemptions. As long as these individuals have a sufficient net worth to cushion against losses, they are not subject to SEC reporting rules and regulations.

Here is an article that also defines accredited investors.

Benefits of Being an Accredited Investor

There are several benefits of being an accredited investor. These individuals are highly qualified but unaware of how powerful their position is. Some of these benefits include the ability to invest in small businesses, the diversity of an investment portfolio, and access to more favorable returns.

Below, we’ve taken a closer look at three of the benefits of being an accredited investor:

Benefit 1. Favorable Investment Opportunities

A private placement is when a business raises capital outside of the public capital markets. These private placements offer higher yields than the public markets since the underlying issuer has available capital. Gaining access to higher-yield capital markets is far easier when you are an accredited investor.

Learn more about private placement memorandums .

Benefit 2. Small Businesses Investment Opportunities

Accredited investors can support small businesses with missions that align with their values, and Seed-funding platforms connect them with startups at any stage of their development. Typical small business investment opportunities include food manufacturers, “Main Street” businesses, online retailers, product manufacturing, social causes, and other small businesses startups.

Benefit 3. Investment Portfolio Diversity

As interest rates rise, investing exclusively in the public markets stagnates investment portfolios with limited diversification options. Finding non-correlated alternative assets and debt securities in which to invest will reduce systematic risk and exposure. As an accredited investor, you have access to capital that non-accredited investors do not.

Here is an article that also discusses accredited investors.

Who Qualifies as an Accredited Investor?

The SEC requires accredited investors to possess a specific level of wealth, knowledge, income, and due diligence to invest in opaque financial securities. It is not easy to qualify as an accredited investor, which is another reason why it is highly prized.

You may qualify as an accredited investor if you meet the following requirements:

  • Requirement 1 . Possess professional certifications or credentials or work as a knowledgeable employee at a private fund.
  • Requirement 2 . Have a net worth that exceeds $1 million, excluding the value of your primary residents, as an individual or with a spouse.
  • Requirement 3 . Earn above $200,000 per year individually or $300,000 with a spouse with a two-year lookback period and demonstrate the ability to maintain these thresholds for the remaining year.

As you can see, there are very stringent financial and professional requirements. Ensure that you discuss your situation with securities lawyers if you are wondering about your qualifications. You can learn more about qualifying as an accredited investor here .

Learn about investor rights agreements .

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How to Become an Accredited Investor

There are specific criteria and standards that you must meet to become an accredited investor. The SEC recently passed new rules that make the qualification process more accessible. You must pass two specific tests to become an accredited investor and receive approval.

Here is a step-by-step process that shows you how to become an accredited investor:

Step 1. Meet Specific Financial Requirements

The most direct way to become an accredited investor is to have a net worth that exceeds $1 million or earns at least $200,000 per year . Firms will consider individuals with spouses who collectively have a pre-tax income of $300,000. Couples also need to pass the $1 million net worth threshold, not including their primary place of residence.

Learn about statements of net worth .

Step 2. Pass the Knowledge Test

There are two types of knowledge tests used to qualify as an accredited investor. These types include specific credentials or knowledgeable employee status. The qualifications necessary for your situation will vary according to your employment or credentialing.

Here is a closer look at the two types of knowledge tests below:

Credentials and Certifications

You must pass the knowledge test to become an accredited investor. Possessing specific professional credentials, certificates, and more from a high-education or accredited institution, such as Financial Industry Regulatory Authority (FINRA) , will help you earn accredited investor status. With the proper certification and knowledge, accredited investors can carry out investments for other individuals and entities.

Knowledgeable Employee Test (Private Funds Only)

Private fund employees can qualify under the knowledgeable employee designation. Knowledgeable employees serve in a high capacity over a private fund or affiliate, such as a director, executive officer, partner, or trustee. These individuals can be employees who participate in investment activities of their employer for at least 12 months.

Step 3. Obtain Accredited Investor Documentation

Proving your accredited investor qualifications starts with careful documentation. Here are some documents that you may need to obtain to verify your status:

  • Financial statements
  • Bank account statements
  • Credit reports
  • Tax returns and documents
  • FINRA certifications

Your primary residence’s value is not something you can include in your net worth report. However, you may add investment properties and vacation homes as long as you can verify ownership and valuation. The financial firm reviewing your submitted documents will accept or deny your accredited investor status.

Step 4. Apply to Become an Accredited Investor

The SEC requires accredited investor issuers to verify that an accredited investor meets the requirements above concretely. This process does not skim over self-affidavits and forms to check off items on a list. Instead, issuers use verification methods to confirm their status.

Two types of verification may occur, including individual and entity verification, as described below:

Type 1. Individual Verification

An individual can prove their qualifications by providing their tax documents for income over the last two years. Bank statements and accounts can help issuers understand more information about the subject’s finances. The issuer can request any type of documentation necessary to determine their eligibility and status.

Type 2. Entity Verification

Entity verification involves locating assets and investments by a bank or brokerage firm that maintains the accounts. These documents must fall within a 90-day time frame when going through the verification process. Verification methods can also confirm accredited investor status by identifying individuals of an entity and then pursuing the verification process for individuals.

Final Thoughts For Accredited Investors

Upon approval, you have valid accreditation for at least one year or until the following tax day. At this point, you are ready to invest in capital markets that matter to you. Financial services lawyers can help you manage your investments and protect your legal rights with convertible promissory notes , private placement memorandums, and other investment contracts .

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ContractsCounsel is not a law firm, and this post should not be considered and does not contain legal advice. To ensure the information and advice in this post are correct, sufficient, and appropriate for your situation, please consult a licensed attorney. Also, using or accessing ContractsCounsel's site does not create an attorney-client relationship between you and ContractsCounsel.

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