Accredited Investors Defined
How Do You Define an Accredited Investor and what Advantages Do They Enjoy?
If you have explored the heady worlds of hedge funds, venture capital, and private equity, the term accredited investor is not unfamiliar. For those new to these exotic investment options, an explanation of the term accredited investor (AI) is warranted.
Investor status falls under a variety of definitions per the SEC and other governing bodies, and as you will learn, the AI holds a higher, even coveted status in the investment firmament.
For example, when private equity investing is being discussed, it is clear that an AI has certain characteristics that set them apart from other investors.
An AI may be a retail or institutional investor, but our focus today will be the retail AI.
What Is an Accredited Investor?
In the United States, the Securities and Exchange Commission (SEC) determines the definition of accredited investor under Regulation D of the Securities Act 1933 which states that an AI must:
demonstrate an individual income exceeding $200,000 in each of the two most recent years, or joint income of $300,000 with their spouse, and they must reasonably expect to reach the same income level in the current year, or
have a net worth exceeding $1 million (individually or jointly with a spouse), excluding the value of their primary residence, or
be otherwise approved by SEC regulators.
Under Canadian law, the definition falls to the Ontario Securities Commission by way of the National Instrument (NI 45 106). An accredited investor must
be an individual who, either alone or jointly with their spouse, beneficially owns financial assets with an aggregate realizable value, before taxes but net of any related liabilities, exceeding $1 million, or
beneficially owns financial assets having an aggregate realizable value that, before taxes but net of any related liabilities, exceeds $5 million, or
whose net income before taxes exceeded $200 000 in each of the 2 most recent calendar years or whose net income before taxes combined with that of a spouse exceeded $300 000 in each of the 2 most recent calendar years and who, in either case, reasonably expects to meet or exceed that net income level in the current calendar year, or
an individual, or jointly with their spouse, has net assets of at least $5 million, or
a person, other than an individual or investment fund, that has net assets of at least $5 million, as shown on their most recently prepared financial statements, or
be otherwise approved by the Ontario Securities Commission regulators.
Both jurisdictions require proof of the foregoing via relevant paperwork, such as:
Current bank statements or affidavits from an approved entity about personal assets,
property title deeds,
pay slips showing salary, bonuses, or other payments received,
employer verifications that confirm income for the preceding 12 months
An Accredited Investor in Layman’s Terms
Accredited investors may make certain types of investments (or trade certain securities) even when unregistered with financial authorities. An AI may be a high net worth individuals (HNWI), an experienced private equity investor or a family trust, to name a few.
Most times, the investments are not registered and do not follow normal disclosure requirements, and therefore carry greater risk. Examples include units of collective investment schemes or securities-based derivatives contracts.
Wealth is the principal qualification for accredited investors, and the source of the wealth is not a factor. Regulatory authorities strive to ensure that AIs are financially stable, experienced, and knowledgeable, which, in theory, suggests they have a diminished need for the protections provided in regulatory disclosure filings.
There is no exam that one must take to qualify as an AI. They must only meet the requirements outlined earlier.
How Do Accredited Investors Invest?
As an AI, you will be offered investments that non-accredited or retail investors cannot be offered, but such investment opportunities carry greater risks. Of course, they also hold the promise of greater returns. Such investments may include:
Private Equity:
Funds that raise money for buying and selling real estate assets. After raising the targeted amount, the fund will close to new investors and, within 5 to 10 years, the fund is liquidated by selling its assets and taking profits.
Equity Crowdfunding:
This is when several people invest in an unlisted fund to acquire a multi-family property for shares in the fund, and which share depends on the amount invested.
Private Placements:
Shares in a property investment allocated to pre-selected investors. LLCs use private placement as an alternative means to raise capital.
Hedge Funds:
These are limited partnerships of investors investing in a pool of investments, frequently using borrowed funds, hoping to capture above average capital gains. Hedge funds usually trade in liquid assets and use complex trading and risk management techniques to improve performance. Funds may engage in short selling, leverage, derivative investment, and other techniques.
Venture Capital (VC):
Venture capitalists invest in start-up companies which are deemed to have exceptional potential but need capital to set up or expand their operations. VC is private equity in which investors provide funds to fledgling companies in return for an ownership stake in the company. Apart from monetary help, VC firms often provide technical or managerial expertise.
Advantages of Being an Accredited Investor
Principal advantages for AIs include:
access to otherwise restricted unique investment opportunities,
the possibility of earning higher returns through participation in dynamic investment opportunities, which have the potential of creating wealth in a short time frame,
a broader choice of asset classes in which to invest, while avoiding competition with typical investors.
However, there is a downside, represented by the higher risk compared to registered investments. Also, that higher minimums for investment are often required. Performance fees paid besides management fees are also a drawback, as these may range from 15 to 30 percent, depending on the actual project.
AI investors are routinely found as participants in multi-family real estate investments., because there are many unique opportunities, the prospect of higher returns, and portfolio diversification.
Passive private equity real estate investing is an excellent option for accredited investors as they seek to achieve their wealth building aims.