Requirements for Accredited Investors

The regulations for accredited investors vary from one jurisdiction to the other and are often defined by a local market regulator or a competent authority. In the U.S, the definition of an accredited investor is put forth by SEC in Rule 501 of Regulation D.2

To be an accredited investor, a person must have an annual income exceeding $200,000 ($300,000 for joint income) for the last two years with the expectation of earning the same or a higher income in the current year. An individual must have earned income above the thresholds either alone or with a spouse over the last two years. The income test cannot be satisfied by showing one year of an individual's income and the next two years of joint income with a spouse.2

A person is also considered an accredited investor if they have a net worth exceeding $1 million, either individually or jointly with their spouse. The SEC also considers a person to be an accredited investor if they are a general partner, executive officer, or director for the company that is issuing the unregistered securities.2

An entity is considered an accredited investor if it is a private business development company or an organization with assets exceeding $5 million. Also, if an entity consists of equity owners who are accredited investors, the entity itself is an accredited investor. However, an organization cannot be formed with the sole purpose of purchasing specific securities. If a person can demonstrate sufficient education or job experience showing their professional knowledge of unregistered securities, they too can qualify to be considered an accredited investor.2

In 2020, the U.S. Congress modified the definition of an accredited investor to include registered brokers and investment advisors.3

On Aug. 26, 2020, the U.S. Securities and Exchange Commission amended the definition of an accredited investor. According to the SEC's press release, "the amendments allow investors to qualify as accredited investors based on defined measures of professional knowledge, experience or certifications in addition to the existing tests for income or net worth. The amendments also expand the list of entities that may qualify as accredited investors, including by allowing any entity that meets an investments test to qualify."

Among other categories, the SEC now defines accredited investors to include the following: individuals who have certain professional certifications, designations, or credentials; individuals who are “knowledgeable employees” of a private fund; and SEC- and state-registered investment advisors.4

Purpose of Accredited Investor Requirements

Any regulatory authority of a market is tasked with both promoting investment and safeguarding investors. On one hand, regulators have a vested interest in promoting investments in risky ventures and entrepreneurial activities because they have the potential to emerge as multi-baggers in the future. Such initiatives are risky, may be focused on concept-only research and development activities without any marketable product, and may have a high chance of failure. If these ventures are successful, they offer a big return to their investors. However, they also have a high probability of failure.

On the other hand, regulators need to protect less-knowledgeable, individual investors who may not have the financial cushion to absorb high losses or understand the risks associated with their investments. Therefore, the provision of accredited investors allows access for both investors who are financially well-equipped, as well as investors who are knowledgeable and experienced.

There is no formal process for becoming an accredited investor. Rather, it is the responsibility of the sellers of such securities to take a number of different steps in order to verify the status of entities or individuals who wish to be treated as accredited investors.

Individuals or parties who want to be accredited investors can approach the issuer of the unregistered securities. The issuer may ask the applicant to respond to a questionnaire to determine if the applicant qualifies as an accredited investor. The questionnaire may require various attachments: account information, financial statements, and a balance sheet to verify the qualification. The list of attachments can extend to tax returns, W-2 forms, salary slips, and even letters from reviews by CPAs, tax attorneys, investment brokers, or advisors. Additionally, the issuers may also evaluate an individual’s credit report for additional assessment.

Example of an Accredited Investor

For example, suppose there is an individual whose income was $150,000 for the last three years. They reported a primary residence value of $1 million (with a mortgage of $200,000), a car worth $100,000 (with an outstanding loan of $50,000), a 401(k) account with $500,000, and a savings account with $450,000. While this individual fails the income test, they are an accredited investor according to the test on net worth, which cannot include the value of an individual's primary residence. Net worth is calculated as assets minus liabilities.

This person's net worth is exactly $1 million. This involves a calculation of their assets (other than their primary residence) of $1,050,000 ($100,000 + $500,000 + $450,000) less a car loan equaling $50,000. Since they meet the net worth requirement, they qualify to be an accredited investor.

Who Qualifies to Be an Accredited Investor?

The SEC defines an accredited investor as either:

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.1
Are There Any Other Ways of Becoming an Accredited Investor?