how to become accredited investor

Left to its own devices, investing can be a ruthless game. The government regulates how companies connect to the public to protect people from potential scams and extremely high-risk investments. The accredited investor receives less of this protection but also has the ability to connect with early-stage companies before they go public.

Getting in early on a company like Uber (NYSE: UBER) or Slack (NYSE: WORK) means enormous profits — gains well beyond the scope of what any individual can expect in a public offering.

Rule 501 of the U.S. Securities and Exchange Commission (SEC) Regulation D defines the accredited investor. We'll discuss the major points in that definition and what it means for your investment opportunities.

Accredited Investor Requirements and Qualifications

The accredited investor is assumed to be a sophisticated financial entity that can handle higher levels of risk. The accredited investor can be a natural person or a business entity.

Source: Wikimedia

The current standard for a natural person is as follows:

Income over $200,000 per year (for married couples, $300,000) in the prior 2 years and can prove a similar income for the current year, or
A net worth of over $1 million that does not include the value of the primary residence

The criteria for other categories of accreditation is as follows:

A trust with more than $5 million in assets, or
A business entity with 100% accredited investors as equity owners

Opponents of this standard point to the fact that individuals and firms can make money without investment sophistication. For instance, a surgeon who makes $500,000 is automatically considered a sophisticated investor — even though that surgeon may not know the first thing about buying a common stock or reading a balance sheet.

How Do Firms Determine if You're an Accredited Investor?

Taking money from nonaccredited investors can mean big trouble for a company, whether it succeeds or fails. Failure means court cases from angry investors, but success without compliance can bring penalties and sanctions once you get on the SEC's radar. If you are looking to invest in unregulated opportunities, you should be ready to prove your accredited status. Most reputable opportunities require this.

Companies looking for accredited investors may check your status as they see fit. You will probably be asked for a professional record of your finances. You may also be asked to prove how you will make your $200,000 minimum this year if you don't have at least $1 million net worth. Each investor chooses the amount of scrutiny he is willing to face in order to gain access to a certain opportunity.

Not all firms are worried about accreditation, however.

Regulation crowdfunding and the Jumpstart Our Business Startups (JOBS) Act are relatively new mods to securities law that work around accreditation.

Regulation crowdfunding allows companies to raise up to $1.07 million within 12 months with no accreditation standard. The JOBS Act created a Tier 2 standard business under Regulation A that allows companies to raise up to $50 million from nonaccredited investors. Companies are not required to disclose as much information about themselves when compared to companies raising money under traditional regulations.

Depending on who you ask, companies looking for investments break securities law all the time. If you get money from your working class cousin to start a neighborhood fish fry, you might be breaking SEC Regulation D. Fortunately, the SEC makes some provisions for smaller companies and family businesses in Rule 504 and Rule 506. To stay in general basic compliance, you cannot make a securities offer to anyone you don't already know or market the offering to the public in any way.

Rule 506 allows a company up to 35 nonaccredited investors in a funding round. These investors must meet an experience requirement that is purposely worded to give courts the ability to judge problems on a case-by-case basis.

Source: Flickr

Who Can be an Accredited Investor?

As long as you meet the financial criteria set forth in Rule 501 of Regulation D from the SEC, you can legitimately claim to be an accredited investor. The SEC doesn't actually certify you, nor is there any official documentation you can apply for. Determining your accreditation is left up to the companies who are scrutinizing investors.

The SEC recently proposed an expanded criteria on how to become an accredited investor. Previous to the expansion, the only criteria for accreditation were financial, and only individuals could qualify. New proposed rules for accreditation would create new categories of accredited investors based in the following:

Educational credentials: Individuals with credentials from accredited institutions would be able to qualify regardless of financial status.
Knowledgeable employees of established institutions: The Investment Company Act of 1940 regulates companies whose main activity is investing. Knowledgeable employees are defined in Rule 3c-5, and the expanded definition of accredited investor would allow them to qualify as accredited investors of the issuer they represent.
Investment entities: Any entity owning more than $5 million in investments may qualify as accredited, including government bodies and Native American tribes.
Family offices: Family offices can qualify as accredited if it has at least $5 million in investment assets.
Registered investment advisors: Investment advisors registered with the state or the SEC would be able to qualify as accredited investors based solely on that registration status. This classification also includes rural business investment companies.

Should these changes pass, it will be the first major change in the definition of accredited investor since 1985.

What Can Accredited Investors Invest In?

Accredited investors have access to many unregulated hedge funds, private equity investments and venture capital investments that common investors legally do not. The main advantage of being accredited is access to these unregistered investment opportunities.

The process of getting registered with the SEC is costly and time-consuming. SEC registration also requires that companies maintain a certain financial stability and accounting transparency. Early stage companies often do not want to invest the resources necessary to become registered. Instead, they limit investment offers to accredited investors only. Those offers usually have substantially more upside than public offerings, but they come with no government protection in case of default, unethical behavior or even illegal behavior.

Why Become an Accredited Investor?

The reason to become an accredited investor is simple — other investors will trust you more. As stated before, passing muster with government minimum standards doesn't actually get you anything in and of itself. But when other investors open your books and see financial stability and sophistication, they'll be much more likely to invite you to the VIP table.

Don't Jump the Gun

If you've opened an account with any brokerage firm, you have been asked to accredit yourself. Before the brokerage decides on your margin status or options level, you are asked for your income and level of investment sophistication. Hint: They don't check. You can easily self assert a $2 million net worth, 20 years of stock trading experience and an average trade size of $50,000. They'll give you 4X your capital for day trading and all of the unlimited options trading you can handle.

As 80%-90% of investors quickly find out, pretending to be smarter than you are is the fastest way to lose all of your money.

You are practically free to lose every dime you have despite the standards the government tries to put in place. So before you go jumping into a Regulation A Tier 2 investment pool or some crowdfunding pool because it sounds cool, consider that caution may be the best accreditation you have until you get that $1 million minimum.

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