What Does It Mean To Be An Accredited Investor?
Investment assets like venture capital, hedge funds, and startups are seemingly unavailable to your average investor. This is mostly due to companies having exemptions from regulations and policies that protect investors from unwanted or unnecessary risks. An accredited investor invests in these types of unregulated securities. They have a reputation for possessing capital and the knowledge to handle the risks in unregulated investment assets.
In this article, we’ll cover exactly what an accredited investor is, requirements, the assets they can buy, and their relationships with startups, venture capitalists, and hedge fund companies.
Defining an Accredited Investor
It refers to a person or an entity investing in private securities that are unregistered or unregulated by the SEC (Securities and Exchange Commission). The SEC defines an accredited investor based on the following requirements:
Income
An accreditor investor has a minimum income of $200,000 or $300,000 (joint income with a spouse). Investors should maintain their income level every year.
Net Worth
An accredited investor must have a net worth of $1 million or more, independently or jointly with a spouse. The net worth should exceed the total value of the primary residence.
Skills
The accredited investor should be a knowledgeable employee holding a series of 82, 65, or 7 licenses.
Such strict parameters protect the investors who might fail to accumulate cash reserves to handle the significant losses. SEC believes that investors with less experience might fail because such offerings demand a minimum investment. It doesn’t mean that hedge fund companies and early-stage companies lose money because of the strict criteria. Unregulated investments are risky because they disclose information to their investors,
Assets that Accredited Investors Buy
An accredited investor invests in:
- Angel investments
- Venture capital
- Hedge funds
- Real estate investment funds
- Private equity funds
- cryptocurrency
Such entities selling investors’ securities offerings are Regulation D offerings or private placements. The private placements exempt some securities from SEC guidelines and policies. The company registering with Regulation D offerings should submit basic details like location, staff, and offerings. Any extra info investors receive depends on the company or organization issuing the private placement offerings.
How Companies Verify Accredited Investors?
The parameters for becoming an accredited investor are strict but need a well-defined federal verification process. It depends on the organizations to verify the status of potential investors before allowing them to invest capital. Companies seek skills, net worth, and income verifications, like investment and bank statements, proof of employment, licensing, employment, and tax returns. A potentially accredited investor shouldn’t include primary residence value towards his net worth requirement.
Investing in Startups
Accredited investors have multiple options for investing in startups. They accomplish this through a VC (Venture Capital) firm or by leveraging the opportunities of an online marketplace and sourcing private placement offerings. With VC firms, accredited investors become the investors in the fund, and the VC firm invests capital in startups. Startups should understand that there is a liquidity limit in the VC fund and be mindful of the risks. The online marketplaces connect investors with investment scopes across multiple platforms, and due diligence is pivotal.
Investing in Hedge Funds
The primary motive of hedge funds is to give positive ROIs, irrespective of the market conditions. Investing in a hedge fund is challenging and cannot be done through a brokerage (online) or by calling a hedge fund company. There must be someone at the company, and the vetting process isn’t easy. Similar to VC investments, there is low liquidity, and the investment minimum amount is high.
Other Fund Investments
Accredited investors invest in funds that mimic the variegation of mutual funds, known as funds of funds. The fund invests in several other hedge or mutual funds. The fees for such funds are similar to those of hedge funds. Their performance can be benchmarked and monitored using the online Funds of Funds Index.
Conclusion
Along with net worth and income, an accredited investor should be cautious about investment opportunities. Every investment comes with risks, but accredited investors should be more careful as securities offerings demand higher upfront financial commitments. If investors want to explore the available options, reaching out to financial advisors is wise.