What is an Accredited Investor?

An accredited investor is a person or a business entity who is allowed to deal in securities that may not be registered with financial authorities. They are entitled to such privileged access if they satisfy one (or more) requirements regarding income, net worth, asset size, governance status or professional experience. In the U.S., the term is used by the Securities and Exchange Commission (SEC) under Regulation D to refer to investors who are financially sophisticated and have a reduced need for the protection provided by regulatory disclosure filings. Accredited investors include natural high net worth individuals (HNWI), banks, insurance companies, brokers and trusts.

ACCREDITED INVESTORS NEED TO KNOW: An accredited investor is a person or entity who is allowed to deal, trade and invest in financial securities as long as they satisfy one (or more) requirements regarding income, net worth, asset size, governance status or professional experience.

Requirements for Accredited Investors

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

To be an accredited investor, a person must have an annual income exceeding $200,000, or $300,000 for joint income, for the last two years with expectation of earning the same or 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. The exception to this rule is when a person is married within the period of conducting a test.

A person is also considered an accredited investor if they have net worth exceeding $1 million, either individually or jointly with his spouse. The SEC also considers a person to be an accredited investor if they are a general partner, executive officer, director or a related combination thereof for the issuer of unregistered securities.

An entity is 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 a sole purpose of purchasing specific securities.

In 2016, the U.S. Congress modified the definition of an accredited investor to include registered brokers and investment advisors. Also, 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.

Purpose of Accredited Investor Requirements

Any regulatory authority of a market needs to perform a fine act of balancing between promoting investments and safeguarding the investors.

On one hand, regulators need to promote investments in risky ventures and entrepreneurial activities which may 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 which leads to the risk of investors losing all of their investments.

On the other hand, regulators need to protect the common, often less knowledgeable, individual investors who may neither have the financial cushion to absorb high losses nor the understanding of where they are putting their hard earned money. Therefore, a balanced approach is taken through the provision of accredited investors, who are financially strong as well as knowledgeable and experienced to fit the job of being allowed to invest in such unregistered securities and investments.

Per Investopedia.com