WHAT IS AN ACCREDITED INVESTOR

What is an Accredited Investor?

In the broadest sense, an "accredited investor" is an investor, individual or institution, who is financially capable of investing in "private placements" as defined by the Securities and Exchange Commission.

These types of investments are normally more speculative than other financial products and are less liquid.

With this in mind, we can better understand the legalese of the statutory definitions under which the Broker-Dealer/Placement Agent operates, and under which you, the "accredited investor" must operate when purchasing privately offered securities, routinely referred to as a "private placement".

Therefore before an issuer of Private Placement Securities can offer to sell to you, and before a Broker-Dealer/Placement Agent can recommend that you purchase a particular Private Placement, you must first satisfy certain criteria for what constitutes an "accredited investor," as defined by federal and state regulators.

In a moment, we will explain how these regulators define an "accredited investor" in more detail; but before we do this, you must first appreciate that there are at least 50 state securities regulators whose definitions do not always line up exactly with the federal definition of an "accredited investor."

We begin with the Federal definition of an "accredited investor" and who is the author of this Federal definition.

Congress has given the U.S. Securities and Exchange Commission (the SEC) the authority to outline the Federal definition of an "accredited investor" and has broken down the definition into two designations.
1.  The definition of "accredited investor" that applies to individuals who are natural persons; and,
2.  The definition of "accredited investor" that applies to persons who are legal entities who, by definition, are not natural persons. These investors are called "institutional investors."

Individual Accredited Investors

In order for an individual natural person to be considered an "accredited investor" by the SEC, two components must be satisfied; (a) an asset component and (b) an income component.

A. The asset component:

The investor must have net worth of $1 million or more (either as an individual or jointly with their spouse), at the time of purchase.

  1. By definition, an individual's private residence is excluded from the SEC's definition of assets (The SEC is not so clear about real estate other than a private residence.)
    1. Since the SEC is not clear about real estate other than a private residence, if an investor hypothetically has, outside of his primary residence, real estate assets amounting to a fair market value in excess of $1 million, this investor most likely qualifies under the Federal definition of an "accredited investor." These investors must be aware of a secondary issue regarding whether this particular private placement is suitable the investor under the self-regulatory organization rules (i.e. rules of the Financial Industry Regulatory Authority of FINRA rules).

B. The income component:

  1. If the investor is single, he or she must have gross income in excess of two hundred hhousand dollars ($200,000.00) and a reasonable expectation of reaching the same level in the current year.
  2. If the investor is a married couple, they must have a collective gross income in excess of three hundred thousand dollars ($300,000.00) and a reasonable expectation of reaching the same level in the current year.

Thus, an individual investor may be an accredited investor under Federal Rules if he or she has liquid net worth in excess of $1 million comprised of assets outside his/her/their primary residence OR has net income for the past two years in excess of $200,000.00 if single or $300,000.00 if married.

 

Different States, Different Requirements

What happens if the individual accredited investor happens to reside in Louisiana, Michigan, Wisconsin, Wyoming or other states?

These states have different criteria than the Federal "accredited investor" standards for individual natural persons.

Thus, even if a resident of Louisiana meets the Federal standard, a Private Placement will not be offered by an issuer to this investor and a Private Placement will not be recommended to this investor by a Broker-Dealer/Placement Agent, if the Louisiana resident's investment exceeds 25% of his net worth - regardless of the dollar amount or type of liquidity of his or her net worth.

Similarly, if the investor is a resident of Michigan, a Private Placement will not be offered by an issuer to this investor and a Private Placement will not be recommended to this investor by a Broker-Dealer/Placement Agent, if the Michigan resident's investment exceeds 10% of his Net Worth. If the investment exceeds this percentage, it does not matter that the Michigan investor meets the Federal "accredited investor" standard.

If the individual natural person is a resident of Wisconsin, this investor "... must have a net worth (exclusive of home, furnishings and automobiles) in excess of three and one-third (3 1/3) times the aggregate amount invested" and must have:

  1. A net worth (exclusive of home, furnishings and automobiles) of two hundred fifty thousand dollars ($250,000.00); and,
  2. The purchase price of units subscribed by the investor may not exceed twenty percent (20%) of the investor's net worth.

The general rule of thumb for the investor is that even if he or she meets the Federal "accredited investor" criteria, the investor must also meet the State "accredited investor" criteria in the state of his or her residence. Because law is routinely in flux, the investor must also keep in mind that States that currently have "accredited investor" criteria identical to Federal criteria could change at or by the time of purchase of a Private Placement. For this reason, final assessment is always made at the point of sale.

Institutional Accredited Investors

Institutional Accredited Investors are defined not only by their assets but by their types. Therefore an organization must review the details of their structure in order to determine if they are qualified as an accredited investor.

  • Banks, savings and loan associations, insurance companies, investment companies, Small Business Investment Companies and plans maintained by state, political sub divisions for the benefit of employees that have assets in excess of $5,000,000 qualify as accredited investors. However, institutions should look at the detailed definition and get a legal opinion regarding its qualification prior to investing in private placement transactions.
  • Organizations, corporations or partnerships that are described in section 501(c)(3) of the Internal Revenue Code and are not formed specifically for the purpose of acquiring the securities offered, with total assets of over $5 million qualify.
  • Officers and Directors of the issuer of the securities being offered are qualified.
  • Trusts with total assets of more than $5 million and directed by a sophisticated person as described by Rule 506 (b) (2) (ii) qualify.
  • Entities where all of the equity ownership is held by accredited investors would qualify.
  • IRA or similar benefit plans (Keogh) that cover accredited investors would qualify.
  • Non-profit entities described in Section 501 (c)(3) of the Internal Revenue Code with assets of over $5 million also should qualify.

However, institutional investors should carefully review the Rule 501 (a) definition under the U.S. Securities Act of 1933 as amended and make sure they qualify. Your attorney or securities professional can assist you in making the proper determination prior to making any investment.

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