Choosing between accredited investor and qualified purchaser regulatory categories shapes your investment opportunities as a startup investor. Both standards enable you to purchase privately held stocks, but purchase options differ according to your investor type.
We provide a comprehensive breakdown of each purchaser category to help you decide the best path for your investment goals. Our guide offers essential information on the types of purchases available for each investor category and how you can qualify for the role.
What Is an Accredited Investor?
Individuals or entities that qualify as accredited investors fulfill specific financial income, licensure, or net worth standards, giving them exclusive access to private market investments. These privileges provide accredited investors with a competitive edge over standard retail investors.
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How to Become an Accredited Investor?
Becoming an accredited investor involves meeting specific financial criteria established by the SEC. Firstly, individuals need to have an annual income of at least $200,000 (or $300,000 combined with a spouse) for the last two years, with a reasonable expectation of maintaining the same level of income in the current year. Alternatively, individuals can qualify by having a net worth exceeding $1 million, either alone or combined with a spouse, excluding the value of their primary residence. Another pathway is holding certain professional credentials, such as Series 7, Series 65, or Series 82 licenses. Once these criteria are met, prospective accredited investors must provide documentation, such as tax returns and financial statements, to verify their status.
SEC Qualification Requirements for Accredited Investors
The US Securities and Exchange Commission (SEC) classifies accredited investors as individuals or entities qualified to make complex security investments. The prerequisites for SEC recognition must include one or more of the following:
- Accredited investors must have a minimum of $200,000 in personal income or combined incomes of at least $300,000 in the past two years. Additionally, the candidate should have an expected amount of similar or higher income in the current year.
- Individuals with a net worth exceeding a million dollars jointly with their spouse and excluding home value may also qualify.
- Entities operating as private business development companies or organizations with assets exceeding $5 million.
- Registered brokers and investment advisors holding 7, 65, or 82 licenses and currently in good standing. These are, namely, the General Securities Representative license (series 7), the Licensed Investment Adviser Representative (series 65), and the Private Securities Offering Representative license (series 82). Individuals must pass relevant exams to obtain each license and certification while maintaining good standing involves compliance with the latest state and FINRA rules.
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Example of an Accredited Investor
America had an estimated 13,665,475 accredited investor households during 2020, accounting for roughly 10% of all households. Individuals may qualify as accredited investors by fulfilling at least one of the SEC’s prerequisites.
For instance, an individual has a personal income of $170,000 for the past 2 years, a primary property valued at $1 million (with a mortgage of $200,000), a 401(k) plan of $500,000, and savings of $500,000. The individual’s total net worth excludes primary residence value, amounting to a million. Although the person might fail to meet the SEC’s income requirements, they may qualify based on net worth.
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Pros of Becoming an Accredited Investor
An accredited investor’s proven acumen in investment offers various advantages that include:
- Exclusive access to unique investment opportunities such as venture capital, real estate private equity funds, and hedge funds.
- Generally higher yields and returns of investment. The higher the risks involved, the greater the potential profits. Accredited investors will also have the option of investing in private deals with high yields through longer maturity.
- Greater opportunities for diversified portfolios that weather against volatile market conditions such as price swings.
Cons of Becoming an Accredited Investor
Despite the benefits accessed by accredited investors, it is essential to pay close attention to several cons that come with the regulatory category. These investment cons may include:
- Higher minimum investment amounts required by private companies potentially result in more significant losses, especially when coupled with the typically higher investment risks.
- Illiquidity of investments presents additional issues, such as selling assets at a significant loss during financial crises.
- Higher fees are involved in private investments, such as steep transaction charges for selling illiquid securities.
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What Is a Qualified Purchaser?
Qualified purchasers usually include individuals or family businesses managing an investment portfolio of at least $5 million. These investments exclude primary residences and properties used for business purposes. Investments may include diverse assets such as bonds, stocks, cash or cash equivalents, and futures contracts.
How to Become a Qualified Purchaser?
To become a qualified purchaser, you must meet higher financial thresholds as outlined by the Investment Company Act of 1940. Individuals need to have at least $5 million in investments, excluding their primary residence and business properties. Trusts can also qualify if they meet the $5 million investment threshold and are not formed specifically for the investment, with the individuals who contributed assets to the trust being qualified purchasers themselves. Entities, on the other hand, must have $25 million or more in investments. To verify your status, you will need to provide documentation proving the value of your investments. This verification process ensures you meet the stringent financial requirements necessary to access exclusive investment opportunities .
Qualification Requirements of a Qualified Purchaser
Investors may take on the role of qualified purchaser by fulfilling several requirements outlined by the Investment Company Act of 1940. Specifically, section 2(a)(51) of the ’40 Investment Company Act specifies the criteria for qualified purchasers as:
- An individual with at least $5 million of investments
- A trust with $5 million or more in investments. However, these do not include funds specifically created for the investment. Additionally, the individuals granting assets to the trust should hold the status of qualified purchasers.
- A company holding $25 million or more in investments.
- An organization with a minimum of $5 million in assets or investments owned by close family members.
- An investment manager with at least $25 million in a managed portfolio.
Example of a Qualified Purchaser
Unlike accredited investors, the status of a qualified purchaser considers the value of a person’s investments rather than their income and net worth. For instance, a family-run business holding $9 million in assets may become a qualified purchaser. In another example, a trust with $7 million in its portfolio and owned by two close members of the family who are qualified purchasers may become a qualified purchaser.
Pros of Becoming a Qualified Purchaser
Qualified purchasers have broader investment opportunities compared to accredited investors. Specifically, qualified purchasers can expand their investment portfolios by:
- Qualifying for 3(c)(1) funds and 3(c)(7) funds. The accessibility offers qualified purchasers added opportunities to expand their portfolios since 3(c)(7) funds accept up to 2,000 qualified purchasers.
Cons of Becoming a Qualified Purchaser
While qualified purchasers have access to some of the most exclusive and profitable investments, the path toward the qualification comes with a few notable downsides.
- Individuals must undergo a more stringent qualifying process than those laid out for accredited investors, requiring additional time and effort.
- Qualified purchasers must meet much higher financial thresholds compared to accredited investors. Due to the higher thresholds, some people identify qualified purchasers as super-accredited investors.
Why does the SEC Restrict Certain Investments?
The SEC restricts certain investments to protect individual investors from high-risk opportunities that could lead to substantial financial losses. These restrictions ensure that only those with sufficient financial knowledge, experience, and resources—accredited investors and qualified purchasers—can invest in complex and potentially volatile financial products. By doing so, the SEC aims to shield less experienced and less financially secure investors from the heightened risks associated with private securities, hedge funds, and other high-stakes investments. This regulatory approach helps maintain market integrity and investor confidence, while also promoting fairness and stability within the financial system.
Similarities and Differences Between Accredited Investors and Qualified Purchasers
While the SEC considers accredited investors and qualified purchasers as two of its top investor categories, they have varying prerequisites and investment entitlements. Ultimately, it is critical to distinguish between an accredited investor and qualified purchaser designations to determine the most suitable path for your investment needs.
How They Compare
- Both regulatory categories provide standard retail investors with a one-up in the investment process by opening doors to private investment opportunities.
- Each category presents a similar verification process of approaching the issuer of unregistered securities for eligibility confirmation. You will need to submit various documentation (e.g., tax returns, credit reports, CPA letters, and W-2 forms) to complete the verification process.
How They Differ
- Accredited investors may invest in 3(c)(1) funds, while qualified purchasers may expand their portfolios to include 3(c)(1) and 3(c)(7) funds.
- While the qualifying process for accredited investors focuses on a person or entity’s net worth and income, the status of qualified purchasers relies on investment value.
Accredited Investor vs. Qualified Purchaser: Which Route Is Right For You?
Choosing between the role of accredited investor and qualified purchaser depends on your investment scenarios.
For example, some investment companies may exclusively sell securities to accredited investors, particularly those unregistered with the SEC. As SEC securities registration often results in a tedious and expensive process, many companies seek exemption through Regulation D of the Securities Act, where they may sell to an accredited investor.
Companies must register their funds under the ICA and sell their securities to qualified purchasers under the 3(c)(7) exemption for scenarios involving more than 100 investors.
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