WHAT IS AN ACCREDITED INVESTOR?
Under the federal securities laws, only persons who are accredited investors may participate in certain securities offerings. One reason these offerings are limited to accredited investors is to ensure that all participating investors are financially sophisticated and able to fend for themselves or sustain the risk of loss, thus rendering unnecessary the protections that come from a registered offering.
Unlike offerings registered with the SEC in which certain information is required to be disclosed, companies and private funds, such as a hedge fund or venture capital fund, engaging in these exempt offerings do not have to make prescribed disclosures to accredited investors. These offerings involve unique risks and you should be aware that you could lose your entire investment.
Who is an accredited investor?
An accredited investor, in the context of a natural person, includes anyone who:
- earned income that exceeded $200,000 (or $300,000 together with a spouse or spousal equivalent) in each of the prior two years, and reasonably expects the same for the current year, OR
- has a net worth over $1 million (excluding the value of the person’s primary residence), either alone or together with a spouse or spousal equivalent, OR
- holds in good standing a Series 7, 65 or 82 license.
Financial professional licenses. The General Securities Representative license (Series 7), the Private Securities Offering Representative license (Series 82) and the Licensed Investment Adviser Representative (Series 65) are professional certifications and designations for financial professionals. In order to obtain and qualify for these licenses, an individual must pass the related exam. Whether one is considered in good standing is specific to the designation, and persons accredited investor status as a Series 7, 65 or 82 license holder should consult FINRA rules and any state rules applicable to them.
There are other categories of accredited investors, including the following, which may be relevant to you:
- any trust, with total assets in excess of $5 million, not formed specifically to purchase the subject securities, whose purchase is directed by a sophisticated person, OR
- certain entity with total investments in excess of $5 million, not formed to specifically purchase the subject securities, OR
- any entity in which all of the equity owners are accredited investors.
In this context, a sophisticated person means the person must have, or the company or private fund offering the securities reasonably believes that this person has, sufficient knowledge and experience in financial and business matters to evaluate the merits and risks of the prospective investment.
How do I calculate my net worth?
Generally, to qualify as an accredited investor under the net worth test, you must have a net worth that exceeds $1 million, either alone or with a spouse or spousal equivalent, at the time of the sale of the securities. If calculating joint net worth with a spouse or spousal equivalent, it is not necessary that property be held jointly and the securities being purchased do not have to be acquired jointly. Calculating net worth involves adding up all your assets and subtracting all your liabilities. The resulting sum is your net worth.
Spousal equivalent. A spousal equivalent means a cohabitant occupying a relationship generally equivalent to that of a spouse.
The value of your primary residence is not included in your net worth calculation. In addition, any mortgage or other loan on the primary residence does not count as a liability up to the fair market value of the residence. If the loan is for more than the fair market value of the primary residence (i.e., if your mortgage is underwater), then the loan amount that is over the fair market value counts as a liability under the net worth test.
Further, any increase in the loan amount (other than for the purchase of the primary residence) in the 60 days prior to your purchase of the securities (even if the loan amount does not exceed the value of the primary residence) will count as a liability as well. The reason for this is to prevent net worth from being artificially inflated through converting home equity into cash or other assets.
The following table sets forth examples of calculations under the net worth test for being an accredited investor:
Jane Doe |
John Smith |
James Lee |
|
Primary residence (not included except for related liabilities below): |
|||
Home value..................... |
$ 500,000 |
$ 500,000 |
$ 500,000 |
Mortgage......................... |
300,000 |
200,000 |
600,000 |
Home equity line.............. |
- |
150,000 |
- |
Included assets: |
|||
Bank accounts.................. |
$ 400,000 |
$ 400,000 |
$ 400,000 |
401(k)/IRA accounts.......... |
400,000 |
400,000 |
400,000 |
Other investments............. |
400,000 |
400,000 |
400,000 |
Car................................. |
20,000 |
20,000 |
20,000 |
Total included assets...... |
$ 1,220,000 |
$ 1,220,000 |
$ 1,220,000 |
Included liabilities: |
|||
Student and car loans......... |
$ 100,000 |
$ 100,000 |
$ 100,000 |
Other liabilities................. |
100,000 |
100,000 |
100,000 |
Portion of mortgage underwater..................... |
- |
- |
100,000 |
Balance on home equity line (less than 60 days old)..... |
- |
100,000 |
- |
Total included liabilities |
$ 200,000 |
$ 300,000 |
$ 300,000 |
Net worth......................... |
$ 1,020,000 |
$ 920,000 |
$ 920,000 |
Accredited investor........... |
Yes |
No |
No |