“Learn the history, definition, and confusion behind what makes someone an accredited investor.”
So you want to invest in private placements? Welcome to the club!
With more than a trillion dollars worth of investment capital passing through this space every year, you’re in good company. But if you’re interested in Regulation D private securities, then you better be an accredited investor.
“What’s an accredited investor?” you ask.
Is it some covert underground club that involves an obscure handshake and a secret password that gets you through the door?
Fortunately, that’s not the case.
Accredited Investor History
The “accredited investor” concept comes out of securities law dating all the way back to the Great Depression. It started with The Securities Act of 1933. Ultimately, the government wanted to keep novice investors out of investments they didn’t have the knowledge or experience to thoroughly evaluate.
I think we can all agree that if you don’t have the ability to objectively assess the merits and risks of an investment then you probably shouldn’t be investing in it.
We lead the industry in educational content because we strongly believe that educated investors make better investment decisions. Conversely, uneducated investors tend to produce poor outcomes.
Therefore, the goal of protecting uninformed investors through government regulation seems prudent. This concept has evolved through the years through things like:
- Rule 4(a)(2)
- Securities and Exchange Commission v. Ralston Purina Co. court case
- Rule 146
- Regulation D
Rule 501 of Regulation D ultimately defined what an accredited investor is. That definition includes institutional investors, insiders, and individuals. Since institutional investors and insiders have high-powered attorneys to explain securities law to them, we’ll focus on the definition for individuals.
Accredited Investor Defined
Under Rule 501, you’re an accredited investor if you meet any one of the following criteria.
- Your net worth is at least $1 million excluding the value of your primary residence
- You have a minimum income of $200,000 as an individual for the last two years with a reasonable expectation of achieving the same in the current calendar year
- Your combined income with your spouse is at least $300,000 for the last two years with a reasonable expectation of achieving the same in the current calendar year
These criteria are centered on net worth and income levels. While this may seem straightforward, I talk to people all the time who are confused as to whether or not they’re an accredited investor.
One common source of confusion is in calculating net worth. Net worth is a simple calculation in that you take the dollar value of all your assets and subtract out all your debts or liabilities.
So if your entire assets equaled $500,000 and your debts totaled $200,000, your net worth would be $300,000.
$500,000 (assets) – $200,000 (liabilities) = $300,000 net worth.
As straightforward as this is, it’s important to remember that the net worth definition of an accredited investor can’t include the value of your primary residence. Therefore, you need to exclude the value of your home and the debt you have on it. You simply can’t include your home equity in your calculation.
This is particularly unfortunate for those who have the bulk of their net worth wrapped up in their primary residence. Nevertheless, the law is clear.
There are several online net worth calculators that can assist you. I’ve included a couple of links for your convenience here and here.
Two More Common Confusions
Another common error I see people make in determining if they’re an accredited investor revolves around the income definitions. Some people think that if they’re married, they have to qualify by combining their income with their spouse.
For example, I’ve spoken with people who make $250,000 a year, but their spouse stays at home with the kids. Since their spouse doesn’t have income, they believe they’re not accredited because they don’t meet the $300,000 threshold.
What they don’t realize is that married people can qualify under the individual standard. They don’t have to combine their income with their spouse. In the case above, the working spouse qualifies as accredited since his or her income exceeds the $200,000 individual threshold.
Lastly, some people believe to be an accredited investor, they have to meet both the income and net worth requirements. That’s not true. When met, any one of those three criteria can make you an accredited investor.
I hope this article has made the definition of an accredited investor crystal clear to you. If you meet the definition of an accredited investor, then congratulations. A whole new world of investments is open to you.
But don’t forget that all investments have potential risks and benefits. It’s on you to educate yourself about the investments you’re considering. We’re here to help. We’ve made it our mission to teach people the ins and outs of apartment investing. So please bookmark this site and be sure to tear through our learning center.
We’re committed to your success. So don’t hesitate to reach out with questions; we’d love to hear from you.