Accredited Investor Definition
Accredited Investor is someone who has special power who is allowed to deal in securities, investments and venture capital without exactly being registered with financial authorities. In general, if you want to be an investor, you ought to be a financial body who is registered with the federal bank and security exchange commission. However, if you have lots of money to invest and want to do it yourself, you can get the status of accredited investor and do the investing yourself.
How to become an Accredited Investor?
One can look at the details put forward by federal regulations (here) to see how to become an accredited investor. Some of the major ways to get accreditation are:
- Total assets of over 500,000 USD.
- The net worth of 1,000,000 USD (it might be joint net worth too).
- Any director, executive officer of the issuer of securities being sold.
- Net yearly income of over 300,000 USD.
The investor has to have one or more of the above to become an accredited investor.
A university with 5 million USD can be an accredited investor, so does an individual worth 1 million USD. Essentially, any individual who has enough money to invest can be an accredited investor. The reasoning behind the government putting up such barriers for entry is that investing is a tough and risky job. People who become investors should be in such a position that they can lose their investment and still stay safe.
Types of Accredited Investors
- Investment banks and private equity companies (Example: Goldman Sachs, KKR, JP Morgan).
- Corporate Partnerships – Two or more companies coming together to form a consortium that invests.
- The insiders who are already a part of the company.
Example of Place Where Only an Accredited Investor can Invest
Let us assume I am an investor who is trying to invest in a very risky asset. I choose to invest in startups – one of the most difficult and risky areas to invest in. Essentially, the money we put in startups either go to zero or zoom to 100x, unlike the regular investments, which give reasonable returns. To invest in a startup, I go to angel.co (Angelist) to see where I want to invest.
The rules for investing in Indian startups (only Indian) is that the investor is supposed to have more than 20,000,000 INR worth of tangible assets. Keep an eye on the word tangible, we cannot have a patent or intangible asset that is worth the same, the asset has to be tangible and provable. To invest in American startups, I need to have a net worth of more than a million USD. Angelist verifies the accreditation of the investor before allowing them to invest. There are very few funds in the world that invest in startups, and fewer that invest in the way an investor likes, so it makes sense for the investor to go and find out a startup that he can invest indirectly and make the investment.
Advantages of Becoming an Accredited Investor
- There are a lot of investments that are not accessible to everyday investors. Those investments become accessible to accredited investors – investments like startups, venture capital funds, private equity, and hedge funds and so on.
- The government does not get involved with the daily workings of the investor / the company that investors. The investor is relaxed from the regulations that are followed by traditional financial institutions.
- The investor has the freedom to cut a deal with any company he likes in any way he likes. He can make tailor-made investments that are not possible with the traditional way of investing. For example, Warren Buffet’s convertible stock deal with Goldman Sachs during the financial crisis is one of the most famous deals in the financial industry and that was tailored for such that Goldman is obligated to act in a way Mr. Buffet wants. Such deals are possible only with accredited investors. the everyday investor cannot go and cut such deals.
Disadvantages of Becoming an Accredited Investor
- There are no specific disadvantages of becoming an accredited investor, but the information flow to the society halts if there are people in between acting beyond the government’s scope.
- Cases like Theranostic (the financial fraud of Elizabeth holmes) are becoming more common and it increases the inherent risk in off-chart investing.
- It depends on the ability of the investor to make money.
- You need a very good financial education to be successful by investing in a non-conventional way.
Limitations of Accredited Investor
- The accredited investor does not mean they are better than others, or worse than others. they are just at a different stage of investing.
- The ability to analyze information is limited to the scope of an investor.
- Being an accredited investor does not mean you can invest in anything, there are still limitations on what you can invest in.
- As a generic rule, the lesser the type of investment (lower the liquidity) higher the cost of investments. by that observation, accredited investors actually pay more than regular investors do. For example, an average hedge fund charges around 2% of the actual fund and 20% of the returns as fees.
- These sort of investors have the power to move the market and hence they have to make sure that they break no rules while they invest in companies. Cases of financial frauds made by accredited investors are not new and the punishment for such cases is also severe.
- This is just a recognition by the government that you have lots of money and you are allowed to risk your money in a way you deem fit.
- It gives extra power, but also the risk inherent in those investments is way more.
- Cost of investing in unconventional methods is more than the cost of investing in regular methods.
- Any accredited investor will be more prone to government scrutiny – including your relations.
The ability to invest in a wider range of securities or assets or financial assets is incredibly exciting to look at, especially when you are sitting on a pile of money. But once the accredited investor status is granted, there is not much difference in the way once invests or in the financial knowledge. To put it bluntly, it is just a pass that takes you into the club of elite investments. but you will be charged for that.
This has been a guide to what is an Accredited Investor and its Definition. Here we discuss its types and how to become an accredited investor along with advantages, and disadvantages. You can learn more about portfolio management from following articles –