Online alternative finance platforms have become commonplace in today’s investment world, growing to ~$35 billion in total market volume in the U.S. alone. These platforms use technological innovations to change the way people invest and what investments they can access, opening many markets that were previously inaccessible to the crowd. However, this “crowd” is many times still quite limited as many platforms allow only accredited investors to invest in their offerings.
What is an accredited investor?
(note: we’re going to focus on individual investors and not companies)
In the U.S. an accredited investor is one that has a net worth of $1 million (excluding the person’s primary residence) or an income of at least $200k in the last two years ($300k for a couple) with the expectation of keeping such income in the next year. In other countries, the term (sophisticated/qualified instead of accredited) and the asset and income thresholds may be different, but the idea is pretty much the same.
What are the benefits of being an accredited investor?
Accredited investors are allowed to invest in securities that are not registered with financial authorities. They basically get privileged access to investment opportunities that other individual investors cannot invest in.
When a company or a fund wants to raise money, it has to register its shares or securities with the local financial authority (e.g. the SEC). This registration is all for investor protection. The regulators want to ensure that these companies are legitimate businesses and so they require them to provide certain information upon registration and through ongoing reporting to make sure that’s indeed the case. Since the registration can be costly and burdensome, some companies prefer to use exemptions that allow them to offer securities without registering them. One of the most popular exemptions allows these companies to offer their securities to accredited investors only (and 35 other non-accredited investors, even though that allocation is rarely used).
For example, if you want to get unique access to startup investing through our EquityBee platform, you must be an accredited investor since our securities are not registered with any financial authority.
The regulators decided that investors who have enough money are sophisticated enough to invest in companies without the oversight and reporting requirements that come with SEC registration. These investors can also afford the higher risk of such investments given their financial situation.
Does this definition make sense?
Let’s break accreditation into two: knowledge/sophistication and money. These two together put the regulators at ease that this group of investors is capable of analyzing private investments and take the associated risk.
Money sometimes translates to investment sophistication, but not always. Therefore, the SEC should consider adding true sophistication qualifications to the definition of an accredited investor. While wealth doesn’t necessarily translate to investment sophistication, it’s easier to argue that certain degrees and certifications do.
Now to the money piece: accreditation thresholds in the U.S. were put in place in 1982, when less than 2% of the population met them. A million dollars can buy a whole lot of less in 2018 than it did in 1982, so it may be time to re-evaluate these thresholds as well.
In the meantime, if you are an accredited investor, keep enjoying favorable access to investment opportunities, but remember that this increased access comes with additional risk that you must asses carefully.