CNBC Explains

Who qualifies as an accredited investor?

The Securities and Exchange Commission allows certain securities offered by companies and private funds to be exempt from registration as long as they are only offered to, or purchased by, accredited investors. These securities can include hedge funds, venture capital funds, and companies raising capital in the burgeoning sector of equity crowdfunding.

But what, or who, is an accredited investor?

The Securities and Exchange Commission in Washington.
Jim Bourg | Reuters

Simply put, an accredited investor is someone who the SEC deems capable of taking on the economic risk of investing in unregistered securities. Entities may also be deemed accredited investors, including banks, partnerships, corporations, nonprofits and trusts.

The accredited-investor guidelines are intended to identify, in a value-neutral way, who is a "sophisticated" investor with sufficient knowledge and experience in financial and business matters to evaluate the merits and risks of the prospective investment.

The net-worth test

The SEC specifically defines an accredited investor based on income and net-worth tests.

To be an accredited investor, an individual must have had earned income that exceeded $200,000 (or $300,000 together with a spouse) in each of the prior two years and "reasonably expects the same for the current year," according to the SEC.

Or, the individual must have a net worth of more than $1 million, either alone or together with a spouse. With the passage of the Dodd-Frank Act, this now excludes a primary residence as being eligible as part of an investor's net worth (investors who had existing accredited investments but who now fail the net-worth test without their residence being valued were grandfathered).

The income test cannot be met using one year of an individual's income and the next two years based on joint income with a spouse. The only exception is if a person is married within this period.

The SEC offers an explanatory table to help investors determine if they meet the accredited-investor guidelines.

The new landscape

More changes to the accredited-investor standards may be forthcoming. The SEC has been debating tougher standards for accredited investors as part of the mandate in the Dodd-Frank Act to review the existing accredited investor rule. There has also been debate about whether the SEC should consider non-financial standards for accredited investors, such as education or professional background.

The Jumpstart Our Business Startups (JOBS) Act has also played a major role in changing the landscape for private investments and investor access to these offerings.

In late 2013 the SEC removed a ban on advertising by private placements offered to accredited investors, including the Internet, social media, seminars, print, or radio or television broadcast, under Rule 506(c).

Currently under review—and already delayed by the SEC from the original implementation plan—is a rule that would allow non-accredited investors (i.e., anyone) to invest in crowdfunded offerings, per the JOBS Act Title III, which covers equity crowdfunding, and the SEC's proposed Regulation Crowdfunding. Some U.S. states have enacted their own equity crowdfunding statutes as a way to circumvent the ongoing SEC review period.