Accredited investor requirements

In short

I once watched a neighbor turn down a friend's invitation to join a private deal, and he could not say why he was shut out. If you are curious about the same door, the first thing to know is that the rules are set by the Securities and Exchange Commission, and they apply to the company selling the shares, not to you. A person can qualify in one of three broad ways: by income, by net worth, or by holding certain professional licenses. The income test looks at your last two years and what you expect this year. The net worth test leaves out your main home. Companies selling private shares often ask for proof, so gather your papers early. Nobody is chasing you here. This is simply how the gate works.

The whole of it

What it is

A friend of mine once said that the stock market is a public square, and a private placement is a back room where the door has a bouncer. I thought that was fair. An accredited investor is a person or group the SEC treats as able to look after themselves in a private offering that skips the usual registration paperwork. The reasoning is that a seller who does not file full public disclosures should sell mostly to people who can absorb a loss and ask sharp questions.

The definition lives in Rule 501 of Regulation D, a set of SEC rules written under the Securities Act of 1933. A company that sells shares privately under Rule 506 leans on that definition. It does not make anyone a better or worse person. It is a legal label, and the label belongs to the buyer at the moment of the sale.

You have probably heard the term thrown around as if it meant rich and clever. It means neither. It means a person met a test written into federal law. Plenty of wise people fall short of it, and plenty of foolish ones clear it with room to spare. The test measures money and training, not judgment.

How it works

If you are holding a pitch deck from a startup or a small fund, the seller has a job to do before taking your money. The seller must either reasonably believe you are accredited or must take steps to verify it, depending on how the offering was advertised. When a company advertises broadly under Rule 506(c), the seller has to take reasonable steps to verify. When it does not advertise, the seller can often rely on what the buyer says about himself.

Verification can look ordinary. A seller might ask to see tax returns or W-2 forms for income. For net worth, a seller might ask for bank and brokerage statements plus a credit report. A letter from a licensed attorney, a certified public accountant, a registered investment adviser, or a registered broker dealer can also do the job, if it confirms the person was reviewed within the prior three months. The SEC lists these methods on its own pages, so the seller is not guessing about them.

A person can qualify by license, too. The SEC has named certain securities licenses in good standing as a path to qualify, and its Accredited Investor page lists which ones. Directors, executive officers, and general partners of the company doing the selling count as well. Certain entities qualify, such as banks, trusts above an asset line, and organizations holding enough in investments. Spouses can pool their money for the income and net worth tests.

The numbers, and where to find yours

I like to look at my own figures before anyone else's, and I suspect you do too. Here are the thresholds, all set in the rules and all subject to change by the SEC. The income test asks for individual income above the current figure, which the official source publishes each year in each of the two most recent years, with a reasonable expectation of the same this year. For a married couple filing together, the joint income threshold is the current figure, which the official source publishes each year. The net worth test asks for more than the current figure, which the official source publishes each year alone or with a spouse, counting everything except the value of your primary home.

There is a small wrinkle about the home. If a mortgage on your main residence is larger than the home is worth, the extra debt counts against you. The SEC's own page spells out how other debt tied to the home is treated, so check its wording before you add up your figures. The SEC wrote these details to keep people from fattening a net worth statement with a quick loan.

Where do you find your numbers? Income lives on your tax returns, on the line for adjusted gross income, plus any items the rule says to add back. Net worth is assets minus debts, and you can build it from your latest statements. Ask your seller or your adviser which method they will accept before you spend an evening on paperwork. And check the SEC's page titled Accredited Investor, because the limits there are the ones that count.

A worked example

A woman I will call Dana lives in Ohio. She earned $180,000 last year, $195,000 the year before, and expects about $200,000 this year. She is single. A friend offered her a chance to buy into a small private company, and she wanted to know if she could take part.

Dana looked at the income test first. Her last two years are $180,000 and $195,000, and this year looks like $200,000. She compared each against the single filer limit, which the site shows as the current figure, which the official source publishes each year. If each of those figures sits above that line, she passes the income test. If even one year falls short, she does not, even if the other two years are strong.

Then she tried the net worth test. Her house is worth $410,000 with a $260,000 mortgage, but the house does not count, so she set it aside. Her savings were $45,000. Her retirement accounts held $310,000. Her brokerage account held $120,000. Her car loan was $14,000. Her credit card balance was $3,000.

Her assets that count are $45,000 plus $310,000 plus $120,000, which is $475,000. Her debts that count are $14,000 plus $3,000, which is $17,000. Her mortgage stays out of it because it is not larger than the home's value. So her net worth for this test is $475,000 minus $17,000, which is $458,000. She then compared $458,000 to the figure the site shows as the current figure, which the official source publishes each year.

Dana did not pay anything or sign anything that night. She wrote down her two results and kept them with her statements. When the seller asked, she could hand over proof within a day. That is a sensible way to go about it. Nothing was bought, sold, or held in that story, and nothing here says what Dana ought to do. It only shows the math done in the open.

Where it goes wrong

I have seen people trip over small things, and the tripping is rarely about honesty. It is about haste. The most common slip is counting the main home in net worth. The rule leaves it out, and adding it can turn a failing number into a passing one that is simply wrong. A seller who relies on a false statement can face trouble, and so can a buyer.

Another slip is looking at only one year of income. The rule asks for two years, plus a reasonable expectation for the current one. A big bonus last spring does not carry the whole test. Mixing up a joint figure with a single figure causes grief as well. A married person may use the joint income threshold only if the spouse's income is counted too and the couple files that way.

Stale paperwork is a quiet problem. A verification letter must be dated within three months of the sale under the SEC's methods. A statement from two years ago will not do. Some people also assume that qualifying once means qualifying forever. It does not. The seller looks at the buyer at the time of the sale, so a drop in income or a market loss can change the answer.

Last, a person can pass the test and still lose every dollar. The label opens the door. It says nothing about whether the room is safe. Private companies are often hard to sell out of, and they can fail. The SEC describes these as higher risk, and that deserves a straight look.

Questions to answer before you leave this page

Have you written down your income for each of the last two years, and do you honestly expect the same this year? Have you listed what you own and what you owe, and did you leave your main home out of the total? Do you know whether you hold a securities license that the SEC lists as opening the door a different way? Has the seller said whether it will accept your word or ask for proof, and what kind of proof it wants? Are your statements recent enough to satisfy a three month window? Have you looked at the SEC's own Accredited Investor page to see the current limits, rather than leaning on a friend's memory? And if you do clear the test, have you asked yourself how much of your savings you could stand to lose, and whether a trusted adviser has looked over the paperwork with you?