Gaining Accredited Investor Status

Interested in investing in non-traditional platforms? Here’s how to be come an accredited investor and the opportunities it affords.

From time to time, I come across investment opportunities that are only available to accredited investors. It’s often enough that I think it warrants today’s article explaining accredited investor status, since you’ll need to be an accredited investor before you can invest in some of these alternative platforms.

What’s an accredited investor?

Essentially, it’s someone the SEC believes is rich enough that they can lose significant amounts of money investing in platforms or securities that are less-regulated and require less disclosure than an investment found on the public stock markets.

Lawyers are often targets for private investments because they may qualify as an accredited investor.

Accredited Investor Requirements

  1. A bank, insurance company or registered investment company.
  2. An ERISA employee benefit plan with total assets in excess of $5 million.
  3. A charity, corporation or partnership with assets exceeding $5 million.
  4. A director, executive officer or general partner of the company selling the securities.
  5. Any business entity in which all of the individual equity owners are themselves accredited investors.
  6. A natural person with a new worth in excess of $1 million, excluding the value of the individual’s primary residence.
  7. A natural person with income exceeding $200,000 in each of the two most recent years (or joint income with a spouse exceeding $300,000 of those years) and a reasonable expectation of exceeding the same amount in the current year; or
  8. A trust with assets in excess of $5 million.

As you can imagine, lawyers mainly qualify under the income qualification, although many lawyers won’t qualify at all unless it’s later in their investment career and they’ve achieved a net worth of over $1 million, excluding the value of their primary residence.

Why do we have accredited investor status?

The SEC was formed to protect investors. Interesting sidenote: The first SEC commissioner, Joseph P. Kennedy, wrote regulations that outlawed insider trading, a method he used to generate an immense amount of wealth in the 1920s.

I suppose the thinking is that if you’re an accredited investor, you don’t need the same level of protection as a non-accredited investor. Given that you can be an accredited investor and lose your entire investment, I’m not sure this makes a lot of sense, but presumably some lobbying was involved in setting the thresholds and the wealthier class of investors didn’t want these restrictions to apply.

Rest assured that you can go your entire life without purchasing an investment that requires you to be an accredited investor.

However, if you invest in something that does require accredited investor status, there will be very few regulations that protect you. You’ll need to do your own due diligence on the investment and could potentially need the expertise of advisors (lawyers, accountants, etc.) that may eat up some of the investment returns.

Qualified purchaser vs accredited investors

Occasionally there is some confusion over the difference between a qualified purchaser and an accredited investor, mainly because people will use the term “qualified investor” which isn’t an actual SEC term.

While you may be an accredited investor, you are almost certainly not a qualified purchaser. To be a qualified purchaser, you’d need at least $5,000,000 in investments or to be an investment manager (or company) with at least $25,000,000 in investments.

In other words, qualified purchasers are super accredited investors. If you’re a qualified purchaser, the SEC things you’re sophisticated enough to be making all kinds of your own investments without SEC oversight. Note that there is no income requirement to be a qualified purchaser. Having a high income is no longer enough, you actually need to be wealthy.

Investment opportunities for accredited investors

It’s beyond the scope of this article to talk about all the types of investments that open up to accredited investors, but here’s a few that become available:

  1. Private Equity. Private equity includes the entire investment sphere of non-public investments. Private equity typically raise money from institutional and non-institutional investors.
  2. Start-ups. Accredited investors can be angel investors that directly invest in start-ups and private companies.
  3. Hedge Funds. You’re not getting into a hedge fund unless you’re an accredited investor. But then again, why would you?
  4. Real Estate Crowdfunding. Most of the real estate platforms are only available to accredited investors.

Joshua Holt is a former private equity M&A lawyer and the creator of Biglaw Investor. Josh couldn’t find a place where lawyers were talking about money, so he created it himself. He spends 10 minutes a month on Empower keeping track of his money. He’s also maxing out tax-advantaged accounts like 529 Plans to minimize his taxable income.

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    Seventeen thoughts on Gaining Accredited Investor Status

    1. Thanks for this interesting post. I am an accredited investor and have made angel investments in some start-ups. But as you rightly imply, much like hedge funds, they are not all that they are cracked up to be. You can possibly luck out with the next Amazon or Google, but the odds of that happening are extremely remote. Sometimes, simple stock investments (either in index funds or established dividend stocks) are all that’s needed, whether you are accredited or not.

      1. What percentage of your portfolio have you devoted to angel investing? I’m not currently invested in anything that risky but I wouldn’t be opposed to putting a percentage less than 5% into angel funds. I’d find this more interesting that investing in individual stocks in the public market. Of course, I’d also only want to invest in a start-up where I could provide some type of assistance to the start-up to help it be successful. I almost invested in a friend-of-a-friend company that manufactures and markets a holiday season product. They already had trial run contracts from the big box stores when I had my opportunity to invest. Ultimately I skipped the investment because it represented too large a chunk of my net worth at the time but I probably would do it now if the opportunity presented itself. In the beginning it’s just too important to lay down a solid base in standard index funds.

    2. I often wonder what’s the point since no one actually checks anyway. Honestly I am an accredited investor but to date I have never invested in something that requires you to be one. I’d much rather invest in index funds.

      1. The risk is on the seller of securities. If it turns out they’re selling to non-accredited investors, there’s the possibility that the SEC will rescind the transaction. The issue has to take “reasonable steps” to determine whether the investor is accredited or not in order to be in the safe harbor.

    3. Being accredited, for me personally, helped get real estate back into my portfolio – albeit real estate crowdfunding. I am of the opinion that real estate, in some form, should be in everyone’s portfolio, but as a former landlord, I just didn’t want to get back into dealing with the acquisition process, constantly negotiating with tenants and worrying about vacancies.

      So I transitioned from an active real estate investor to a passive one via a real estate crowd funding site, which is only for accredited investors. It is unfortunate that everyone is not able to participate, because I very much enjoy this type of real estate investing much more. Hopefully soon, I’ll get around to finishing my review of the site I am on.

      Great post, BigLaw. Very informative and to the point.

      1. Would you mind sharing which real estate crowd funding site you invest through? I have some money invested through Peer Street (which is limited to accredited investors). After about a year with an IRR of less than 7%, I am reconsidering whether that return is worth the risk–a default on any one loan will wipe out my gains entirely.

        1. Hello Meg,
          I am also with PeerStreet. I have been with them since late Aug ’16 and have a 6.4% ROI after 9.5 months. I don’t think that return, or yours for that matter, is that bad considering the tenor of our investments (just my opinion). I have had some late payments that were cured and also have a buddy, who I have referred to the site, who is going through the bankruptcy process with them now on one of his investments. It will be interesting to see how that falls out, but in terms of my investments, I am pretty satisfied and continue to roll earnings and principal payback into new loans – a ladder effect, if you will.

          Here is how I am viewing the risk and why I believe the downside is capped:
          1. Collateralized by the asset. I love this. I don’t get to take a lien on many other investments I have, especially securities in my retirement accounts. Also, when throwing money at PeerStreet properties, I always invest in LTVs < 70% to conservatively haircut any appraisal/comps that is being marketed for the area.

          2. Reputational Risk. Peerstreet continues to boast they have zero principal defaults (posted May 2, 2017 on their blog). Effectively, I believe they will go above and beyond in order to preserve this honor.

          Anyway, these are my two biggest highlights. Curious to know where you would put your money, with an assume lower risk profile, if you were to take your money out? I ask because I assume accredited investors have similar issues as I where they are locked out of certain investments (i.e. IRAs) because of their income.

          1. I’m not a particularly knowledgeable investor. Most of my investments are in index funds, which are not less risky but at least have historically given me a better return than what I’m seeing from Peer Street–that’s probably where I would move my money.
            The interest rates on my loans range from 6.75% to an outlier of 11.75%. My IRR is lower because of the lag time of having money sitting in the account not doing anything. I started withdrawing money as soon as it’s distributed to me, which (assuming no defaults) should boost my rate of return. I’m not planning to make additional loans for the time being, but will reevaluate if things go well as my existing loans mature over the next 2-3 years.

            1. Church and Meg – Interesting discussion. I’ve also been investing with PeerStreet but that’s the subject of a future post.

              Church, can you elaborate on the friend that is going through the bankruptcy process? After speaking with PeerStreet, I understand that they’ve had one loan default but that in that case all of the investors received their principal back plus a small about of interest.

    4. I believe you are a knowledgeable investor or you would not have invested as you did. For what its worth, I believe you have landed in fairly decent investment. Just be patient with it.

      Index funds are great and have been performing well since 2007/08, but if there were to be a market correction and everyone pulls their money out – one safe haven could be real estate, which could work to your favor.

    5. @BigLaw –
      With regards to your question about my buddy on Peerstreet, he was notified that one of his investments has defaulted and legal proceedings have begun. That is not to say there is a realized loss on the books by any means and write it off. It simply means that PeerStreet needs time to exercise their ownership rights to the property on behalf of those invested, sell the property and ultimately return any and all proceeds to the investors (less legal costs – I assume).

      It got really interesting when, right before the default, the borrower “gifted” a 10% equity ownership to another stakeholder who also is in default. My buddy and I just shook our heads when we read that notification on this account.

      Nonetheless, I go back to my point about the “reputational risk” that PeerStreet needs to preserve. As long as principal is returned, that tells me they are accurately providing good investments at the right LTVs and their market due diligence is a fair estimate of the market in order to have your money returned in an event of default. Otherwise, I will need to reassess the risk profile of this platform.

      1. Thanks for the update, I very much appreciate. I’ll see if I can bring this up with the PeerStreet team to learn a little more about the default. You’re definitely correct in that a default doesn’t necessarily mean that an investor will lose principal. It’s one of the great things about the asset class, since your loan is technically backed by the underlying asset and as you correctly point out, with a decent LTV ratio, there should be enough cushion that even if the property is sold at a loss the investors should do fine since they sit ahead of the equity.

        I say technically backed by the underlying asset because PeerStreet appears to have a structure whereby one entity, Peer Street Funding LLC, actually holds the security interest in the underlying assets. That entity then sells notes to you, the purchaser of such notes. The notes you buy don’t have a security interest in Peer Street Funding LLC or the actual real estate but instead have a contractual back-to-back right to receive payment from the proceeds of any liquidation on account of a default. It’s not as tight as having the direct security interest yourself, but it’s still pretty good (and Peer Street Funding LLC is separate and remote from the Peer Street platform). I’m still digging into this myself but will have a future post on Peer Street. So far I think this is a minor flaw in the structure but as I learn more my opinion could change (for better or worse).

        Again, thanks for the background.

    6. Hi Biglaw Investor – Sorry I am late to the party, but I had a few minutes and thought I would leave a comment. I have been an accredited investor for many years and have invested in startups, a hedge fund, and private equity funds.

      Here’s my 2 cents

      1) Crowdfunding – Pretty much everything that uses crowdfunding is likely to be a terrible investment. One reason for this is that crowdfunding is usually a lender of last resort. This means that more experienced investors have already reviewed the investment and decided it stinks enough to not invest in it. Banks have passed on it – likely even more risky, local banks. This is not a recipe for above-average returns. I have periodically reviewed several crowdfunding sites and risk/reward was always way off. The platforms make it very easy to invest in these deals, but they are not great – the only people that make good money are the platform itself.

      2) Hedge funds – I agree that the overwhelming percentage don’t beat the market and are really only good at collecting the 2&20 for the fund.

      3) Startups – oh my god do so many of these fail. Again, you have the issue that if the startup is coming to you for money they have already been passed over by more experienced investors and are likely a lower-probability play. I have even been in fairly major angel groups and the odds are so, so low – like 2-5%-ish. Basically, if you are a startup with a good team and a compelling idea, money is super-easy to get now and the good concepts go to the bigger money.

      4) Private equity – these companies can be hard to find (they may be prohibited from advertising), but some are great. For example, I have been in a fund with MLGCapital
      for a few years. They basically buy, fix, and flip larger real estate developments like 450-unit apartment complexes – although they do some industrial and commercial as well. They pay an 8% dividend and they seem to be on target for a 12-14% IRR (we sill see when all portfolio properties are sold). Their deal is you get the 8% dividend, return of capital, and they split profits 70-30 at the end of the fund – your 70% is the 12-14% IRR.

      That’s the kind of risk/reward profile that I want to see if I am going to venture beyond publicly traded stocks. None of this 6% business! Save yourself the risk and get a better return in the SP500!

      1. Managing Partner – Always a pleasure to get your insight. It really fulfills my goals of creating a place where lawyers can talk about money.

        You make a great overall point that I see in my daily work in private equity: there is tons of capital out there with people looking to get a good return. That means that if an investment opportunity is trickling down to you, the individual investor, you’re dead on that it’s been passed over by many, many people, such that you have to wonder if it’s a good deal. And then, as you say, if you’re getting something like a 6-8% return, is that even remotely appropriate for the risk you’re taking when you could do better in the S&P 500? I think you argue pretty convincingly that the answer is no.

        Where I hope you’re wrong is that as the crowdfunding platforms gather steam, I’d like to believe that they could eventually replace (or substitute) for some of the private capital available in the market place. Lately we’ve seen plenty of large companies eschew going public (why deal with the headache when you can raise billions as a private company?). Isn’t the next logical step to raise money from the crowd (why deal with annoying PE funds when you can instead deal with 1,000 of individual investors with no collective power?).

        If that were to be the case, then perhaps the individual investors could capture part of that return (or perhaps my argument is weak because even if individual investors gained the upper hand, they’d eventually drive down returns to the point where the risk/reward ratio is out of whack as you mentioned).

        I’ll have to check out MLG Capital. How does a lawyer even get involved in private equity deals? I’d think the capital outlays would need to be quite large.

    7. Hi Biglaw!
      With regard to crowdfunding, the general principle is when you add additional market participants with lesser negotiating power, valuations get worse. Taking a step back, in general, if I am a company, why do I want to go public? Well, in a typical historical situation I can probably get a 10-12 multiple for my stock with private equity, but I can probably get a 16-20 multiple from the public market. There is just more “dumb” money and they have little negotiating power. They might even bid up the multiple even further if they are really “bubbly”. (See internet boom and crash). If instead I could do my placement on a platform that would give me a 25-30 multiple (like a crowdfunding platform) I would totally do it! I have gotten a better price for my stock – but it does NOT mean that it is a good deal for the people who are purchasing on the crowdfunding platform.

      Frankly, if I can get enough suckers through crowdfunding to fund me at a 25 multiple, I will go there again and again as opposed to the regular market or PE. However, there likely won’t be enough money to completely fill my offering, so I might have to go to the regular market. Also, as I exhaust the dumb money available on the crowdfunding platform, the multiple will decline to that of the market – why? Well, the market participants are also allowed to participate on the crowdfunding site – anyone can sign up – but they just have better sense to pay too high a multiple. However, I think that you will see more and more companies exploiting the crowdfunding market – the prices are just too good. It is easy money!

      There is NO SCENARIO where I as a company would choose to sell on a crowdfunding site if the multiple that I would get would be worse than that of the market. This is absolutely why I applaud the SEC in imposing crowdfunding limits for non-accredited investors. They are really just getting fleeced.

      On the other hand, why would I NOT go public? Well, maybe I think that I can’t get a better multiple on the public market (earlier investors have overpaid – that is, I convinced them to pay more than they should have for the stock). We have seen several recent instances in tech companies where private equity firms have either lost a bunch of money when a company went public – or else are using their Board positions to prevent a company from going public in order to not have to book the loss and hope that things eventually turn around or revenue grows.

      Bottom line – crowdfunding is great for sellers of stock (they will get a much better price) and is pretty bad for buyers of stock (they will pay a multiple greater than the market). The crowdfunding platforms surround themselves with a lot of “Robin Hood”-type rhetoric, but it doesn’t hold up mathematically.

      Here’s another way to think about it – if you have $100K-$500K to invest, most PE firms would be interested in you (at least outside of NY!). You can invest your money through them and they can buy companies at maybe a 10-12 multiple – or you can buy it on a crowdfunding platform at a 20-25 multiple. Which is a better deal for you?

      New subject – in terms of investing in a PE fund, different funds court different investors, but for most funds you can invest in $100K chunks. Some funds will go to $50K – some funds only want $1MM or more. However $250K seems like it will get you into about 95% of the non-institutional-oriented funds. That’s big but not that big. You can get into MLG for $100K.

      However, you really have to look around with regard to these companies and find what you want. I personally like that MLG includes multiple properties, is geographically diverse, and has a “flip” mentality rather than a “manage for rents” mentality. It’s a pure return play. I actually didn’t like that they invested in an industrial property rather than residential, but they have done well with it. Conversely, many investors in these types of funds seem to be very particular in what they are looking for.

      For comparison, you have companies that set up individual-property deals like Syndicated Equities – you would be buying into a specific 450-unit residential complex, for example, instead of a fund with several. There is also more of a “buy-and-hold” mentality.
      You can get into one of their offerings probably at 50K and definitely at 100K.

      Side note – We are talking about being outside NY. If you are looking at a NY-focused fund, they seem to go for 500K-1MM. NY costs are crazy and they tend to under perform. They seem to take advantage of a local bias in the investors.

      As I mentioned, it is tough to find these funds. If you know any resources that provide a convenient way to compare them and their returns, that would be valuable. It’s actually something that I am surprised no one has done yet!

    8. Ahh accredited investor status. Yes, I am an accredited investor but I’m honestly not a fan of the concept. Seems a bit too paternalistic to me that the government gets to decide what I can or cannot invest in. And using my salary as a proxy for my business savvy at that! I haven’t invested in anything requiring me to be accredited yet, but I will likely use it to get involved in real estate syndications at some point. There really are some good deals available if you look. I generally prefer direct syndication ownership to crowdfunding so I can have a direct relationship with the sponsor. There’s security in relationships sometimes!

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