Accredited Investor Status

Mark Creason

3/16/2021

I have had several prospective clients ask me if they qualify for accredited investor status. Many do not understand what accredited status means or how to qualify. Accredited status was designed to protect the client and not the firm. If someone is deemed to be accredited, it generally means they are sophisticated enough to have a better understanding of the risks involved in making important investment decisions.

Many ways exist to be considered accredited. Let us start with the three main classes of accredited investors. Single individuals, married couples, and entities:

Single individuals can qualify in two different ways:

An individual with an annual income above $200,000 for the last two years, with the anticipation that it will continue, or

An individual with a net worth above one million dollars (not including the value of a personal primary residence) qualifies.

A married couple can qualify in two different ways:

A married couple with an income above $300,000 for the last two years, with the anticipation that it will continue, or

A married couple with a net worth above one million dollars (not including the value of a personal primary residence) qualifies.

The third classification would be for entities. Entities would include the following types: C Corporations, S Corporations, Limited Liability Company, Limited Partnerships, Investment Company, Bank, Savings and Loan, a Broker-Dealer, Insurance Company, a 501(c)3 organization, a private development company, a revocable Trust, Family Trust, and an Irrevocable Trust. This list of entities is not conclusive and there maybe other classifications that would qualify:

Any of these entities excluding an irrevocable trust would qualify based on all the equity owners being accredited investors.

Also, these entities would all qualify if they have over five million in assets. A caveat should be listed that the entity can not be set up for solely purchasing the new investment.

Over ninety percent of accredited investors qualify in one of these three ways. Some other ways to qualify:

A director, executive officer, or general partner of the issuing company are considered to be accredited investors regarding the particular security being sold.

A natural person who holds a current Series 7, Series 65, or Series 82 FINRA issued license would be considered accredited investors. The SEC added these classifications in late 2020.

“Spousal equivalent” has been added to the definition of an accredited investor. Spousal equivalents may pool their finances together for the purposes of qualifying as accredited investors. The SEC modified this classification in late 2020. A spousal equivalent is defined as a cohabitant who has a relationship generally equivalent to that of a spouse. Spousal equivalents will now be able to pool their resources.

Irrevocable trusts can be difficult to document. An irrevocable trust is required to have over five million in assets to qualify as an accredited investor. As the trust is irrevocable, the all equity investors are accredited exemption does not qualify. Irrevocable trusts have a difficult time qualifying for accreditation for this reason.

The list above does not include every way to qualify but is fairly inclusive.

An issue related to accreditation concerns 506(b) versus 506(c) offerings. Some information about each is provided:

506(b)

A 506(b) offering is allowed to include accredited investors and up to 35 non-accredited investors, as long as the accredited investors are “sophisticated.” A 506(b) is not allowed to be advertised. In a 506(b), investors self-accredit, meaning that a sponsor may rely on a statement by the investor to conclude a reasonable belief that the investor is accredited. A 506(b) has fewer restrictions to achieve accredited status as a reasonable preponderance is necessary.

506(c)

A 506(c) offering is restricted to include only accredited investors (non-accredited investors are not allowed). A 506(c) is allowed to be advertised. In a 506(c), investors do not self-accredit. Documentation proving that the investor is accredited is necessary. An example would be a 1031 exchange with over one million dollars in equity or bank/brokerage account with over one million dollars or some combination. A 506(c) is harder to qualify for when an accredited investor has significant intrinsically valued assets. Valuing real estate can be difficult without the expense of getting appraisals, which can be hard to document a million dollar plus net worth.

The SEC has announced a new rule to take effect on March 15, 2021. This new rule will relax the standards for 506(c) accreditation. Under this new rule change, sponsors will only need to verify accredited status every five years. These changes will make it easier for investors to invest in multiple 506(c) investments.

Now your thinking, why do I care about a deal being a 506(b) or 506(c)? The 506(c) requires more documentation. Some people will think it is intrusive. A 506(c) offering can be difficult to verify accredited status.

I recently had a client with approximately three million dollars in a 1031 exchange. To qualify him, we needed additional information. We cleared his status after receiving a letter from his attorney claiming accredited status, taking an extra three days. Clearing accredited status could have potentially caused his deal to fail as the Delaware Statutory Trust was selling out fast.

Another example of a 506(c) issue would be the investor who holds mostly real estate. Real estate can be difficult to value without getting an appraisal. A site like Zillow or Trulia can give an estimate of value but does not disclose any debt on the property. Commercial property can be difficult to evaluate as Zillow type sites do not exist for commercial property. Most investors are unwilling to wait three weeks to get an appraisal and do not want to spend potentially thousands of dollars to value their portfolios.

In conclusion, accreditation is not as scary as it sounds. If you can make a reasonable presentation of net worth or income, then qualifying for a 506(b) should not be a problem. If you are willing to go under the financial microscope, a 506(c) might work too.