José Padilla is an attorney and the owner of Padilla Law PLLC, where he represents startups and investors. His practice focuses on the formation, seed and VC financings, private equity, acquisitions, strategic corporate transactions, and general advisory regarding corporate and financing strategy.
In August 2020, the Securities and Exchange Commission (SEC) amended the definition of accredited investor. The SEC developed qualifications and rules under the Securities Act of 1933 to protect individuals from risky investments.
Accredited investors can more freely invest in hedge funds’ lucrative and risky world, private equity, venture capital, and equity crowdfunding. Private or unregistered securities are considered inherently riskier, so the Securities Act empowered the SEC to create eligibility requirements for accredited investors.
Why does the SEC definition of an accredited investor matter?
Historically, the SEC had allowed only the wealthy to make private venture investments largely because of their supposedly greater ability to sustain losses in light of financial risks. Individual investors who did not meet specific income or net worth tests, regardless of their financial knowledge and background, have had more limited opportunities to invest.
Before August 2020, accredited investors had to meet net worth or income requirements known as the “wallet test.” In the United States, to be considered an accredited investor, one must have a net worth of at least $1,000,000, excluding the value of one’s primary residence, or have an income of at least $200,000 each year for the last two years (or $300,000 combined income if married) and expect to make the same amount in the current year.
Investors can now qualify as accredited investors based on defined measures of professional knowledge, experience, or certifications in addition to the existing tests for income or net worth. The SEC also expanded the list of entities that may qualify as accredited investors by including tribal governments and other organizations that may qualify to participate in certain private offerings.
This is important because the sale of securities requires registration under the Securities Act. To qualify for an exemption from registration, most such exemptions require that an investor meet the SEC definition of an accredited investor.
Who can qualify as an accredited investor now?
The updated SEC definition allows investors with knowledge and expertise in business and financial matters to become accredited investors.
- Under the newly expanded definition, people holding basic stockbroker certifications like the General Securities Representatives (Series 7), Private Securities Offerings Representatives (Series 82), and Licensed Investment Adviser Representatives (Series 65) licenses are considered accredited investors.
- Knowledgeable employees of certain private or mutual funds may invest only in offerings by the private fund and other private funds that their employer manages.
- A private business development company or organization with assets exceeding $5 million or one with equity owners who are accredited investors can qualify under the new SEC definition.
- Family offices with at least $5 million in total assets under management and family clients also qualify accredited investors.
- The new SEC definition also allows for “spousal equivalents” (domestic partners or partners in a civil union), so such spousal investors may pool their assets to qualify.
SEC Changes: Takeaways
For the first time, the SEC decided to update its definition of an accredited investor which opens investing to people based on their knowledge and qualifications, rather than simply asking for proof of personal wealth.
Since the ability to invest in high-growth private ventures relies on SEC rules, the modernized definition is good news for both those seeking investment opportunities and for startups seeking different kinds of investors.
This post (1) is not provided in the course of and does not create or constitute an attorney-client relationship, (2) is not intended as a solicitation, (3) is not intended to convey or constitute legal advice, and (4) is not a substitute for obtaining legal advice from qualified professionals.
The featured image is of an investor checking on investments on a cellphone and laptop. Photo credit: Austin Distel on Unsplash.