What Is an Accredited Investor, and Why Does It Matter?

As your wealth grows, you may hear about investment opportunities open only to accredited investors, such as private equity funds, hedge funds, venture capital deals and private real estate offerings. Understanding what it means to be an accredited investor, and the risks that come with these investments, can help you make informed decisions.

The definition of an accredited investor

The Securities and Exchange Commission defines who qualifies as an accredited investor. Under SEC rules, individuals generally qualify if they meet one of several tests.

The net worth test requires a net worth over $1 million, alone or together with a spouse or spousal equivalent, not counting the value of their primary residence. Debt secured by the primary residence generally isn’t counted as a liability up to the home’s value, with some exceptions.

The income test requires income over $200,000 in each of the past two years, or $300,000 combined with a spouse or spousal equivalent, with a reasonable expectation of reaching the same income level in the current year.

The professional certification test allows individuals holding certain professional licenses in good standing, such as the Series 7, Series 65 or Series 82 licenses, to qualify regardless of income or net worth.

Certain knowledgeable employees of private funds, along with certain entities, such as trusts, businesses and family offices meeting specific requirements, can also qualify.

The SEC updated the definition in recent years to include professional certifications and spousal equivalents. The income and net worth thresholds haven’t been adjusted for inflation since they were established decades ago, which means more people qualify today than when the rules were created.

Why accredited investor status matters

Accredited investors can participate in private placements, investments that are exempt from some SEC registration requirements. Public investments, like stocks and mutual funds sold to the general public, must be registered with the SEC and provide extensive disclosures.

Private offerings can be sold without that registration, based on the idea that accredited investors have the financial sophistication to evaluate opportunities and the financial capacity to bear potential losses.

These private investments may include private equity funds, which buy and improve private companies, hedge funds using various strategies, venture capital investments in startups, private real estate offerings and funds, private credit funds and direct investments in private companies.

Some private offerings allow a limited number of non-accredited investors, but most are restricted to accredited investors.

Risks to weigh

Private investments come with significant risks and drawbacks compared with public investments.

Less disclosure means you may receive far less information about the investment, its holdings, performance and risks than you would with a public investment. This makes thorough due diligence more difficult and more important.

Higher fees are common, often including management fees and performance fees, which share a portion of profits with the manager. These fees can significantly reduce net returns.

Limited liquidity means money may be locked up for years. Many private funds have lockup periods and limit when and how much you can withdraw. Private equity and venture capital investments may tie up money for a decade or more.

Higher minimum investments, often tens or hundreds of thousands of dollars, make diversification across private investments more difficult.

Greater risk of loss exists, including the possibility of losing your entire investment, particularly in early-stage ventures. Many startups fail.

Valuation challenges mean private assets aren’t priced daily, so it can be difficult to know their true value.

Fraud risk can be higher in private offerings due to less oversight, so verifying the legitimacy of offerings and sponsors is essential.

Questions to ask before investing

How and when can I get my money back? Understand lockup periods, redemption terms and any restrictions on withdrawals.

What are all the fees? Ask for a complete breakdown, including management fees, performance fees, organizational expenses and any other costs.

Who manages the investment, and what’s their track record? Research the manager’s experience, performance history, reputation and any regulatory or legal issues. You can check backgrounds using FINRA BrokerCheck and the SEC’s Investment Adviser Public Disclosure website.

How does this fit my overall portfolio? Consider whether the investment aligns with your goals, risk tolerance, liquidity needs and diversification.

What are the risks, and what could cause me to lose money? Read offering documents carefully, including the private placement memorandum.

How will I receive information about performance? Understand how often you’ll receive reports and what they’ll include.

Get independent advice

Before investing in private offerings, consider talking with a fee-only fiduciary adviser who doesn’t earn commissions on the product and is required to act in your best interest. An independent adviser can help you evaluate whether private investments make sense for your situation and review the specific terms of any offering. Many successful investors build wealth without private investments, so they’re optional rather than necessary.