Under the Securities Act of 1933, any company that sells securities must register with the SEC or file for an exemption if they so qualify. The Act provides companies with a number of exemptions from federal registration requirements. One of these exemptions is that the company may sell its securities to Accredited Investors. Selling securities to Accredited Investors is deemed to be an exemption because the assumption is that Accredited Investors have the skill and knowledge to evaluate and determine the risk of the investment.
The term Accredited Investor is defined by the Securities and Exchange Commission (SEC) and is used to describe investors who have achieved a level of financial sophistication that eliminates or diminishes the need for protection that some government filings may provide.
An Accredited Investor is:
- A bank, insurance company, or other similar company;
- An employee benefit plan if a registered investment advisor is involved in the decision making and the plan has assets in excess of $5 million;
- A charitable organization, corporation or partnership with assets in excess of $5 million;
- A business whose equity owners are all accredited investors;
For an individual to qualify as an Accredited Investor he must achieve one of the following:
- A yearly individual income in excess of $200,000 per year or a joint income of $300,000 in each of the last two years and can expect to adhere to this standard in the future.
- Have a net worth in excess of $1 million (this can be individual or combined with a spouse).
- Have a trust with assets exceeding $5 million which was not formed to acquire securities.
These categories were created to attempt to evaluate whether a company or individual has adequate knowledge to determine the risks and rewards of investments.
Some investments may only be available to Accredited Investors. Because Accredited Investors can avoid many of the filing requirements most other companies are subject to they are often singled out because of convenience and privacy. Selling securities to a non-accredited investor is much more difficult because the disclosure requirements are much harder to meet. There are certain rules that businesses must follow when selling securities to raise capital. Rule 506 (of SEC Regulation D) allows businesses to raise an unlimited amount of capital through securities sales to Accredited Investors, whereas they can only sell securities to 35 non-accredited investors who must meet certain standards. On top the standards being rather hard to meet, the company will often have to spend thousands of dollars in legal and accounting fees during this process because of the rules of disclosure. This is often why companies will choose to sell securities to Accredited Investors in order to avoid this hassle.