Private equity and other nonpublic offering companies offer unique risks to investors. This makes it important to understand how those risks differ from publicly traded companies. There are several ways to qualify as an accredited investor or qualified purchaser, depending on what type of investment opportunity you want to pursue. For example, some people meet the definition of an accredited investor because they make over $200,000 per year, while others do not. In either case, however, there are certain criteria that apply to each category.
Qualification Requirements for Qualified Purchasers
The SEC has announced some changes to how it regulates alternative investment fund managers. Under the proposed rule change, qualifying investors must meet certain criteria. These include having $5 million or more invested in private capital, either directly or indirectly, such as via a family office.
This includes individuals or entities that have invested at least $25m in private capital, either personally or on behalf of others. Qualified purchasers must also be able to invest at least 25% of their assets into private equity. They cannot be formed for the express purposes of investing in private funds – meaning they cannot be set up specifically for the purpose of buying private companies.
Also read about the SEC’s definition of a venture capital fund
By Contrast, What is an Accredited Investor?
Under Rule 501(a)of the Securities Act of 1933 (the “Securities Act”), only persons having a net worth (or joint net worth in the event of a married couple) exceeding $1 million ($2 million in the case of certain publicly traded companies), excluding the value of their principal residence, are deemed to meet the definition of an “accredited investor.” Read more about the details of the accredited investor history.
However, to qualify as an accredited investor under Section 2(a)(3) of the Securities Act, an individual must show evidence of either (i) an annual personal income of over $200,000; or (ii) an annual household income of over $250,000. In addition, the individual must maintain such income for each of the two preceding calendar years. If both spouses reside together, the combined incomes of both must equal or exceed the applicable threshold. See what is an accredited investor?
In addition, an individual must possess one of three types of licenses issued by FINRA: a Series 7, Series 65 or Series 82 Financial Services License. Such licenses authorize the holder to act as a broker dealer, municipal securities dealer, investment advisor, etc., and thereby render him/her eligible to transact business with others holding such licenses.
The Securities Exchange Act of 1934
This Act created the SEC, the agency responsible for overseeing and regulating stock markets. It mandated public companies disclose information about themselves, including financial statements and executive compensation. It standardized what must be included in those documents. It also prohibited insider trading, requiring publicly traded companies to report trades within five days.
The Investment Company Act of 1940
Jack Bogle wrote the Investment Company Act of 1940, which became law in June of that year.
The act required fund managers to disclose certain financial information to shareholders, including the size of the fund, how much it cost to run, what fees they charged, and the performance of the fund. In addition, the act established rules governing how funds could invest in securities. And finally, it set up a system of independent directors to oversee the management of each fund.
This was a huge step forward for the industry, and it helped prevent another crash like the one that happened just three years later. But it didn’t stop people from trying to game the system. So Bogle introduced the concept of indexing—a way for funds to track the overall movement of the market without actually owning every single security.
Qualified Purchaser Criteria
To be considered a “qualified purchaser,” at least one of the above criteria must be met. This includes individuals, trusts, partnerships, corporations, LLCs, etc., which meet the definition of a qualified purchaser. A qualified purchaser is defined as follows:
• An individual (or family-run business not formed just to purchase shares in the Fund), or a trust sponsored and managed exclusively by qualified purchasers, that owns $5 million dollars or more in investments;
• Or a trust sponsored and managed solely by qualified purchasers, where none of the trustees or managers of the trust are affiliated with the issuer of the securities being purchased;
• Or an individual (or any other entity not formed just to purchase the Fund) that owns and invests at least 25 million dollars in investments (or someone acting on behalf of such a person);
• Or an entity, if all of its owners are qualified purchasers.
The term “qualifying shareholders” refers to those persons or entities that qualify under the terms of the Trust Agreement to become a shareholder of the Fund upon completion of the offering. Qualifying shareholders include, among others, individuals, trusts, partnerships (including limited liability companies and general partnership), joint ventures, corporations, unincorporated associations, and governmental units.
Accredited Investor vs. Qualified Purchaser: Main Differences
Qualified purchasers are individuals, businesses, and other legal entities that meet certain criteria. They must invest $1 million or more and have total annual gross revenue of $5 million or less during the previous three fiscal years.
They can buy securities offered directly to qualified purchasers, such as private placements, and exchange-traded funds (ETFs).
Accredited investors are considered wealthy because they have a net worth of $1 million or more, or earn $200,000 or more annually ($300,000 for married couples filing jointly), excluding their homes.
The Securities Act of 1933 defines accredited investors as those who fall into one of these categories:
• Individuals whose individual net worth exceeds $1 million;
• Business owners with a personal net worth exceeding $2 million;
• Individuals who have earned $200,000 or above per calendar year in each of the preceding five years;
Eligibility requirements
The Securities and Exchange Commission defines an “accredited investor” as someone who meets certain criteria. These include having more than $1 million in net worth or making over $200,000 per year. But there are ways around those rules.
One way to become an accredited investor is to meet the investment threshold set out by the SEC. Another way is to have a high net worth and earn above a certain income level. And finally, you could invest up to $2.8 million and still qualify if you know about securities.
Investment opportunities
The Securities Act of 1933 requires investment advisers to register with the SEC. This law applies to anyone who provides advice or recommendations about buying or selling securities, including brokers and dealers. In addition, it applies to people who sell securities directly to individual investors, like stockbrokers and financial advisors.
Under Section 203 of the Investment Advisers Act of 1940, certain types of investment companies are exempt from registration requirements. These include registered investment companies, unit investment trusts, money market mutual funds, and registered closed end funds.
Qualified purchasers can invest up to $1 million in a fund without registering with the SEC. Accredited investors – those who meet specific criteria set out in Section 401 of the Internal Revenue Code – can invest in units of 3(c)(7), or “closed-end,” funds. They cannot purchase shares in open-ended mutual funds, however.
Examples of Qualified Purchasers
The IRS defines a qualified purchaser as someone who meets certain requirements. These qualifications are outlined in Section 404(c)(1). This includes having either $500,000 in IRAs, $250,000 in 401(k) plans, or $200,000 in mutual funds. Also, you must have $100,000 in a brokerage account. In addition, there are several additional rules that apply depending on whether it is an IRA, 401(k), or mutual fund.
For example, if you have $500,000 in an IRA, you cannot contribute more than $5,000 per year. If you have $250,000 in a 401(k), you cannot make contributions greater than $12,500 per year. And if you have $200,000 in a mutual fund, you cannot make contributions greater that $23,000 per year. Finally, you cannot use the money in the account for personal expenses. Instead, you must pay taxes on the earnings generated by the investments.
If you do not meet the qualifications, you are considered a nonqualified purchaser. However, you still have options. You could open a Roth IRA, which allows you to withdraw funds tax free upon reaching age 59 ½. Alternatively, you could convert some or all of your traditional IRA into a Roth IRA. Or, you could sell your mutual fund shares and move those proceeds into another type of investment like stocks or bonds.
Benefits of Holding Qualified Purchaser Status
The SEC recently announced changes to how qualified purchasers will be treated under the Securities Act of 1933. Under current law, qualified purchasers generally do not have to register with the Commission prior to purchasing securities. However, there are some exceptions to this rule, including when a purchaser purchases shares directly from issuers or affiliates of the issuer, or where the purchase price exceeds $1 million. As part of the proposed rules, the SEC is proposing to amend Section 3(a)(58) of the Securities Exchange Act of 1934 to provide additional exemptions for qualified purchasers. These amendments would allow qualified purchasers to avoid registering with the Commission when they purchase securities from qualifying issuers, even if the amount paid for those securities exceeds $1 million. This change would exempt such transactions from the registration requirement set forth in Rule 506 of Regulation D.
Summary of Qualified Purchaser vs. Accredited Investors
The Securities Act of 1933 requires that issuers of securities must register their offerings to ensure that potential investors receive the appropriate protections afforded by government oversight, including the ability to sue under the Securities Exchange Act of 1934. This requirement applies regardless of whether an issuer is selling shares directly to the public or soliciting investments from others.
However, there are certain exceptions to the registration requirement, specifically those identified in Section 4(2) of the Investment Company Act of 1940. These include situations where an issuer sells securities only to Qualified purchasers or Accredited Investors, as well as transactions involving certain types of exempt securities.
A Qualified purchaser is someone who has amassed a minimum of $5 million in total assets. An accredited investor is one who has either a minimum annual income of $200K or a minimum net worth of $1M.
If you are unsure about your own qualification status, it is important to consult with an experienced attorney regarding what steps you might take to determine your eligibility.
Should You Become an Accredited Investor?
Becoming an accredited investor gives you access to more investments than the general population. This includes real estate, hedge funds, venture capital, private equity, commodities, collectibles and even cryptocurrencies.
You might think that becoming an accredited investor will make it easier for you to invest in traditional stocks and bonds, but there are several drawbacks to doing so. For one thing, you will likely pay more fees to brokers and banks. Additionally, you will have to go through greater scrutiny from regulators. Also, some types of investments require special licenses and registrations.
While many people see accreditation as a way to make extra cash, becoming an accredited investor doesn’t automatically give you better returns. Many accredited investors end up losing money because they don’t know what they’re doing. If you want to become an accredited investor, you’ll need to do extensive research into individual investments and understand how each works.
