Guide to Accredited Investors – What do startups need to know?
In this article, we take a deeper look on who are accredited investors and how they can help in your startup’s growth.
Fundraising is important for a startup’s growth. Venture capitals, angel investors, and crowdfunding are just a few ways a startup can raise funds for its business. But did you know that accredited investors can also help finance startups? An accredited investor is someone, can be either a person or a company, who are allowed to trade in securities not accessible to the general public. In this article, we take a deeper look on who are accredited investors and how they can help in your startup’s growth.
Accredited investors for startups
An accredited investor is an individual or institution permitted to engage in securities that have not been registered with the Securities and Exchange Commission (SEC). The person or the company must achieve specific income and net worth requirements to be considered an accredited investor. For startups, accredited investors can be a great benefit for scaling up their businesses.
What is an accredited investor?
An accredited investor is a person or a corporation that is permitted to purchase securities that are not regulated by financial institutions. They are eligible for this special access if they meet at minimum one of the following criteria based on income, asset size, net worth, governance standing, or relevant expertise.
An accredited investor is someone who has a net worth of more than $1 million, either alone or collectively with their spouse. The SEC additionally considers an individual to be an accredited investor if they work for the firm issuing the unregistered securities as a general partner, executive officer, or director.
A private business development corporation or an organization with assets above $5 million is also considered an accredited investor. Furthermore, if an entity has equity shareholders who are accredited investors, the business is an accredited investor. An organization, on the other hand, cannot be founded solely for the purpose of buying certain securities.
Requirements of accredited investors based on countries
For someone to become an accredited investor, it’s important to look into the requirements. These requirements also differ by country. Below are some requirements needed for the US, Canada, and Australia:
- US – To be considered an accredited investor in the United States, the individual must possess a net worth of a minimum of $ 1 million, with the exception of the worth from one’s main residence. They can even qualify with a minimum income of $200,000 per year for the past two years or $300,000 joint income in married status and anticipate earning the same amount during the current year.
- Canada – Accredited Investor in Canada is defined similarly to one in the United States, and they must be registered as an advisor or dealer under securities regulation and own financial assets with an aggregate realizable worth of $1,000,000. They are eligible if they generated $200,000 in each of the previous two calendar years or $300,000 combined if married. They should anticipate the same or exceed that amount of net income in the current fiscal year.
- Australia – 708(8) of the Corporations Act 2001 of Australia is contained in Chapter 6D (Fundraising), defining “sophisticated investors” in order to exempt them from certain disclosure obligations. That clause allows an accountant to grant a certificate declaring that the individual fulfills the conditions outlined of net assets of a minimum $2.5 million or annual income of a minimum of $250,000 during each of the previous two fiscal years.
Why are there requirements for becoming an accredited investor?
Market regulators have the dual roles of promoting investment and protecting investors. On the one hand, authorities are incentivized to encourage investments in high-risk initiatives and entrepreneurial activities that could pay off in multiple ways in the future. Such endeavors are high-risk, could be backed by concept-only market research with no commercially viable end result, and could very well fail. But at the same time, these projects promise substantial returns to backers if they find financial success and could be a multibagger. However, there is a significant risk of failure associated with them.
However, on the other hand, authorities are responsible for safeguarding non-potential individual investors who may lack the financial wherewithal to withstand substantial losses or who may not fully comprehend the dangers involved in their investments. Therefore, the inclusion of accredited investors opens the door to financially secure and professionally experienced investors.
Accredited investor status isn’t formalized. Instead, sellers of such securities must investigate necessary credentials to verify an accredited investor’s eligibility. Accredited investors can contact the unregistered securities issuer. The issuer may require the applicant to complete a questionnaire to determine authorization. The questionnaire may demand proof.
Types of investments accredited investors can make
For many accredited investors, they can venture into different types of investments. These investments enable these investors to diversify their portfolio. Some of these investments include:
- Hedge funds – A hedge fund is a limited partnership of private investors. Money is managed by skilled fund managers who utilize a variety of methods to produce above-average returns. Hedge funds are only available to certified investors since they have large minimum investment amounts and huge risks, but great profits.
- Venture capital – Venture capital is private equity investment given by venture capital firms to entrepreneurs, and early and rising enterprises with great growth potential. Only accredited investors can qualify as a GP or issuer of securities.
- Real estate investment funds – Real Estate Funds invest in real estate-sector securities. Accredited investors get access to bigger, higher-quality real estate projects with greater ROI and other perks.
- Angel investments – Angel investing is a sort of private equity investment in which only high-net-worth investors can participate. They are allowed to take on greater risk than in public markets to earn greater returns.
- Private equity funds – Private equity funds only accept accredited investors and qualified customers. Similar to a mutual fund or hedge fund, a private equity fund combines the investors’ money and invests it on their behalf.
How can startups identify an accredited investor?
Individuals who earned $200,000 or more in income during the previous two years, as stated above in the US qualifications for Accredited investors, automatically qualify as accredited investors, as does a couple when their income totals $300,000 or more. Individuals can also qualify if they have a net worth of a million dollars or more after deducting the value of their primary house. The only time the principal residence may affect net worth is when an owner has an outstanding mortgage or a balance on a line of credit for home equity.
How can accredited investors invest in startups?
Accredited investors have various alternatives when it comes to investing in startups. They typically do so through a venture capital (VC) company or by sourcing private placement deals through an internet marketplace.
Accredited investors can find investment possibilities through online markets such as Yieldstreet, Peerstreet, and Cadence. Liquidity varies across different platforms, and thorough research is required before making any investments. Accredited investors join investors with a venture capital fund, and the business subsequently invests capital from the fund in a variety of startups. A VC fund’s liquidity is always limited, which means you won’t be able to withdraw your money anytime you want. Accredited investors should constantly be aware of the risks associated with a VC fund’s investment horizon.
How can accredited investors invest in hedge funds?
A hedge fund is an investment option in which fund managers spend funds on a variety of different investments in an attempt to produce positive returns. A hedge fund’s purpose is to generate good returns irrespective of market conditions.
To participate, you usually need to know someone at the fund, and the verification process may be rigorous. Hedge fund management costs might also be substantial. Additionally, fund managers often get 20% of the fund’s profits, reducing an investor’s gains even further. A hedge fund, like venture capital investments, has very little liquidity, and investment thresholds can be quite high.
Accredited investors can also invest in funds of funds, which are designed to imitate the flexibility of mutual funds. Funds of funds typically invest in many other mutual funds or hedge funds. Fund of funds charges are comparable to hedge fund costs, and its profitability can be tracked and compared using the Barclays Fund of Funds Index.
Recent SEC amendments for accredited investors
The Securities and Exchange Commission (SEC) changed the definition of a qualified investor On August 26, 2020, and issued a press release that stated, “the amendments allow investors to 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 amendments also expand the list of entities that may qualify as accredited investors, including by allowing any entity that meets an investments test to qualify”.
Professionals from a private fund regarded as “knowledgeable employees” are now recognized as accredited investors inside that fund. Persons with Series 7, Series 65, and Series 82 registrations are also considered accredited investors. SEC- and state-registered investment advisors, limited liability firms with $5 million in assets, rural business investment corporations, and exempt reporting advisers are also eligible.
The SEC’s definition has also been expanded to include several other agents, including Indian tribes, government entities, funding sources, and organizations structured under the legislation of overseas nations with investments in an abundance of $5 million as described in Rule 2a51-1(b) under the Investment Company Act and that did not establish for the particular goal of investing in the securities issued. The SEC can add credentials and qualifications in the future, and the public is encouraged to make recommendations for further certificates, designations, or qualifications to be considered.
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