Many companies need to raise money to fuel their growth, but private companies can’t sell their shares on the stock exchange—that only becomes an option after the company goes public. Instead, private companies often turn to accredited investors, a classification that the U.S. Securities and Exchange Commission (SEC) defines in Rule 501(a) of the Securities Act of 1933. In 2020, the SEC updated the qualifications for accredited investors, so that more individuals and entities can now qualify as one.
What is Rule 501(a) of the Securities Act of 1933?
Congress passed the Securities Act of 1933 (also called the ‘33 Act or the Truth in Securities law), to help protect investors after the stock market crash of 1929. The law prohibits fraud, deceit, and misrepresentation in the sale of securities, such as bonds or stocks. Rule 501(a) is the part of Regulation D of the ‘33 Act that defines who and what qualifies to invest in unregistered securities, or an accredited investor.
Accredited investors are typically wealthy individuals with enough money to risk losing their investment, or enough experience to understand what’s being offered and make an educated decision. They invest in private companies, often startups, that find it too costly to register the securities they want to sell. These companies fundraise by selling securities to qualified investors, including accredited investors. Unregistered securities are riskier investments since they don’t have as many disclosure requirements as registered offerings.
The 2020 update to the accredited investor definition in Rule 501
The SEC occasionally updates its accredited investor definition to keep up with new laws and the new ways that private companies raise money. In August 2020, the SEC updated the accredited investor definition by expanding the ways people and entities can qualify.
The agency’s goal was to “simplify, harmonize, and improve” the framework that allows companies to raise money with exempt offerings. At the same time, the SEC is upholding the original intention of the Act, which is to protect investors from potentially risky investments.
The amended rule expanded and added to the eligibility requirements for both individuals and entities. Here’s an overview of the accredited investor requirements now that the amended rule is in place.
Accredited investor requirements for individuals
The changes to Rule 501(a) acknowledge that someone can be capable of understanding an investment’s risks even if they don’t have a high income or net worth. Individuals, or “natural persons” under the ‘33 Act, can now qualify as an accredited investor based on one of the existing, new, or revised requirements:
- Income requirement: Make at least $200,000 (or $300,000 with a spouse or spousal equivalent) during the last two years and expect to earn at least that much in the current year. The 2020 update added “spousal equivalent” to both the income and net worth definitions.
- Net worth requirement: An individual or couple who has a net worth of at least $1 million, not including the equity in and most liabilities against their primary home. The 2020 update allows couples, including spousal equivalents, to use their combined net worth to meet this requirement.
- Directors, executive officers, and general partners requirement: Work for the company that’s selling the securities. These people can qualify as an accredited investor when purchasing those securities only. This rule didn’t change in the 2020 update.
- Knowledgeable employee requirement: Be an employee of a private fund (such as a hedge fund). These individuals can qualify as an accredited investor to make an investment in their employer’s funds. This is a new qualification as of 2020.
- Family client requirement: Be a family client of a family office—a company that’s created to invest a family’s wealth—that has at least $5 million in assets under management. While the client qualifies as an accredited advisor, someone who has more financial and business experience may need to oversee the investments. This qualification was added in 2020.
- Professional certifications and designations requirement: Holds in good standing either the Series 7, Series 65, or Series 82 licenses, which are related to selling securities and offering investment advice. This bucket could include bankers, brokers, and investment advisors. This was also a requirement added in 2020.
Accredited investor requirements for entities
Entities such as companies and investment funds can qualify as accredited investors depending on the type of organization, its structure, or its assets. The 2020 update added several new categories of entities that may be eligible to qualify as accredited investors:
- Financial institutions requirement: Including banks, insurance companies, and registered investment companies.
- Entities owned by accredited investors requirement: An entity that’s completely owned by accredited investors is also an accredited investor.
- Entities with at least $5 million in assets requirement: Entities that have at least $5 million in assets and aren’t created specifically to buy the securities. This previously included corporations, partnerships, trusts, 501(c)(3)s, and employee benefit plans; the 2020 amendment added family offices and limited liability companies (LLCs) to the list.
- Investment advisor requirement: SEC- and state-registered investment advisors, exempt reporting advisors, and rural business investment companies. This is a new qualification as of 2020.
- Entities with at least $5 million in investments requirement: Any entity that wasn’t created specifically to buy the securities and has at least $5 million worth of investments, as defined by the Investment Company Act. This 2020 amendment is significantly more inclusive than the previous rule, allowing entities including tribes or nations of indigenous peoples, governmental bodies, funds, and entities organized under the laws of foreign countries to qualify.
The bottom line
Rule 501(a) of Reg D of the ‘33 Act defines how a person or entity can qualify as an accredited investor—a requirement for purchasing some unregistered securities. The update to the Rule, as of 2020, expands who can qualify and lowers the barrier by permitting certain qualified individuals to do so regardless of their income or net worth.
