There are many benefits to being an “accredited investor,” primarily centered around being able to invest in securities not registered with financial authorities. In other words, the government blocks non-wealthy folks from making “high risk / high reward” investments. Is this fair? Shouldn’t I be allowed to invest my money in any investment if I earned that money?
While investments open only to accredited investors are high risk, there are many other investment types open to any income level which are extremely high risk. Even investing in one individual public stock – which anyone can do – is nearly the equivalent of putting all of one’s money on red in Vegas.
To become an accredited investor, you either need to have an annual income of $200,000, or $300,000 for joint income for the last two years OR you need a net worth of $1M not including your primary residence OR you need to be a general partner, executive officer, director or a related combination thereof. If you meet any of these requirements you can invest in:
- private equity: ownership of a private company or part of a private company, often via a private equity fund. These companies have chosen to remain private but are stable and could be compared to companies on the public market, but you can only invest in them if you’re an accredited investor. You can also buy shares of stock from employees in successful growth companies who are looking to turn a profit on their shares before the company goes public.
- venture capital: think you can spot the next Facebook? Accredited investors can invest in early-stage companies. This is a very high-risk investment, but also offers very high rewards if you have a talent for picking the best teams and markets that need funding. You get preferred stock as an “angel” investor which means even if the company liquidates, you’ll get your money back first (while the employees who have stock options won’t get anything.) You can also invest in venture capital funds where you trust someone who does this for a living to pick the companies they think will succeed — most will fail, but as long as one does really well you will do really well too.
- hedge funds: these funds require you to put your money in up front, and they’re actively managed by someone who thinks they can pick the best investments across private, public, and derivatives to return the best rate for their investors. But you can only get in on this if you’re an accredited investor.
- hard assets: some funds invest in actual things like “rare coins” a non-traded real estate, and even wine. See if you can beat the market by investing in hard assets for a high risk, potentially high reward investment.
Of course, if you’re not certifiably wealthy, you are not allowed to make these investments. Is the government protecting us from ourselves? Maybe.
One of the recent changes you may not be aware of is that on May 16 this year, Crowdfunding became legal. This is actually a really big deal. Before this, individuals were not allowed to invest in early-stage private companies unless they met these investor requirements (never mind that anyone can go on Kickstarter and put money into an early-stage company in order to get the product when it’s available – that wasn’t an investment.)
Investing in an early-stage startup is a huge risk, and shouldn’t be taken lightly. The act still has limitations – it limits companies to raising up to $1M in crowd funds per year, they must be a U.S. entity, and certain financial information must be disclosed and audited.
With the act, investors are still limited based on their income or net worth. And the SEC’s regulations to “protect” small investors make it very challenging for a company to raise money via crowdfunding, which some describing this as “last resort funding” – not exactly the type of company one would want to invest in, ESPECIALLY if she is not a high net worth individual. You basically get access to only the companies rejected by accredited investors.
Most companies are staying far away from using the Title III regulation, because even with low cost solutions like iDisclose and Crowdcheck, the upfront costs to conduct the financial audits are a huge gamble and not worth it for the companies. For the investor, the limitations are still very, well, limiting:
- If annual income is less than $100,000, then you can only invest the greater of $2k or 5% of annual income or net worth (not counting home), whichever is less on an annual basis.
- If annual income is over $100,000 you can invest 10% of income or net worth (not counting home) per year, up to a maximum of $100,000.
Typically middle class people have most of their net worth locked up in their homes, so they probably will be limited to investing $2k to $10k per year in crowdfunding investments. This may be for the best, as these investments are very risky — but there are plenty of risky investments available to anybody. The reality is the issue is much more about regulation of a larger pool of investors and tax consequences than it is in protecting investors.
And the rich continue to get richer.