Summary: Understanding the purpose of the accredited investor designation is important for you and your investing business. This article walks through how to determine if you’re an accredited investor, your net worth’s contribution to investor accreditation, and how you can still invest in private placements if you are not yet accredited.
Today’s crowdfunding platforms offer many new opportunities that investors may not have discovered in the past. Unfortunately, most of these deals are available to accredited investors only. Why, and how do you become accredited?
The Birth of Crowdfunding
During the Great Recession, the Obama Administration passed the JOBS Act of 2012 in an attempt to jumpstart an ailing economy. This was a game changer for start-ups and small businesses wanting to raise capital.
Before the JOBS Act, private companies could raise capital and still avoid the rigorous and expensive process of filing with the Securities Exchange Commission (SEC) by filing an exemption. This exemption is spelled out in Rule 501 of Regulation D of the Securities Act of 1933.
It basically says a company or “issuer” can raise money through a private placement, which means the company can only reach out to people with whom they’ve had a pre-existing relationship. They cannot advertise their need for capital or solicit investor dollars from the general public.
The JOBS Act of 2012 changed the Act by creating a new exemption – Regulation D 506 (c) – which basically eliminates the prohibition against general solicitation and general advertising. This was a monumental event because, for the first time in U.S. securities history, private companies trying to attract capital could advertise their investments to the public without being a “public” company.
However, new regulations also came with the change. Only accredited investors can participate in a Reg D 506(c) offering, and their accredited status must be verified by a third party, such as a CPA, financial planner, or attorney.
Savvy internet marketers suddenly popped up out of nowhere, advertising various investments through public crowdfunding platforms. Third party verification companies also sprouted up, such as www.verifyinvestor.com where they, “Verify potential investors quickly, reliably and confidentially. VerifyInvestor.com is the leading resource for verification of accredited investor status as required by the JOBS Act, the SEC, and federal laws.
Before the JOBS Act, Regulation D 506(b) was the exemption most private companies used to raise capital through syndications. In a Reg D 506 (b), issuers are still required to only take funds from accredited investors, but the main difference is, they don’t need a 3rd party verification to prove they are accredited.
Instead, investors in a private placement are typically allowed to “self-accredit,” which means they don’t need a 3rd party verification. Instead, they fill out a questionnaire and then check the “I am an accredited investor” box on the subscription agreement. No back up documentation or proof has been required for accredited investors in a private placement. The SEC assumes that if the issuer has a pre-existing relationship with the investor, they would know enough to determine if the investor is indeed accredited.
Determining If You Are Accredited
There is no “formal” certification issued from an agency or institution that confirms you are accredited. Instead, the SEC allows two different ways for issuers to determine if someone is accredited. Interested investors only need to comply with one of the following criteria:
1| “A natural person with income exceeding $200,000 in each of the two most recent years, or joint income with a spouse exceeding $300,000 and a reasonable expectation of the same income level in the current year.”
2| “A natural person who has individual net worth or joint net worth with the person’s spouse that exceeds $1 million at the time of the purchase, excluding the value of the primary residence of such person.”
Using income as proof you are accredited is easy – you simply provide a W-2 or tax return to the issuer of the investment in order to verify how much you’ve earned for the past two years.
Proving your net worth can be a bit more complicated. It requires a balance sheet, subtracting liabilities against assets. For example, a bank statement showing one million dollars in cash is not enough evidence to prove you have a million-dollar net worth.
Instead, you need to provide a balance sheet detailing all assets (cash, bank accounts, 401Ks, IRA’s, other investments, and cars), then deduct all liabilities (student loans, car loans, and equity lines of credit).
You cannot include your home equity as an asset, but you also don’t have to include your mortgage as a liability – unless you took out a home equity line of credit or did a cash out refinance within the past two months. In which, you’d have to calculate the additional debt as a liability. Additionally, if your mortgage is higher than your home’s value. you would need to include the amount the loan is “upside down” as a liability.
How to Boost Your Net Worth
If you own a business, talk to your CPA or broker about using the valuation of that company as an asset. This could significantly increase your net worth.
If you have a lot of home equity, you may want to consider refinancing your home and taking some “cash out,” as long as you wait two months. You can then count the cash you took out of your home as an asset.
Given today’s low interest rates, investing home equity can be a solid plan if done right. For example, if you took cash out of your home with 30-year fixed rate debt at 4 percent and then reinvested those funds into a note earning 8 percent, you would then be earning 4 percent on funds that otherwise would have been sitting as “dead equity.” The note should be secured to property, ideally at a low loan-to-value ratio (LTV), offering low risk to you as the noteholder. Be sure you understand the ins and outs of private lending, or any other investment for that matter, before writing the check.
Reasons Why Having Debt on Your Primary Residence can be Beneficial
1| Mortgages on primary residences tend to be the lowest cost debt you can have.
2| In case you have to file an insurance claim on your home, your lender may very well negotiate on your behalf since they often have more to lose than you.
3| High leverage offers some asset protection. It’s simple for an attorney to look up your home’s value when determining if they should pursue a lawsuit. Liens on the property may discourage them.
If you are not an accredited investor yet, you may still be able to invest in private placements that are filed as a Regulation D Rule 506 (b) offering. The SEC allows up to 35 non-accredited investors who can prove they are sophisticated enough to understand the deal, and who have enough reserves in place to withstand any potential losses.
If you are not accredited yet, but pick the right investments, you will eventually get there!
Enjoyed this article? Sign up for your FREE Think Realty membership to receive access to membership only content, benefits, and stay up to date on our upcoming events.
Kathy Fettke is the founder and co-CEO of Real Wealth Network. She can be reached at firstname.lastname@example.org.