An accredited investor is the term used by the SEC to refer to investors who are “financially sophisticated”. Accredited investors are able to invest in a wide variety of opportunities that normal investors are not – some of which (such as capital raises for tech startups) are much riskier than the investment options that are generally available such as the stock market. This is the SEC’s attempt to protect the general public, who has little or no investment knowledge, from professionals selling high risk investments using high pressure sales tactics. Most syndications are defined as securities by the SEC, just like raising capital that other early stage businesses, because the return on the investment is solely due to the efforts of others. As a result, most syndications require investors to be accredited in order to participate.
There are two ways that you can prove to the sponsor (who needs to prove it to the SEC) that you are a sophisticated investor –financial or profession – which I touch on briefly here, see the SEC website for more details [1].
The financial criteria is satisfied by having or earning a lot of money. Specifically having a net worth of over $1M (not counting your personal residence) or having income over $200k/yr (or $300k/yr with your spouse). If you are participating as an LP in a syndication, this would typically be the criteria you would meet. I have to admit that I don’t know how this equates to sophistication but it does make sense as far as being able to better withstand the loss of your investment. For high income professionals, such as those working in tech or the medical field, this can be the easiest way to prove that you are accredited as you just need to show 2 years of W-2 income over the threshold. There are consistent rumors that these thresholds will be increased at some point, but so far, that hasn’t happened. In fact, the latest changes made it slightly easier to become accredited as a professional.
If you don’t qualify through the financial criteria, you can qualify as an investment professional. This criteria allows individuals who have obtained certain licenses showing expertise in investments (e.g. Series 7, 65, or 82), are part of the management team for the investment, or fill specific roles in certain types of investment businesses to be considered accredited whether or not they meet the financial criteria. This allows those individuals to continue to operate in their roles and be part of the capital raise without violating the rules. For example, it would be odd if the founder of a startup was unable to participate in their own capital raise because they weren’t accredited.
If you are investing in a deal through an entity, such as your own LLC, there are similar rules for establishing that the entity is accredited. In this case, the easiest thing to show is that all of the owners of the entity are accredited. So if you have a single member LLC that you want to hold the syndication investment in, you would need to show that you are the only owner of the LLC and that you as an individual meet the criteria for being considered accredited.
In most cases, you will need to prove to the GP that you are accredited in order to be allowed into a deal. There are a variety of ways that you can do this. For example, your CPA can provide a letter stating that you are accredited based on your income for the past 2 years. If your CPA isn’t willing to provide that letter, most GPs work with a third party legal service that will certify that you are accredited based on the documentation you provide (which can include other documentation such as w-2s, tax returns, operating agreements, etc.). I have found that these services are typically fast and affordable. You should not need to provide your personal financial information directly to the GP, although that may be another option (not one I would recommend, however). All the GP should require is your affirmation as part of the subscription agreement and a verification letter from an appropriate professional.
If you are unable to qualify as an accredited investor many syndication opportunities will not be available to you. In this case, you may want to determine what the easiest path for you to accreditation is. For example, if you are close to the income threshold, it might simply be waiting until you have the income history. Alternatively, you might want to study for one of the professional licenses, which have other benefits. If none of the paths to becoming accredited appear feasible, you may want to look for real estate deals that don’t require accredited investors. For example, you could stick with SFRs until your portfolio was valued over $1M, become a hard money lender to increase your income, or look for similar deals on crowdfunding sites (I don’t have any experience there, so can’t offer any insights).
If you have any questions about this post, please email them to me at blog@mbc-rei.com, I will reply to the questions that are straightforward and will turn the questions requiring more detailed answers into future blog posts.
For additional reading:
[1] https://www.sec.gov/education/capitalraising/building-blocks/accredited-investor
[2] https://www.investopedia.com/terms/a/accreditedinvestor.asp