Accredited Investor vs Qualified Purchaser

When looking for potential investments, you can find easily accessible publicly traded mutual funds and ETFs that anyone can invest in. If you're looking for larger, more exclusive investments, such as syndicated real estate or private real estate funds, you'll need to meet specific requirements and qualifications.

The legal terms "qualified purchaser" and "accredited investor" apply here. To invest in private funds, you must have a certain amount of money and investments.

While some people confuse the two terms, there are significant differences between them. This article will explain what these distinctions are and what types of investments fall into each. We'll also walk you through the steps to becoming an accredited investor or qualified purchaser.

Securities and Exchange Requirements

The Securities and Exchange Commission has requirements for being classified as an accredited investor or qualified purchaser. These categories aid in identifying investors who are permitted to take on the risk of private investments.

Private equity and other nonpublic offerings are not as transparent as registered public securities and are less liquid. Investors must therefore meet one or more criteria related to their income, net worth, expertise, or knowledge.

What is a Private Investment?

Private investments are also known as alternative investments. According to a recent article published on Nasdaq, private investments are financial assets separate from assets traded on the public markets, such as stocks, bonds, and cash.

Qualified investors often participate in private investments through investment funds. Private investment funds commonly invest in real estate, hedge funds, private credit, natural resources, infrastructure, and private equity.

Private investment assets under management represent a minor portion of total public market capitalization. However, recent trends indicate that AUMs are growing at a fast rate.

According to one recent study, AUMs for private investments increased from $4.1 trillion in 2010 to $10.8 trillion in 2019. Furthermore, they are expected to grow to $17.2 trillion by 2025. On a dollar-weighted average basis, institutions have also significantly increased the percentage of private investments in their portfolios from 27.7% in 2003 to 54% in 2020.

According to KKR surveys, high-net-worth investors increased their allocation to private investments from 22% in 2017 to 26% in 2020.

Needless to say, private investments will play a growing role in both accredited investors and qualified purchasers' investment portfolios.

Qualified Purchaser vs Accredited Investor

​​All qualified buyers are likely to be accredited investors, but accredited investors are not always qualified buyers. This is because the qualification threshold for qualified purchaser status is higher than that of an accredited investor.

Let’s take a closer look at their characteristics and qualification requirements.

Why These Classifications Matter

The SEC is committed to protecting small investors, both from themselves and from unscrupulous market participants. The general public is shielded from such events by limiting participation in the riskiest investment categories to those with the knowledge and resources to absorb the consequences of a large investment gone wrong.

Keep in mind that unregulated investments typically have no reporting or disclosure requirements and are usually less liquid. People who lack the means to cope with losses of this magnitude as well as the experience and sophistication to comprehend them are thought to be better off staying outside of them.

This, however, excludes many people from participating in the upside opportunities that such investments provide. Even so, it is thought that the general public is better off protected from the temptation these offerings can present given the circumstances leading up to some of the previous recessions.

So, becoming a qualified buyer or accredited investor requires being a seasoned investor with the resources to withstand potentially sizable losses.

Investor qualification is an essential component of participating in the private market ecosystem and managing an investment fund, as this article will demonstrate.

Among other things, the category of investor has an impact on:

● whether an investor is eligible to invest

● whether the fund is required to register with the SEC

● the maximum fee that can be charged

Understanding the various types of investor qualifications can assist you in better structuring your fund, remaining legally compliant, and avoiding the unintended consequences of accepting money from the wrong investor.

The Qualified Purchaser

The definition of a qualified purchaser is based on investment holdings rather than net worth or income. Also, the requirements are stricter than those for accredited investors. However, qualified buyers have a wider range of investment options than accredited investors.

Most private funds are exempt from SEC registration if they are owned by fewer than 100 people. If the fund is owned by more than 100 people, all the owners must be qualified purchasers.

A qualified purchaser is an individual or family-run business that owns investments worth $5 million or more. The primary distinction between accredited investors and qualified buyers is that the benchmark includes investments rather than yearly income or net assets.

In this context, the term "investments" refers to a wide range of assets held for investment purposes. These assets typically include stocks, bonds, financial contracts, futures contracts, cash, cash equivalents, commodity futures contracts, real estate, and cash.

Similar to accredited investors, some funds, such as many private funds, hedge funds, or venture capital funds, are only accessible to purchasers.

Qualification Requirements for Qualified Purchasers

Although the terms qualified purchaser and qualified investor are frequently used interchangeably, the legal term is a qualified purchaser. Individuals or entities can be qualified purchasers under any of the following conditions:

● A person who has $5 million or more in investments, either alone or with a spouse. The value of a primary residence or commercial property must be deducted.

● A family with at least $5 million in investments through a charity, company, estate, or a trust established for their benefit.

● A trust formed and managed by qualified purchasers that are not solely for the purpose of investing in a fund.

● A person who has the discretionary control to manage at least $25 million in assets, either for their own accounts or those of other qualified purchasers.

● An organization made up only of qualified purchasers.

The funds with a small number of private equity investors can buy and sell public assets like mortgage-backed securities without having to comply with the reporting requirements of a publicly traded bond fund thanks to the higher threshold requirements for qualified purchasers.

However, there is an important caveat to the above categories of qualified purchasers. That is, none of these entities can be formed specifically to invest in private funds.

The SEC grants exemptions to funds that are only available to qualified purchasers. This is due to the fact that they are not required to register under the ICA regulatory requirements. As a result, these unregistered funds are not required to disclose information such as an investment thesis or positions to the public.

By obtaining this exemption status, these funds gain access to an unlimited number of investors while still maintaining their corporate strategy and investment methodology flexibility.

Identifying the Status of a Qualified Purchaser

Unregistered securities issuers are responsible for ensuring that investors meet the qualifications to be considered qualified investors. The actual procedures can vary depending on the type of unregistered securities being offered.

That being said, tax returns, W-2s, bank statements, and brokerage statements are typical documents that issuers must take into account for asset-based accreditation. The SEC's new definitions require the provision of proof of accreditation, which may be acquired in a number of ways.

Investments for Qualified Purchasers

The following investments are suitable for serving as a foundation for the confirmation of qualified purchaser status:

● Securities other than those of a third-party issuer held in common control with the entity seeking qualified purchaser status, such as stocks, bonds, and notes.

● Real estate held solely for investment purposes — primary residences and/or property used in the ordinary course of the entity's business are ineligible.

● Commodity futures contracts, commodity futures options, and physical commodity options are all traded on a contract market or board of trade for investment purposes.

● Physical commodity stockpiles, such as precious metals, are held solely for investment purposes. These are valid as long as the futures contracts for these commodities are traded on a contract market or a board of trade.

● Aside from securities, swaps and similar individually negotiated financial instruments are held specifically for the purpose of investment.

● Capital commitments made by an investment firm or commodity pool that are legally binding.

● Liquid assets are held solely for investment purposes. The cash used by the investor to meet daily expenses is exempt from consideration. A company's working capital is also important.

As you will see below, one of the benefits of having qualified purchaser status is the ability to participate in a broader range of investment opportunities than accredited investors.

The Accredited Investor

Accredited investors are individuals or entities that are authorized to trade securities, such as private funds, that are not registered with financial authorities. Accredited investors meet income, net worth, or educational requirements that allow them to purchase non-registered financial investments such as securities or real estate.

Accredited investors are those who have a reduced need for the protection offered by regulatory disclosure filings, as defined by Securities and Exchange Commission (SEC) Regulation D.

The Securities Act's Regulation D provides a number of exemptions from the registration requirements, allowing some companies to offer and sell securities without having to register the offering with the SEC.

Unregistered securities carry greater risk because they are not subject to the same disclosure requirements as publicly traded securities.

Companies benefit from this because they do not have to register securities with the SEC, which saves them money. These unregistered share offerings, also known as private placements, are only available to accredited investors who are financially experienced enough to understand the level of risk, as they are afforded fewer legal safeguards.

Accredited investors exist because they make extremely high-risk, potentially high-reward investments that have a high failure rate. As a result, regulators shield individual investors who may lack the financial resources to handle such an investment.

Accredited Investor Qualification Requirements

The SEC and other regulatory bodies have established criteria for who qualifies as an accredited investor, which is outlined below:

● You must earn more than $200,000 per year to qualify as an accredited investor. If you file jointly with your spouse, your joint annual income must be greater than $300,000.

You must have earned this sum over the course of at least the last two years with the intention of increasing your income in the ensuing year. If you are only able to provide one year's worth of income documentation, this particular requirement will not be taken into account.

● You must also have a net worth of more than $1 million, either individually or jointly with a spouse, to qualify as an accredited investor. This is in addition to the earnings requirement for the first year.

It's important to remember that, as of the 2010 Dodd-Frank Act, your primary residence is not taken into account when determining whether you are an accredited investor.

● A company that issues unregistered securities may also have a general partner, an executive officer, or directors who are accredited investors.

● Accredited investors are private companies and businesses with assets worth more than $5 million.

● A business entity is considered to be accredited if its equity owners are all accredited investors on their own. Organizations cannot be set up solely for the purpose of buying unregistered securities, though.

● If a person can show a certain level of education or professional experience with unregistered securities, they may also be considered an accredited investor.

● As of 2016, registered brokers and investment advisors can also qualify.

● The SEC amended its definition of an accredited investor in August 2020 to include measures of professional experience, knowledge, or certifications in order to expand the private markets and allow more participation regardless of income level.

This includes knowledgeable private fund employees as well as SEC- and state-registered investment advisers.

Investments for Accredited Investors

Accredited investor status' primary goal is to allow individuals and businesses to purchase unregistered securities. These private funds are only available to those who qualify, and they are not available to other investors with less financial knowledge.

Accredited investors have access to venture capital, hedge funds, angel investments, and complex, high-risk transactions.

Identifying the Status of an Accredited Investor

There is no formal process for becoming an accredited investor. This means that sellers of unregistered securities are responsible for verifying the identities of individuals or businesses looking to invest. This will help them meet at least one of the accredited investor requirements.

If you believe you meet the criteria for accredited investor status, you must contact the issuer of the unregistered securities in which you wish to invest. They will send you a questionnaire to determine your eligibility.

Along with the questionnaire, you will need to submit a number of financial documents. You might be required to provide account information, financial statements, a balance sheet, tax returns, W-2 forms, pay stubs, and credit reports, among other common types of documentation.

Additionally, you might be asked to submit letters of recommendation from CPAs, tax lawyers, investment brokers, or advisors.

Accredited investor registration or certification cannot be done in a single location. Investor credentials are not examined by the government. Instead, as part of their due diligence procedure, businesses that offer investments must ascertain who are accredited investors.

Investors can't just check a box, of course. They might be required to start the process by completing an online form after they make an inquiry about an investment opportunity.

Why Do Funds Only Offer Securities to Accredited Investors?

Unless exempt from registration, an issuer must register all securities it offers or sells in the United States with the SEC. Because the registration process can be difficult, costly, and time-consuming, issuers frequently seek exemptions from registration.

The sale of securities to accredited investors under Regulation D of the Securities Act is the most common exemption from registration. Under US law, fund interests, like common stock in a company, are considered securities. Therefore, unless they want to go public, funds are generally limited to selling to accredited investors.

Separately, if the fund sells fund interests to more than 100 investors, it must register with the ICA (this is known as the 3(c)(1) exemption). This is where the Qualified Purchaser definition (the previously mentioned 3(c)(7) exemption) comes into play.

The fund avoids registration under the securities laws and separate registration as an investment company under the ICA by only selling fund interests to accredited investors who are also qualified purchasers.

Accredited Investors vs Qualified Purchasers

Qualified purchasers are a type of fund that wants to maximize their assets under management. Accredited investors, on the other hand, are a subset of investors who have the ability to invest in specific types of assets and are exempt from certain SEC safeguards.

An accredited investor has a lower financial threshold that combines net assets and annual income. A qualified purchaser must meet a much higher financial threshold based on their investment.

Because the financial benchmarks for individuals and businesses are much higher, qualified buyers are also known as super-accredited investors.

Certain private funds are open to both accredited investors and qualified purchasers. The only difference between private funds that are open to both accredited investors and qualified purchasers and those that are only open to qualified purchasers is if the private fund decides to include 100 or more investors.

If a private fund has more than 100 investors, the 3(c)(7) fund will restrict it to qualified purchasers only. This type of fund, however, is less common and generally applies to institutional investors rather than individuals. As a result, most private funds will not restrict their investors to only qualified buyers, instead requiring only that they be accredited.

Qualified Institutional Buyers

A qualified institutional buyer, or QIB, is another term that may be used to distinguish between accredited investors and qualified buyers. An institutional investor who holds at least $100 million worth of securities is known as a QIB.

It can also refer to a bank that, according to an audit, has a net worth of at least $25 million and invests in securities with a value of at least $100 million.

Most QIBs are also thought of as qualified buyers. The phrase qualified institutional buyer refers to the ability to purchase securities on the secondary market. While a fund's exemption from ICA registration and reporting requirements is referred to as qualified purchasers.

Taking Advantage of Being a Qualified Purchaser or Accredited Investor

Accredited investors and qualified purchasers are distinct classes in the United States; according to the financial research website DQYDJ, as of 2020, there were 13,665,475 households in America that qualified as accredited investors, accounting for 10.6% of all households. Despite recent increases, the majority of America's wealth is still controlled by a relatively small number of households.

If you are an accredited investor or a qualified purchaser, you will have access to a whole new world of investment opportunities through various private funds. These investments may provide higher rates of return, and greater diversification, and may assist you in accumulating wealth more quickly.

In both of these categories, you receive less financial protection, and these exclusive funds also have a higher failure risk. The majority of investments have a high minimum investment requirement, as well as higher performance and management costs and less liquidity.

The categories of accredited investors and qualified purchasers exist to deter those with less to lose and less financial expertise from participating in high-risk investments. Make sure to educate yourself on the potential risks and rewards before making financial decisions if you fall under either of these categories or both.

Regulators, on the other hand, have recently come under intense pressure to relax some of these standards in order to broaden the pool of individuals permitted to invest in opportunities such as pre-IPO startups. The fairness of limiting those who are already well-off from realizing the potentially significant yields these investments can provide is increasingly being called into question.