Investing in many categories of alternative investments, such as private equity, venture capital and hedge funds, requires buying private securities that are not registered with the U.S. Securities and Exchange Commission (SEC) and are not traded in public markets. Federal securities law and regulations place restrictions on who can purchase these private securities. Companies and private funds can offer to sell unregistered securities only to investors who qualify as accredited investors. If you are interested in pursuing direct investment opportunities in private companies, investing in portfolios of private companies through a private equity fund or venture capital fund, or investing in hedge funds or managed futures funds, you need to become familiar with the qualifying requirements for accredited investors.
The Securities Act of 1933 requires that offers and sales of securities be registered with the SEC. For example, when a startup company prepares to sell its stock to the public for the first time in an initial public offering (i.e., “goes public”), it files a registration statement with the SEC, registering its shares. Likewise, companies must register any additional offerings (secondary offerings) of their stock to the public by filing registration statements with the SEC. Registration with the SEC is intended to ensure that investors have full and fair disclosure of important information so they can make informed investment decisions.
The Securities Act of 1933 contains a number of exemptions from its registration requirements and also allows the SEC to create new exemptions. The most important exemptions are contained in Regulation D, which consists of a set of rules for issuers of securities. The amount of capital raised by companies and private investment funds is substantial. In 2014, private securities issuers relying on Regulation D exemptions raised over $1.3 trillion, an amount that is comparable with what was raised in registered offerings (i.e., public stock and bond offerings).
A centerpiece of Regulation D is the definition of accredited investor. The accredited investor definition is “intended to encompass those persons whose financial sophistication and ability to sustain the risk of loss of investment or ability to fend for themselves render the protections of the Securities Act’s registration process unnecessary.” In other words, the purpose of the accredited investor definition is to identify investors who have the ability to understand the unique risks of these often complicated investments and who can bear the economic risk of investing in them. Companies and private funds raising capital through non-registered private offerings, sometimes referred to as private placements, are not required to make the same comprehensive disclosures to accredited investors that issuers of registered, publicly traded securities are required to make to public market investors.
Accredited Investor Definition
Accredited investors are defined in Regulation D. Several types of accredited investors are covered, including individuals and certain specifically enumerated entities such as trusts, banks, nonprofit corporations and business development companies. We will cover the definition as it applies to individual investors, including the trusts commonly used by these individuals. The full text of the accredited investor definition is included as an appendix at the end of this article.
Under the accredited investor definition, individuals are accredited investors if they meet either of the following criteria:
- Earned individual income in excess of $200,000 in each of the two most recent years or joint income with their spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year.
- Have individual net worth, or joint net worth with their spouse, of $1 million excluding the value of their primary residence.
For the income test, you must meet the same test for the entire three-year period. For example, you must have individual income of $200,000 or more in each of the last two years, or you must have joint income with your spouse of $300,000 or more in each of the last three years.
The term income is not defined. SEC staff has provided some guidance on what can and cannot be included in income. For example, the gross revenue of a sole proprietorship is not considered income. Only net income after deducting expenses from gross income is considered income. Income does include contributions to a profit-sharing or pension plan as long as the participant is fully vested in those contributions.  Unrealized capital gain is not included in income.
For the net worth test, the equity in your primary residence is not included in your net worth. The value of your primary residence cannot be included as an asset, and any loan on your primary residence, up to the value of the property, also is not included in net worth. However, the value of any debt secured by your primary residence in excess of its estimated fair market value (i.e., negative home equity) is included as a liability in your net worth.
One important point to note: There is a 60-day look-back period that requires that any debt secured by your primary residence incurred within 60 days of purchasing securities is included as a liability in your net worth. The intent of this rule is to prevent investors from artificially inflating their net worth by borrowing against their home equity (e.g., by accessing a home equity line of credit) and converting their home equity into cash or other assets that would be included in the net worth calculation.
Net worth is defined simply as assets minus liabilities. SEC staff has provided some guidance on what can and cannot be included in net worth. For example, the value of vested employee stock options is included in net worth.  You are allowed to aggregate the property that you and your spouse own (up to the amount each of you own) even if the property is not held jointly. And you are not required to purchase securities jointly with your spouse to qualify as an accredited investor under the joint net worth test.
Trusts as Accredited Investors
Individual investors often hold their investment accounts and other assets in a revocable or irrevocable trust for estate planning purposes.
Revocable trusts meet the definition of accredited investor as long as all of the equity owners of the trust are themselves accredited investors. The SEC staff clarified that “where the grantors of a revocable trust are accredited investors” under the definition above “and the trust may be amended or revoked at any time by the grantors, the trust as a legal entity would be deemed not to exist, and the trust would be deemed accredited, because the grantors would be deemed the equity owners of the trust’s assets.” What this means is that if you created your revocable trust and you have the power to amend or revoke it at any time, and you are an accredited investor under the two-part income or net worth test above, then your revocable trust is also an accredited investor and your trust can invest in non-registered securities such as those offered by private companies, private equity funds, venture capital funds, hedge funds and managed futures funds.
Revocable trusts also meet the definition of accredited investor if the more general rules that apply to trusts also apply.However, the asset minimum for trusts is considerably higher than the net worth requirement for individuals, and many potential investors will qualify as accredited investors under the revocable trust rules and not under the general trust rules, which would apply, for example, to an irrevocable trust.
For an irrevocable trust, the general trust rules apply. A trust meets the definition of accredited investor if it has total assets in excess of $5 million, was not formed for the specific purpose of investing in the securities being considered for purchase and whose purchase is being directed by a sophisticated person. A sophisticated investor is someone who either alone or with their financial advisor has enough knowledge and experience in financial and business matters to be capable of evaluating the merits and risks of the prospective investment. 
A trust also qualifies as an accredited investor if the trustee or co-trustee is a bank, insurance company, registered investment company, business development company or small business investment company.
Similar to revocable trusts, an irrevocable trust might qualify as an accredited investor if all of the grantors are accredited investors and each grantor is considered an equity owner due to the specific features of the trust. The rules for determining if all of the grantors of an irrevocable trust are equity owners are complex and beyond the scope of this article.
If you have questions about whether you or your trust meet the definition of accredited investor, a good place to start is the company or private fund offering securities you are considering purchasing. Companies and private funds have staff whose responsibilities include ensuring that investors in their securities are qualified to invest under the SEC’s rules. Their compliance teams typically include securities attorneys who can help analyze the facts and circumstances of your particular situation.
Possible Changes to Accredited Investor Definition
As part of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act), the SEC is required to review its definition of accredited investor for individuals every four years. The SEC staff completed its first review of the accredited investor definition and published a lengthy report on December 18, 2015. The report considered many aspects of the current definition of accredited investors including what changes, if any, might be considered. The SEC has invited public comments on its report.
The SEC has a two-part mandate to promote public safety in investing and to promote capital formation that makes investment capital more readily available to small businesses and at lower cost. Making the definition of accredited investor more restrictive could have the effect of reducing the amount of capital available to small businesses in the United States.
The SEC is exploring options for changing the definition to maintain or expand the number of investors who would qualify as accredited investors. The proposals recommended to date by an SEC Advisory Committee include adjusting the income and net worth thresholds to reflect inflation; expanding the pool of accredited investors to include people who have passed securities examinations such as the Series 7, Series 65 and Chartered Financial Analyst® (CFA®) examination, or who have industry or issuer-specific expertise; and expanding the definition to take into account new measures of non-financial sophistication. This is an active area of review within the SEC.
17 CFR 230.501 – Definitions and terms used in Regulation D.
(a) Accredited investor. Accredited investor shall mean any person who comes within any of the following categories, or who the issuer reasonably believes comes within any of the following categories, at the time of the sale of the securities to that person:
(1) Any bank as defined in section 3(a)(2) of the Act, or any savings and loan association or other institution as defined in section 3(a)(5)(A) of the Act whether acting in its individual or fiduciary capacity; any broker or dealer registered pursuant to section 15 of the Securities Exchange Act of 1934; any insurance company as defined in section 2(a)(13) of the Act; any investment company registered under the Investment Company Act of 1940 or a business development company as defined in section 2(a)(48) of that Act; any Small Business Investment Company licensed by the U.S. Small Business Administration under section 301(c) or (d) of the Small Business Investment Act of 1958; any plan established and maintained by a state, its political subdivisions, or any agency or instrumentality of a state or its political subdivisions, for the benefit of its employees, if such plan has total assets in excess of $5,000,000; any employee benefit plan within the meaning of the Employee Retirement Income Security Act of 1974 if the investment decision is made by a plan fiduciary, as defined in section 3(21) of such act, which is either a bank, savings and loan association, insurance company, or registered investment adviser, or if the employee benefit plan has total assets in excess of $5,000,000 or, if a self-directed plan, with investment decisions made solely by persons that are accredited investors;
(2) Any private business development company as defined in section 202(a)(22) of the Investment Advisers Act of 1940;
(3) Any organization described in section 501(c)(3) of the Internal Revenue Code, corporation, Massachusetts or similar business trust, or partnership, not formed for the specific purpose of acquiring the securities offered, with total assets in excess of $5,000,000;
(4) Any director, executive officer, or general partner of the issuer of the securities being offered or sold, or any director, executive officer, or general partner of a general partner of that issuer;
(5) Any natural person whose individual net worth, or joint net worth with that person’s spouse, exceeds $1,000,000.
(i) Except as provided in paragraph (a)(5)(ii) of this section, for purposes of calculating net worth under this paragraph (a)(5):
(A) The person’s primary residence shall not be included as an asset;
(B) Indebtedness that is secured by the person’s primary residence, up to the estimated fair market value of the primary residence at the time of the sale of securities, shall not be included as a liability (except that if the amount of such indebtedness outstanding at the time of sale of securities exceeds the amount outstanding 60 days before such time, other than as a result of the acquisition of the primary residence, the amount of such excess shall be included as a liability); and
(C) Indebtedness that is secured by the person’s primary residence in excess of the estimated fair market value of the primary residence at the time of the sale of securities shall be included as a liability;
(ii) Paragraph (a)(5)(i) of this section will not apply to any calculation of a person’s net worth made in connection with a purchase of securities in accordance with a right to purchase such securities, provided that:
(A) Such right was held by the person on July 20, 2010;
(B) The person qualified as an accredited investor on the basis of net worth at the time the person acquired such right; and
(C) The person held securities of the same issuer, other than such right, on July 20, 2010.
(6) Any natural person who had an individual income in excess of $200,000 in each of the two most recent years or joint income with that person’s spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year;
(7) Any trust, with total assets in excess of $5,000,000, not formed for the specific purpose of acquiring the securities offered, whose purchase is directed by a sophisticated person as described in § 230.506(b)(2)(ii); and
(8) Any entity in which all of the equity owners are accredited investors.
(ii) Nature of purchasers. Each purchaser who is not an accredited investor either alone or with his purchaser representative(s) has such knowledge and experience in financial and business matters that he is capable of evaluating the merits and risks of the prospective investment, or the issuer reasonably believes immediately prior to making any sale that such purchaser comes within this description.
 U.S. Securities and Exchange Commission, Report on the Review of the Definition of “Accredited Investor” (December 18, 2015) 1.
 Ibid. 2.
 17 CFR 230.501(a).
 17 CFR 230.501(a)(6).
 17 CFR 230.501(a)(5).
 Securities and Exchange Commission, Securities Act Rules Compliance and Disclosure Interpretation (CD&I) 255.16.
 CD&I 255.17.
 17 CFR 230.501(a)(5)(i).
 CD&I 255.14.
 CD&I 255.11.
 17 CFR 230.501(a)(8).
 CD&I 255.21.
 17 CFR 230.501(a)(7).
 17 CFR 230.501(a)(7).
 17 CFR 230.506(b)(2)(ii).
 17 CFR 230.501(a)(1).
 17 CFR 230.501(a)(8).
 CD&I 255.24.
 U.S. Securities and Exchange Commission, Report on the Review of the Definition of “Accredited Investor” (December 18, 2015).
 Recommendations of SEC Advisory Committee on Small and Emerging Companies (July 20, 2016).