What Is An Accredited investor? Accredited investor In A Nutshell

Accredited investors are individuals or entities deemed sophisticated enough to purchase securities that are not bound by the laws that protect normal investors. These may encompass venture capital, angel investments, private equity funds, hedge funds, real estate investment funds, and specialty investment funds such as those related to cryptocurrency. Accredited investors, therefore, are individuals or entities permitted to invest in securities that are complex, opaque, loosely regulated, or otherwise unregistered with a financial authority.

Understanding accredited investors

To explain this concept further, consider that any company wanting to offer its securities must choose from one of two options:

  • It can operate as a publicly-traded entity where it must release quarterly earnings reports to shareholders and the general public. This requires registration with the Securities and Exchange Commission (SEC).
  • Alternatively, it can remain privately owned. In the process, the company can avoid the obligations of a publicly-traded entity but continue to trade with an exemption. One such exemption is the ability of the entity to sell securities to an accredited investor.

Accredited investor criteria

So what is an accredited investor, exactly? According to the SEC, the individual must satisfy at least one of the following three criteria:

Possesses professional qualifications or other credentials that demonstrate competency

This criterium can be satisfied if the investor is deemed a “knowledgeable employee” of an investment fund. Alternatively, the SEC offers entry exams for general securities and private securities representatives who wish to become certified.

Has earned at least $200,000 per year for each of the past two years

This number increases to $300,000 in the presence of a spouse or spousal equivalent.

Has a net worth exceeding $1 million, either by themselves or in combination with a spouse or spousal equivalent

Note that this number excludes the value of the individual’s primary residence.

How to become an accredited investor

While the criteria for accredited investor certification are strict, there is no formal verification process for becoming such an investor. This means it is up to the individual company to screen an investor’s credentials before allowing them to invest. 

As part of the screening process, most will request proof of income from a tax return and proof of net worth from a credit report. Furthermore, the company will also request to see evidence that proves an investor’s prior experience and qualifications in the industry.

Key takeaways:

  • Accredited investors are individuals or entities that are permitted to invest in securities that are complex, opaque, loosely regulated, or otherwise unregistered with a financial authority.
  • Accredited investors must satisfy at least one of three criteria that relate to prior experience and qualifications, individual and spousal income, and individual and spousal net worth. In the United States, these criteria are determined by the SEC.
  • There is no formal process to becoming an accredited investor. Instead, it is up to the company the investor wishes to invest in to screen their credentials before allowing them to invest.

Connected Business Concepts

Circle of Competence

The circle of competence describes a person’s natural competence in an area that matches their skills and abilities. Beyond this imaginary circle are skills and abilities that a person is naturally less competent at. The concept was popularised by Warren Buffett, who argued that investors should only invest in companies they know and understand. However, the circle of competence applies to any topic and indeed any individual.

What is a Moat

Economic or market moats represent the long-term business defensibility. Or how long a business can retain its competitive advantage in the marketplace over the years. Warren Buffet who popularized the term “moat” referred to it as a share of mind, opposite to market share, as such it is the characteristic that all valuable brands have.

Buffet Indicator

The Buffet Indicator is a measure of the total value of all publicly-traded stocks in a country divided by that country’s GDP. It’s a measure and ratio to evaluate whether a market is undervalued or overvalued. It’s one of Warren Buffet’s favorite measures as a warning that financial markets might be overvalued and riskier.

Warren Buffet Companies

Warren Buffett is an American investor, business tycoon, and philanthropist. Known as the “Oracle of Omaha”, Buffett is best known for his strict adherence to value investing and frugality despite his immense wealth. He is among the wealthiest people in the world. Most of his wealth is tied up in Berkshire-Hathaway and its 65 subsidiaries.

Price Sensitivity

Price sensitivity can be explained using the price elasticity of demand, a concept in economics that measures the variation in product demand as the price of the product itself varies. In consumer behavior, price sensitivity describes and measures fluctuations in product demand as the price of that product changes.

Price Ceiling

price ceiling is a price control or limit on how high a price can be charged for a product, service, or commodity. Price ceilings are limits imposed on the price of a product, service, or commodity to protect consumers from prohibitively expensive items. These limits are usually imposed by the government but can also be set in the resale price maintenance (RPM) agreement between a product manufacturer and its distributors. 

Price Elasticity

Price elasticity measures the responsiveness of the quantity demanded or supplied of a good to a change in its price. It can be described as elastic, where consumers are responsive to price changes, or inelastic, where consumers are less responsive to price changes. Price elasticity, therefore, is a measure of how consumers react to the price of products and services.

Economies of Scale

In Economics, Economies of Scale is a theory for which, as companies grow, they gain cost advantages. More precisely, companies manage to benefit from these cost advantages as they grow, due to increased efficiency in production. Thus, as companies scale and increase production, a subsequent decrease in the costs associated with it will help the organization scale further.

Diseconomies of Scale

In Economics, a Diseconomy of Scale happens when a company has grown so large that its costs per unit will start to increase. Thus, losing the benefits of scale. That can happen due to several factors arising as a company scales. From coordination issues to management inefficiencies and lack of proper communication flows.

Network Effects

network effect is a phenomenon in which as more people or users join a platform, the more the value of the service offered by the platform improves for those joining afterward.

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