Accredited Investors, Qualified Purchasers, & Their Differences
The sale of securities is a heavily regulated and often confusing process subject to a web of regulation from both government and quasi-government agencies. Luckily, these regulations contain provisions which exempt certain security issuers from the full disclosure and registration requirements. Without these exemptions, many funds would not be able to operate due to compliance costs. Two such exemptions are the “accredited investors” and “qualified purchasers” designations.
This article will look at who qualifies under these designations, and the impact the designations have on those seeking to invest in the private equities market.
Normally, for a company to sell or offer securities to investors, that company and its securities must be registered with the Securities and Exchange Commission (SEC) or a similar entity. However, a company can avoid the normal SEC filing requirements by offering securities solely to accredited investors under Securities Act of 1933, Rule 506(b) Regulation D.
The most common accredited investor criteria used to qualify investors are as follows:
- An individual who has a net worth which exceeds $1,000,000. Unfortunately for many, this net worth must be calculated excluding the value of one’s primary residence.
- An individual who had an individual income more than $200,000 for the past two years. Alternatively, spouses whose combined income for the past two years exceeds $300,000 will also qualify. The individual must also have a “reasonable expectation” that it will meet this income requirement in the current year as well.
- A trust with assets more than $5,000,000 which was not created to acquire the securities the investor is looking to purchase, and which is managed by a sophisticated person.
- An entity in which all the equity owners are accredited investors.
As noted above, the accredited investor exception arises under the Securities Act of 1933. However, funds offering securities may also fall under the definition of an “investment company” and therefore be subject to Investment Company Act of 1940. To avoid registering under this Act, the fund may need to use the qualified purchaser exception. Under the “qualified purchasers” exception, it can offer securities to qualified purchasers. The bar to be a qualified purchaser is higher than that of an accredited investor and one must be:
- An individual or family owned business who owns $5,000,000 or more in investments.
- A purchaser or individual that invests at least $25,000,000 for their own benefit or in representing others.
- An entity in which all the equity owners are qualified purchasers.
Why the Distinction Matters
After reading the above, you are probably wondering if there is some benefit to being a qualified purchaser as opposed to being an accredited investor (apart from just being wealthier of course). Well, the benefit does not flow directly to the investor per se, but it opens different scaling options for the fund in which you would be investing through. If the fund aims to stay under 100 investors, then accredited investors are acceptable investors in the fund. However, if the fund is seeking to grow beyond that 100-investor mark, then all its investors must be qualified purchasers.
Therefore, on an individual level, the distinction between being an accredited investor or qualified purchaser may not be that important. However, that designation will be important to the fund with in which you are investing as it will likely impact the size, scope, and number of the projects your fund pursues.