Let’s say you are interested in purchasing some shares in IBM. You first need a broker, someone authorized to buy and sell shares for a fee. Finding one might be as simple as one of the online trading companies or stopping by a local branch office. Give a few bits of information and some cash and suddenly you are a shareholder in IBM!
What the broker is helping you purchase is called a security. A security is some sort of financial asset (usually a piece of paper or an idea of one) that holds value and can be traded. In your pocket is a dollar bill, a banknote, which holds value and can be traded. It is a security. Others include promissory notes (which hold debt) and stocks. When you purchase your IBM stock, you are purchasing a security.
Securities can be issued by a government entity, such as banknotes, or by a private entity, such as stock certificates. One assumes that the government will honor its banknotes, even in times of economic downturn, but what about a company that issues stocks? It’s less likely and so carries more risk. Many companies rely on offering securities to raise money for their growth. Bad actors took advantage of this. Partly as a result of dubious securities being issued which later had no value, the U.S. Securities and Exchange Commission (SEC) was formed in 1934.
One of the SEC’s roles is to protect investors. We now have a set of rules defining what is a security. Many rules must be followed to be allowed to issue a security. Creating, registering, and marketing, while following all these rules ‘priced out’ many smaller companies. One example of this type of company is a smaller real estate entrepreneur who wants to raise funds to purchase a property, what we now call syndication.
This regulation from the SEC was created as a way to allow these smaller companies to offer securities and not be required to register with the SEC, thus decreasing their costs. As with everything government-related there are a large amount of sub-rules and this post cannot possibly give them all. One important part is that the SEC has rules for the number of accredited investors and non-accredited investors can be offered the security. In addition, the issuer has to follow strict rules for how they market the security or else be subject to penalties.
The idea is that a knowledgeable person or a person with a large net worth or income can better be able to determine if a security is ‘good’ or ‘bad’ than other persons. People who fit these criteria could then be called accredited investors, and issuers of securities would not have to follow as many rules.
The term ‘accredited’ makes you think that you have to fill out a form and be certified by a knowledgeable team of g-men but this is not the case. If you meet any one of these criteria, you are automatically accredited and can invest in securities requiring it:
- A business with assets > $5,000,000
- A general partner (principal) in the company offering the security
- A person plus spouse with a net worth > $1,000,000 (excluding primary residence)
- A person whose income in each of the past 3 years was > $200,000 ($300,000 with a spouse) and has a reasonable expectation of the same income this year
- A person with certain professional certifications – if you don’t already know about this, you probably don’t qualify
There’s a lot more detail in the actual rule, so consult it before declaring yourself accredited.
Once you have made the determination you are an accredited investor, a lot of investment doors will open to you. These doors carry increased risk over that which the general population can invest in, so do your own diligence. The rewards can be much greater than with other securities, though. When I put together a syndication I allow only accredited investors with very few exceptions. It helps keep the costs down, which means higher returns for everyone. Take the time to determine if you are an accredited investor.