What does it mean to be an “Accredited Investor” vs. a “Sophisticated Investor” and why are some offerings subject to being one or the other to participate?
From a high level perspective…
When we look to raise capital from investors, these activities will fall under the oversight of the United States Securities and Exchange Commission (SEC). There are certain rules and definitions that need to be adhered to in order to contact individuals and raise capital from certain types of investors. Depending on the type of capital raise, only certain types of investor profiles may be legally allowed.
One way the SEC protects potential investors is through the creation of rules that regulate who can put their money into complex financial offerings such as Real Estate Investments, Venture Capital, etc. So while anyone who has the cash to invest in stocks, bonds, or mutual funds can do so without many hurdles, the bar is higher for more complex investments such as larger commercial real estate.
So, what is an Accredited Investor?
For individuals who have been investing in syndications or other substantive real estate transactions, you may already be familiar with this term. The basic definition of an Accredited Investor is someone who is:
- An individual earning more than $200,000 in annual income for at least two years
- A married couple with more than $300,000 in annual income
- A household with more than $1 million in assets (not including their personal residence)
An accountant, third party verification service, or by providing financial information is usually required to confirm this status prior to an investment.
What about a Sophisticated Investor?
This is more subjective. It is defined as someone who has “sufficient knowledge and experience in financial and business matters” to make them capable of evaluating the merits and risks of a prospective investment. These are individuals who have a reasonable expectation of understanding a complex transaction, such as an investment in a real estate syndication, where they may not yet have the same financial qualifications as an accredited investor. These individuals may have business ownership experience, have transacted in private investment transactions on their own, etc.
Before raising your hand to invest in any deal, it is important to know what kind of capital raise is being performed — the most common being a 506(b) or a 506(c) with the bottom line being to remember that Sophisticated Investors are only able to participate in 506(b) offerings and there is a limit on the number of spaces available for sophisticated investors in a raise. These spots may go quickly if provided.
If you are an Accredited Investor, there are many more opportunities and choices of offerings.
