Why Accredited Investors Are Important To Alternative Investments

Masterworks
January 17, 2022

In the investing world, investors are separated into two categories; accredited and non-accredited. Non-accredited investors are limited to specific investing opportunities, regulated by the Securities and Exchange Commission (SEC). Accredited investors are granted greater opportunities to invest outside of the parameters of the SEC, based on certain qualifications such as income. Accredited investors can directly invest without restriction in more  lucrative alternative investments such as fine art and art markets. The investment portfolios of accredited investors have the advantage of exclusive diversification, with the potential for much higher returns than non-accredited investors.

What is an Accredited Investor?

According to SEC.gov, an accredited investor is an entity or person that is permitted to invest in securities and alternative investments not registered with the Securities and Exchange Commission. The SEC lists specific criteria an investor or entity must meet to qualify as an accredited investor. Those requirements include:

  • A natural person whose single income exceeds $200,000 annually in the most two recent years, or a joint income exceeds $300,000 for the same time period, with an assumed expectation that stated joint income will remain the same for the current year.
  • A natural person whose individual or joint net worth with a spouse exceeds $1 million at the time of investment, excluding the value of the individual or couple’s primary residence.
  • For entities to qualify as an accredited investor, there is a separate screening process. Rule 501 of Regulation D of the Securities Act of 1933 sets the provisions for this particular group, including corporations, charitable organizations, financial institutions, trusts, and partnerships.
  • Any entity may also qualify if each equity owner in the organization is an accredited investor.

On August 26, 2020, the SEC amended the eligibility rules of an accredited investor. Individuals who do not meet the income or net worth criteria can now qualify based on their specific educational and financial experience if an individual possesses a:

  • General Securities Representative License (Series 7)
  • Private Securities Offering Representative License (Series 82)
  • Licensed Investment Adviser Representative (Series 65)
  • It is important to note any professional certifications and designations used to qualify as an accredited investor must be considered in good standing by the organization who issues the designation or certificate.

Lastly, any investment made by an accredited investor is not covered by the SEC, and the investor forfeits any protection the SEC offers, unlike non-accredited investments (i.e., treasury bonds). However, this is why the SEC mandates strict rules for those who seek to become an accredited investor. There is an expectation that individuals in this category are aware that there is a higher risk with private investing, and are financially prepared to handle the result of whatever the ROI may be on their investment.

Why are Accredited Investors Important To Investing?

Accredited investors are considered to be more sophisticated investors, who want to earn outsized returns by purchasing securities of private companies who have yet to offer shares to public investors. These private companies include tech startups, private equity funds, and small businesses who are seeking capital to fund the growth of their organization. As these firms grow, they create jobs and give back to local communities. Accredited investors also fuel investing in more modern trading vehicles, such as private platforms that invest in iconic artworks and various artist markets.  

Based on the benefits venture capitalists add to the financial sector, the SEC encourages the practice of accredited investing because it propels private capital markets forward, and private capital markets are essential to the economy. It also allows high-net-worth individuals to invest in organizations, social causes, and innovative products that are important to them, and can benefit society on a local, national, and global level.

Risk vs. Reward for Accredited Investors

As with any investment, there is a risk involved when investing in private companies or purchasing alternative investments. Some of the cons of being an accredited investor include high minimum investment amounts, capital being locked for a specific time period, and high performance fees. Most investments with a high risk threshold only accept accredited investors. These ventures may or may not become profitable in the future, possibly causing you to lose your initial investment.

Despite the risk, many individuals still choose to become accredited investors because alternative investment vehicles provide their investors with extremely high returns within a reasonable period of time. Unique items like blue-chip art generate tremendous returns for accredited investors, according to groups who track returns of high investment pieces, like Artprice. Original paintings and unique art pieces are very popular in the alternative investment sector, because art can be transacted in any currency, and is considered as a vast and global asset.

Becoming an accredited investor is not a difficult process if you meet the income or net worth criteria. Earning an accredited investor status through professional certification or designation may prove to be more arduous, but the knowledge gained from becoming proficient on how the stock market and the alternative markets work makes for a more strategic, smarter, wealthier investor.


Masterworks
Masterworks is a fintech company democratizing the art market. Our investors are able to fractionally invest in $1mn+ works of art by some of the world's most famous and sought-after artists.