The rules for who can invest in private assets
The accredited investor definition determines who can invest in private-market assets.
Latest updates
May/June 2023: The House passed the Accredited Investor Definition Review Act, the Fair Investment Opportunities for Professional Experts Act, and the Equal Opportunity for All Investors Act. Taken together, these bills would codify existing income and net-worth thresholds for accreditation, further expand knowledge-based onramps to qualify as accredited, and require the SEC to develop a test to measure financial sophistication that would permit individuals to qualify as accredited investors.
Carta supports passage of this legislation and will continue to work to advance it in the Senate so it can be signed into law.
Issue
The current criteria for becoming an accredited investor effectively restrict private-market investment to the wealthiest Americans.
Under the Federal securities laws, investments in private companies and funds are largely limited to accredited investors. The accredited investor criteria is largely based on financial criteria with limited other pathways to qualify.
How it works: The Securities and Exchange Commission (SEC) sets the rules for who counts as an accredited investor under Regulation D.
Wealth-based criteria
The vast majority of accredited investors achieve accredited status by meeting one of two wealth-based tests:
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Income: Individual income of more than $200,000 or joint income with a spouse or partner of more than $300,000 in each of the two most recent calendar years
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Net worth: Net worth of at least $1 million, either individually or with a spouse or partner, not including the value of primary residence
Sophistication-based criteria
In 2020, the SEC slightly expanded the criteria to become an accredited investor to reflect financial sophistication instead of just financial means However, these onramps remain narrow, and are limited to:
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Investment professionals holding in good standing any of the following:
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General securities license (Series 7)
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Investment adviser representative license (Series 65)
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Private securities offerings representative license (Series 82)
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General securities license (Series 7)
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Investment adviser representative license (Series 65)
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Private securities offerings representative license (Series 82)
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Knowledgeable employees of private funds for investments in that fund
Unfortunately, not just anyone can take these certification tests. To meet the professional licensure requirement, an individual must be held in good standing by FINRA or the relevant state authority and sponsored by a covered financial institution to take certain exams (Series 7 and 82).
Employees of private funds are also constrained in their ability to invest: Knowledgeable employees are only accredited for offerings managed by their employers.
Why it matters: Restricting private-market investment to the wealthiest Americans limits the pool of capital entrepreneurs can access to build their companies, precludes the vast majority of investors from the upside of owning equity in private companies, and exacerbates income inequality.
Background
The SEC created the current wealth-based accreditation standards in 1982.
Over the next four decades, accredited investors became critical to the innovation economy. Companies at the seed and pre-seed stages often rely on “angel investors” to provide initial financing that allows the business to get off the ground. These are typically accredited investors. Similarly, emerging venture funds rely extensively on accredited investors (rather than larger, institutional investors) to raise funds.
Exempt offerings
Regulation D enables private companies and funds to raise capital without having to register the securities offering with the SEC. Because they are exempt from registration, Reg D offerings are not subject to the same level of disclosure and reporting as public offerings. This framework helps small businesses raise capital without the same compliance costs and burdens of larger, public companies.
Investor protection
Because exempt private offerings do not have the same level of disclosure and liquidity options as those in the public markets, investors may be subject to greater risk. For this reason, policymakers limited access to the private markets to investors they deemed financially sophisticated and able to sustain the risk of loss.
However, wealth does not equal financial sophistication. Greater financial resources should not entitle the wealthy to exclusive access to investment diversification in private companies, and financially sophisticated individuals should not be precluded from accessing these opportunities because of their socioeconomic status.
Possible reforms
The SEC
The SEC has indicated that it is considering changes to the accreditation criteria that would make it more difficult for individual investors to qualify by raising the income and wealth thresholds.
Congress
Congress has the power to overrule the SEC’s determination of accreditation standards by codifying them into law. To level the playing field, Congress could also:
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Expand onramps to become an accredited investor through more widely available testing and certifications
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Update the existing wealth and income thresholds to reflect geographical disparities on both income and cost of living
The case for modernization
Around $2.5 trillion in capital was raised through Regulation D from July 2021-2022, nearly double the $1.3 trillion raised in public markets. As the private markets have eclipsed the public markets in both size and return, investment opportunities for retail investors have decreased. More companies are staying private longer, which means fewer investors have access to the growth curve and miss out on that potential. Only the wealthy were able to invest and benefit.
The evolution of the private markets calls for modernizing the criteria for becoming an accredited investor to achieve four primary goals:
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Democratizing access: On a risk-adjusted basis, private companies do better than public companies, which is why you see such big investments and high returns in private equity and venture capital. Private markets provide investors returns and the ability to diversify into an asset class. Today this asset class is reserved for the wealthy. This limits access, concentrates returns to the already affluent, and further exacerbates economic inequality.
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Creating fair sophistication standards: The American economy is supposed to be based on equal opportunity: Work hard enough and you can achieve anything. But the SEC’s measures of investor sophistication don’t reflect that. Qualifying as an accredited investor means you have to overcome elitist barriers in one of two ways: you are wealthy or you have to be sponsored by a financial institution to take a Series 7 or Series 82. And to qualify as a Series 65 licensee, you have to also be licensed by a state agency as an investment adviser representative. In other words, there’s still a moat that guards against access based on achievement, and we need more bridges to cross it.
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Preventing geographic disparities: The accredited investor wealth and income thresholds apply nationally. Median household income in San Francisco is $126,000; the median household income in Atlanta is $69,000. The blanket wealth standards adversely affect access for many geographies, penalizing investors and entrepreneurs in those markets.
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Ensuring equal opportunities for capital formation: Capital has become more mobile, but proximity still matters. For the earliest stages, investors tend to fund companies in their regions: The average distance between the lead investor and portfolio company is less than 40 miles. Further restricting investor access through stricter accredited investor standards would shrink the pool of capital available to small businesses. This has especially adverse consequences in markets outside of San Francisco and New York.
Bottom line
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Responsibly expanding access to private markets will provide the investor access to investment diversification and assets with high growth potential.
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Broadening the onramps to accreditation will expand the pool of capital private companies can tap into to grow their companies.
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Congress should continue to advance legislation that codifies existing wealth and income standards into statute, establishes a new test for sophistication, and expands onramps through additional knowledge-based qualifications.
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Policymakers should also consider modifying accreditation wealth and income levels to reflect geographical diversity in income and cost of living.
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