Accredited vs Sophisticated Investor: What’s the difference?

Investing in private equities is heavily regulated by the Securities and Exchange Commission (SEC) to protect potential investors. Here, I will explain the two common types of offerings and requirements to invest in these private deals.

First we need to define what is an accredited investor and sophisticated investor.

Accredited Investor:

An accredited investor is an individual or entity that is permitted to invest in certain types of securities that are not available to the general public. It is based on the individuals income, net worth, or professional status. All of which will need to be verified before making an investment.

To be considered an accredited investor, an individual must meet at least one of the following criteria:

1. Income: The individual must have earned an annual income of at least $200,000 (or $300,000 if married filing jointly) for the past two years, with the expectation of earning the same or higher income in the current year.

2. Net Worth: The individual must have a net work of at least $1 million, either individually or jointly with their spouse. The net worth can be calculated by subtracting the individual’s liabilities from their assets. Note: This does not include the primary residence.

3. Professional Status: The individual must have certain professional certifications, licenses, or designations that qualify them as knowledgeable about certain types of investments. For example, a licensed securities broker or investment advisor.

Accredited investors are assumed to have a higher level of financial sophistication and therefore are able to bear the risks associated with certain investments, such as private placements (multifamily syndications).

Sophisticated Investor:

While the IRS does not have an official definition of a sophisticated investor, the term generally refers to someone with a high level of knowledge and experience to make informed investment decisions.

The SEC does, however, have rules and regulations of who is allowed to invest in private deals such as multifamily syndications. The person, if not an accredited investor, must have significant knowledge of investing in these types of assets, the risks involved, and have a pre-existing relationship with the sponsors of the deal.

Being a sophisticated investor (or non-accredited investor) only allows an individual to invest in a deal if the deal is structured and filed as an exemption of Rule 506(b) of Regulation D under the Securities Act of 1933. With a 506(b) offering, only 35 non-accredited (sophisticated) investors are allowed to invest in these deals.

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