Monday, May 21, 2012

How to Become an Accredited Investor

My sisters and I have some money to in an LLC, and we have encountered a problem with a few of the investment opportunities we've seen: only Accredited Investors can take part in them. Our LLC is not Accredited, so we've had to pass on some of those investments - or approach them in a different way (as debt partners instead of equity partners, for instance).

One of our goals as a company is to become an Accredited Investor so that we can take part in equity offerings that may arise. To that end, I sent my sisters/fellow shareholders the following email the other day:

Here?s the deal on being an Accredited Investor. The SEC (Securities and Exchange Commission) regulates the exchange of securities in the US, and so in order for a company to sell equity shares of itself, it has to register with the SEC ? which is super expensive and difficult and requires a ton of documentation and disclosures and ongoing auditing and so on. In order to allow smaller companies who can?t afford that to also sell shares of themselves, the SEC allows several exceptions to that rule.

One exception is that companies don?t have to register IF all the shares are sold to Accredited Investors only. Presumably, these are sophisticated people who need less protection from the SEC and/or who have enough wealth that they can afford to take on risky investments which likely do not comply with all the standards set forth by the SEC in order to be registered.

In short, that is why any ?Average Joe? can purchase equity in a company which is listed on a stock exchange, but to invest in a private equity deal generally you have to be Accredited. It?s to protect the investor. Thanks, SEC.

SO, in order for an entity to be considered an Accredited investor it has to meet one of the following three tests:
  1. It has ?assets exceeding $5,000,000,? OR

  2. ?All the equity owners? of that business are Accredited OR

  3. The entity is a general partner of the company selling the securities (i.e. we are part owners of the investment opportunity already).

With a current value of $301,329 it?ll take the LLC 37 years to be worth $5MM, assuming an annual return of 8% and that we make no contributions or withdrawals along the way. If we each put in $100K right now, making the current value 701,329, then it will only take 26 years for the company to be worth $5MM. [On the bright side, holy crap it looks like by the time we retire the company will be worth five million dollars!]

But as far as qualifying as an Accredited Investor, our best bet seems to be via #2 ? for each one of US to qualify as accredited as individuals. That means that each of us would simultaneously have to meet one of the following tests:
  1. Have an individual net worth, or joint net worth with a spouse, that exceeds $1 million - excluding the value of the primary residence (an important recent update), OR

  2. Have individual income exceeding $200,000 or joint income with a spouse exceeding $300,000 in each of the two most recent years ? plus a reasonable expectation of the same income level in the current year, OR

  3. Be a director, executive officer, or general partner of the company selling the securities.

Clearly we each have a better chance of building a net worth of $1MM than of generating three consecutive years of income in the $200K range. SO start saving ladies! As soon as we each have a net worth of $1,000,000, we will each be Accredited Investors and therefore our LLC will be Accredited as well. Then we can start investing in private equity offerings and start ups and other projects which typically pay much more than the 8% we are getting by lending money instead of investing it in these project (of course buying equity is also much riskier).

Becoming a Millionaire
Whether or not we all make it to this level depends a lot more on who we marry than any single other factor. Marrying somebody with significant assets or earning potential will obviously help, but the key will be key to marry someone who also values saving and becoming a millionaire one day. If you marry somebody who will be pressuring you to spend your joint income rather than save a lot of it, this will be harder to attain.

The other big factor will be how much of our assets we decide to put into our homes. Since home equity doesn?t count toward the calculation, it?s important to note that paying off a mortgage should NOT be a priority for us. If you have excess cash, pour it into savings, retirement accounts, stocks, gold, rental properties, other business interests or whatever else you like. But don?t rush to pay off that mortgage or buy a huge house that you don?t need unless there are other considerations at work. This realization has changed my decision regarding future home purchases at least until I hit the million dollar mark. It?s better that my home equity be lower ? and therefore that my home is less expensive ? until I reach that milestone. So I?m not going to buy a big expensive town home after all.

Of course, becoming an Accredited Investor may not be or may not always be the biggest priority in your life, and that is FINE. If you start a family and want a big house and have to put down a huge down payment to afford it well then it is completely your right to do that! Or if you choose a career that pays lower on average and makes a million in the bank a far off dream, then that is your prerogative. No one should worry that the rest of us will be muttering about how you?re keeping our company from Accredited Status. But just be aware that unless you do have a higher priority, having a net worth of a million would ultimately really help all of us out as a group. And there is really NO reason we can?t all get there sooner or later.

For the record, I could be there in less than 10 years, if all goes according to plan ? and that?s if I don?t marry or if I marry somebody will have no effect on my savings ability. Our individual interests in the LLC and also in our trusts should count toward our personal net worth calculation, by the way, so we don?t have to worry about moving money between those entities.

Happy Saving!

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