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Episode 93: Accredited Investors
220 Plays4 years ago
As your net worth or annual income increases, so do your investment opportunities, not only because you have more money but because the SEC restricts certain investments to those without the capital to reasonably assume the risk. Enter Accredited Investors. In this podcast, we talk about who can be considered an accredited investor, what investment opportunities they have access to, and the risk/rewards associated with these opportunities.
Plus, Bryan talks about the ideal democratization of accredited investor-type opportunities and how to incorporate them into your broad financial plan.
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Transcript
Introduction to the Uncommon Life Project
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Speaker
Everyone dreams about living an uncommon life, but how we define that dream is very different for each of us. And for most, it's a lifelong pursuit.
Meet the Hosts: Brian and Philip
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Speaker
Welcome to the Uncommon Life Project podcast. We're going to introduce you to people who are living that life or enjoying the journey to get there. We're going to also give you some tools, tricks, and tips for starting or accelerating your own efforts to live an uncommon life.
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Speaker
a life worth celebrating and savoring.
What is an Accredited Investor?
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Speaker
Please welcome your hosts, Brian Dewhurst and Philip Ramsey.
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Speaker
Hello everybody, this is Phil Bramsey and Brian Dewhurst with the Uncommon Life Project. Welcome to the show. We got a dual cast for you today. It is the Brian Dewhurst and myself getting excited about a tranche of investing that is only available for higher net worth. And this definition is called an accredited investor.
SEC Regulations on Accredited Investors
00:00:56
Speaker
So where do we start? Why is it important? And why do our listeners need to know about it? Brian Dewhurst.
00:01:03
Speaker
Good morning. The accredited investor specification, I don't know what other word to use for it. We've been getting a lot of questions from our clients about this lately, so we thought it would be a great time to shoot a podcast, talk about it, highlight it, and break it down for you. So the accredited investor, what is an accredited investor?
Investing in Pre-IPO Companies
00:01:27
Speaker
I think it's a great place to start.
00:01:29
Speaker
It's basically a term that was created by the Securities and Exchange Commission, SEC, under Regulation D to refer to investors who are financially sophisticated and have a reduced need for protection provided by regulatory disclosure filings. That's a mouthful to basically say it's regulation that prevents the average person with lesser money to invest in more sophisticated investments like an IPO or a company like pre-IPO,
00:01:59
Speaker
And pre-IPL means like before they go public.
High Returns vs. High Risks for Investors
00:02:03
Speaker
So one that would be like relevant would be, you know, like Uber. So if you invested in Uber before it went public or if you were invested in Facebook before it went public. So let me just say the Philip definition, because I feel like sometimes that's helpful because all that was like Charlie Brown to me, Charlie Brown's parents.
00:02:24
Speaker
it is for a higher net worth individual to be able to invest in higher risk stocks or investments. Now, this is only for higher worth individuals because a lot of those investments go to zero or they don't go as successful as they once would think. And so that's why you have to have higher net worth. So it doesn't completely
00:02:51
Speaker
put you in a bad pickle if you don't have as high of a net worth. So higher net worth accredited investor are for the people who have a lot of money who are okay if this doesn't go to the moon and it's okay if it goes to zero. Now, is it ideal? No, but so that's why they always try to figure this out of like, well, are you an accredited investor? Because really the investment that you're doing is going to be a little bit more risky than normal.
Investment Opportunities and Crowdfunding
00:03:19
Speaker
therefore you have to have a lot more money if this doesn't go as according to plan. Is that a decent definition? Yeah, and I think the other way to explain it is if there was a spectrum, like a line, a basic line, to the far right of that line would be common stock where publicly traded companies
00:03:44
Speaker
Like on the stock market those follow the regulatory authority of the sec the securities and exchange commission what we're talking about today is pretty much everything left of that spectrum so.
00:03:59
Speaker
private placements, Rig-D offerings. If you're ever here on Shark Tank, if you're watching Shark Tank and they're like, have you guys raised money before? And they'll be like, yeah, we did a Series A seed round and we raised this at this valuation. It's stuff like that. Where companies are raising money
00:04:19
Speaker
or doing some sort of capital call for investors because they're trying to fund the growth of their company. They're not under the SEC yet because they're too small and they're trying to grow and they don't want to comply with all the regulation costs and requirements that goes with being an SEC registered company. So it's kind of like everything left of an additional public offering.
00:04:42
Speaker
The other side of this is with what's happened over the internet, really, I think in just the last 10 years, is there's a lot of new platforms where you can, you know, we were kind of familiar with the term crowdfunding, you know, there was some legislation passed by the US government that made it easier to crowdfund or raise money for their projects.
00:05:05
Speaker
And so there's a lot of platforms online now where you can go in and invest in pooled real estate investments, pooled stock investments like investing in companies pre IPO, all these different things. But when you go to those platforms, they're going to ask you, are you an accredited investor? And that that is what we're kind of focusing on, I guess, more
Amendments to Accredited Investor Definitions
00:05:27
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so. So let's talk about the net worth of accredited investor. I think that would be helpful at least at this point before we dive in any further.
00:05:36
Speaker
Sure. The requirements historically have been that if you're an individual or a company, you have to have a net income or annual income, so to speak, sorry, exceeding 200,000 a year of income. If you're a joint tax filer, so that means you and your spouse, then it's 300,000 a year
00:05:58
Speaker
of joint taxable income. And that has to be over the last two years with the expectation of earning the same amount or higher moving forward. So that is the first major way you can classify. So if you don't have a very high net worth, but you've made good money over the last couple of years, you can qualify that way.
00:06:18
Speaker
The other way is a person is considered an accredited investor if they have a net worth exceeding $1 million, and that doesn't include the value of the home, like your equity in your home.
00:06:29
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So that's kind of the other main way that you can classify as an accredited investor. Now recently, actually last year, the SEC actually amended the definition of what an accredited investor was, lowering the bar a little bit. And so that law came into effect August 26,
00:06:53
Speaker
And it says basically that allows investors to qualify as accredited investors based on defined measures of professional knowledge, experience, or certification in addition to the existing test for income and net worth. The amendment also expands the list of entities that may qualify as accredited investors, including by allowing the entities that meet an investments test to qualify.
Private Investments for Accredited Investors
00:07:19
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And so what that investment test is, is the SEC now defines that as individuals have certain professional certifications, designations or credentials, individuals who are knowledgeable employees of a private fund or SEC entity, registered entity and or state registered investment advisors, which would actually be us. So we now actually qualify for the term of an accredited investor with just our registered investment advisory firm.
00:07:48
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So they expanded that a little bit last year. That probably doesn't make it easier for people that aren't involved in this industry, but it did expand the qualifications considerably out of just how much you make or how much net worth you have.
00:08:07
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Okay, so let's say that our listeners are now a credited investor. What investments do they now have access to that they wouldn't have before? Yes, they now have access to essentially invest in private companies through private placements, Reg D offerings, seed round investments, crowd sourced or pooled real estate investments.
00:08:35
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There's just a lot of stuff out there that people are trying to raise money based on this accredited investor rule.
Impact of High Valuation Public Offerings
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And would you say that the investments that they now have access to
00:08:49
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like one, would be riskier, and then two, have more potential of higher return? For sure. I think when you look at it, I think you do a great job of talking about asset allocation and risk tolerance. When you get into a higher net worth, over a million, two million, five million, a lot of times, those people have that net worth because of the wealth they've created through a private business.
00:09:17
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And so, you know, when we look at the seven sources of residual income, which is kind of, you know, one of the purposes of our podcast, talking about investing in business, you know, business investments in real estate are the three main ways, you know, to build wealth, to create residual or passive or passionate income.
00:09:36
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So when you look at it, yeah, I think definitely there's a lot more risk on the table, but with that, that other side of that is there's a lot more upside too. You know, and you look at the firms that were able to invest in the seed rounds of, you know, Facebook or an Uber or Google, some of these companies that have just gone to stratospheric, you know, valuations.
00:09:57
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If you're in on the ground floor, pretty close to the ground floor of those companies, your upside is so much bigger than if you just invested in the stock after it goes through its initial public offering.
00:10:11
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One of the other things that's interesting to note is that for a long time, the stock market helped companies go public to get this capital infusion. A lot of companies in the 60s, 70s, 80s, 90s, even early 2000s, they were going public with less than a $1 billion or $2 billion valuation. Now, companies are going public with valuation well north of $5 billion to $10 billion.
00:10:38
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So the ability to make money on that investment after at IPOs is a lot smaller, in my opinion, than it was from obviously zero to a couple billion.
Business Failure Rates and Investment Risks
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The percentage return when a company is 100 million versus investing in a company that's worth 10 billion is a pretty massive shift. So getting access to that type of stuff can increase your returns over time.
00:11:08
Speaker
I still think this is important to note, just the percentage of actual businesses that fail. And what would you say that number is? Because it's still applicable to these kind of companies. That's why it's higher risk. So what's the percentages of companies that actually don't succeed?
00:11:29
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Yeah, I mean, the average is still 95% of all businesses will fail. 95% I think fail in the first five years and then of the 5% that make it 95% fail in the next five years. So, you know, that is I think age old. I think a lot of times when you're talking about these types of companies,
00:11:50
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in these opportunities, like your local dentist probably isn't raising money through a seed round to fund his local dental office.
Growth Cycles and Capital Needs
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A lot of times companies that are doing this, they have founders that have done it before or they have revenue that's in excess of over a million dollars. They have a proven business model and now they're really trying to scale. This space is really too, I think the important thing to talk about is like banks don't have a lot of appetite for this space.
00:12:18
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I think companies outgrow their local bank in some regards and they need to raise a sizable amount of capital because the bank doesn't want to put up a loan for the business. This is a real extension of company growth cycle outside of your mom and pop type business down the street with your local bank.
Relevance of Accredited Investor Rules
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So I think once the company gets to these levels, I'm not saying that the failure rate isn't 95% for this group, because it probably certainly could be. But that is kind of the bet you're taking, so to speak, of, you know, this company has some infrastructure, it has a proven track record, it has a product that has revenue, you know, it's trying to go from one, five, 10 million in sales to, you know, 50, 100, 200 million in sales, that type of thing.
00:13:09
Speaker
Right. Okay. Thanks. That's all I got. So I think the other thing we wanted to talk about is personally, I think these rules are very archaic. And when you look at the counter, so I think the other important thing to talk about is like, what is the purpose of these requirements? So I'm reading this from like a website, because I think it's just important to like,
00:13:35
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This is more of the book answer type thing. The goal of this is to protect less knowledgeable individual investors who may not have the financial cushion to absorb high losses or understand the risk associated with their investments.
00:13:50
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And this is, again, all under the guise of protection, which I think sounds great. And there's a lot of bad actors in this space. There's been a lot of companies that have raised money over the years and it was just a total Ponzi scheme and people's money got taken. We know those people personally that that's happened to. So I definitely think that is a massive risk.
00:14:11
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With that, I believe that experience is one of your best teachers. And even you talk about that, Phillip, your bad experiences are maybe a better teacher to your good experiences. And I can't tell you how many people we've talked to invested in something.
00:14:32
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It went really well. They put in more money. It went really well.
Diversifying Investments to Mitigate Risk
00:14:35
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And then they put in a ton of money and then they lost all the money. And so perfect hustle, the perfect hustle. Right. And so that.
00:14:45
Speaker
is where you need to approach this space with a plan. Just like anything, if you're going to invest in the stock market or you're going to start a business, you got to have a plan. But when you look at asset allocation, like if you look at the shark tank type people or billionaires, they allocate over five to 10% of their overall portfolio to this space.
00:15:06
Speaker
pre-IPO type companies as part of their overall asset allocation. Even we've talked about with our podcast on Bitcoin and cryptocurrency, that should be, in our view, a small asset allocation piece, 3% to 5% to the average person, whether they're accredited or not, because the returns have been so substantial that mathematically, it makes sense. Now, how you approach that
00:15:31
Speaker
as part of the asset allocation is kind of a different story. But with a lot of people tell us in this space, when you look at the top investors, the top venture capital funds that live in this pre IPO space,
00:15:44
Speaker
It's kind of like baseball. We're looking to make 50 to 100 investments. We plan on 95% of those going nowhere, but the 5% to 10% that do, they're looking at potential 10x, 100x, 1000x type returns. And so the returns on those small winners are so great. It over
00:16:10
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you know, it makes up for the loss on the other, you know, whatever percentage, 80 to
Changing Investment Platforms and Accessibility
00:16:15
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90%. I think about that conversation we have with Matt music. Shout out to Matt music. Remember he was like doing this with investors money. He was like, listen, I always make all my investors invest in 10 different startup companies because eight of them aren't going to make it.
00:16:31
Speaker
But those two that make it will completely dwarf any loss that we had with the other eight. So I always remember that of like, oh, interesting. Like you're almost expected to fail in this, but the two or the one that actually makes it, you'll get that rate of return. So it's interesting. And so let's break that down one more level, because I think that's important. So let's say your net worth, let's say you qualify because you're not in this industry. You qualify as an accredited investor.
00:17:00
Speaker
and your net worth is a million dollars. If we're saying that your overall asset allocation to this space is 5%, that's 50 grand if you have a million dollar liquid investible money. Then if you're saying, hey, you need to spread that over 10 different investments, you're talking about an investment of $5,000 or less.
00:17:25
Speaker
Now, I've kind of started playing with this platform called StartEngine. There's a lot of them out there. So this is not a plug for StartEngine. This is not a plug for you to do this. But now that we qualify as accredited investors just because of our job, I wanted to kind of explore the space.
How to Qualify as an Accredited Investor
00:17:44
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And so, in looking at some of the projects available on StartEngine, again, if you meet the accredited investor definition, you can invest in some of these private companies for a minimum investment of 300, 500 bucks.
00:17:57
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So historically, when these rules were set up, it was more, hey, you got to put in 25 grand. It's a liquid. Companies didn't have websites. These rules have been in place for decades. This isn't something that started in the last 10 years. What started in the last 10 years is the internet has been brought to the space, which has brought the minimums down, which has brought the ability to invest in other companies down.
00:18:22
Speaker
It's a lot easier to invest in these platforms, real estate and pre-IPO platforms, where if you had a million-dollar net worth, you can invest in 10 to 20 of these different projects and be spending $1,000 to $2,000 per investment.
00:18:38
Speaker
I'm just trying to make it tactical of what this could look like. It's not this scary thing where if you have a million dollars, you're putting all million dollars in it and it could go poof gone. We're not saying that. You could break down the investment of the 50 into one to $5,000 increments and invest in a bunch of companies as a part of an overall asset allocation and plan.
Are Current Investment Rules Outdated?
00:19:02
Speaker
When you go to that website, what did you have to do to qualify to be an accredited investor? Click on a couple buttons and there you go. You just click on a couple buttons. We just had a client who emailed us and they said, hey, we want to invest in this private placement with this
00:19:21
Speaker
company here in Iowa. We know that company, they've done a lot of these. We've had clients invest in previous investments with them and it's gone really well. I'm just going to leave at that high level because we're not trying to promote anything today. We just had to sign a form for them as one of their advisor team is either a CPA or financial advisor that says, hey, this person
00:19:43
Speaker
based on all their assets is an accredited investor. And we signed it and dated it as their advisor. And they sent that in with their investment information that the company required. And they invested in that project. And so there's just a lot of stuff that's local. It's not on an internet platform. There's that stuff too. So we can help you based on our relationship with you as a client, say that you were an accredited investor.
00:20:12
Speaker
But on this website, yeah, you just click a few buttons, uploaded a few documents and. I think it's interesting and probably why they can get away with that is because your initial investment can be three to $500. Like this wasn't always the case where, no, we're going to need at least 25 to 100 grand for your investment. That's the smallest placement we're having. So it's like, oh boy, you know, that's a different deal. But so I think that's probably why they can get away with that. I'm just trying to think through like.
00:20:40
Speaker
How many people would go on there and not, you know, just kind of like, oh, yeah, I am. Well, anyway, so it's interesting. So the part that I wanted to touch on and why I think this is an archaic model is twofold. One, because this was this was a, you know, it was kind of the wild, wild west back in the day when there was no Internet. You couldn't verify things. You couldn't double check things like maybe as easily as you could now. Like there's there's maybe a more of a need for this space.
Arguments for Changing Investment Laws
00:21:09
Speaker
Now, I think with the increments being pulled down, over time, the market corrects itself. Obviously, in the short term, things can go wrong in the market, but over the long term, the market corrects itself quite a bit. I think it's interesting if you think about the counter to this argument of a credit investor. Let's say I wanted to go to Vegas.
00:21:33
Speaker
and go gamble. Are there any rules that is going to say, well, Brian, you can only use, you have to be an accredited investor to go gamble your money because you could easily lose. I think we're all in agreement that if you're gambling, you can lose all of your money.
00:21:49
Speaker
There is no stopgap for that. There is no stopgap for you to walk into MGM Grand or any of these casinos and literally lose all of your money. We've all heard those stories. I think a lot of our listeners have probably been to Vegas or one of these other states now that have gambling.
00:22:09
Speaker
And we've all seen it. We've all done it and it's a really slippery slope. You know, my grandfather actually had a gambling problem and it's why my parents are pretty risk averse. And so.
00:22:23
Speaker
There's no rules on that. I mean, anybody could walk in a casino and lose 100% of their money, not like 5% of their net worth. Literally everything you own, you can just walk away. There's no rules protecting you from that. So why are there rules protecting you from investing in something that could go up? You know, 100%, 200%, 1000%.
00:22:44
Speaker
And so I think that's really where there's a lot of talk and movement within our space that these laws need to be changed and the barriers need to be brought down or completely done away with.
00:22:56
Speaker
But when you make mistakes, it's a really good teacher. And so I think we don't want our clients to make mistakes. We don't want people to over invest in this space, but we're getting a lot of people asking of like, Hey, I really like to put 500 or 1000 or start putting, you know, $200 a month into investments
Investment vs. Gambling Regulations
00:23:14
Speaker
like this. And I can't because I'm not an accredited investor.
00:23:17
Speaker
But I could go and put that money in FanDuel or the NFL just signed a deal, the four casinos to do bets on the NFL. I could blow all that money on betting on the NFL now. And there's no rules against that. And so I think that's really where we as a society need to reevaluate these rules. And are they really helping more of the people or are they actually hurting more of the people? And with crypto and the blockchain and being able to tokenize different assets,
00:23:47
Speaker
and the internet and being able to make more information available and reduce the size of some of these investments, I think there's the case that maybe these rules aren't the way they should be moving forward. But the intention is great and was great, and it sounds great, but it's actually limiting a lot of people from making money in a really unique way too. Yeah, in a wise way. Yeah. I think that's a good point.
00:24:17
Speaker
Okay, so what are our listeners? Because I'm sure all of them are credit investors.
00:24:24
Speaker
What do they take away from this? And how do they like really move forward? Maybe they'll just put their faith in you and then you can change all the laws. That'd be awesome, by the way. But I think you do make a really good point. I'm making a joke, but I do think that's a really good point. Like you can go in a casino and no one's asking you whatever, or you're just pulling the slot machines. And I mean, you're basically going to zero. Yeah. The blackjack dealer is not like, Hey, I need you to sign this accredited investor form and submit your last year as a tax returns.
Portfolio Allocation for High-Risk Investments
00:24:51
Speaker
And, uh,
00:24:52
Speaker
Do you have enough liquid net worth to sustain this bet? Right. If you double down on this 11 here. So anyways, I think that's really important. I think the big takeaway is that there is a whole other world of investments
00:25:08
Speaker
And there's a gatekeeper to those as it stands right now. And that is this accredited investor rule and just making light of what it is. And if you want to go play in that pool that has the gatekeeper, you need to understand the barrier to entry to be an accredited investor, which is, you know, 200 to 300 grand a year of income and a million dollar net worth, or you're savvy, you're in an industry or you're in an RA or somebody like you and I.
00:25:38
Speaker
And there's ways around it but so you gotta understand how that game is played and then looking at that once you are able to put money into that pool.
00:25:50
Speaker
What percentage of my overall net worth do I feel comfortable with investing in things like that? And so we're saying a great place to start is always 3% to 5% at the max and looking at a multi-year, multi-investment mindset of like, I'm not going to pick one private company to invest all my money in, and I'm going to hit it
Strategic Investment Planning
00:26:14
Speaker
rich. That's basically like gambling.
00:26:16
Speaker
But if I had an approach and I wanted to invest in 10 to 20 of these over the next three to five years, as it relates to that percentage of my overall asset allocation, that's a better way to strategize that. It's good.
00:26:34
Speaker
Nice. Well, I do feel like it's nice to know. Sometimes it's just fun to know other types of investing in like the other side of the coin. So I do think this is valuable to our listeners. And again, like if you needed help with putting some kind of strategy together to put some kind of accredited investor investments, I think this would be, you know, some of you can totally reach out to, and it's like a part of a comprehensive plan, like Brian saying,
00:27:00
Speaker
We absolutely can help you with that, or maybe another advisor can, but I think it's valuable. So, all right, land the plane, big dog. Yeah. And I think the last thing I would say is we look at a lot of this type of stuff as part of our planning for our clients. And so a lot of times clients will bring, you know, they're getting approached with people that have money and assets, they're getting approached
00:27:20
Speaker
Opportunity finds cash always throughout the history of the world. We know our clients are getting hit up by other advisors, other friends, other business contacts. We want to be open to that. We work with other people's advisors. We're not like, you have to do everything with us because it's a big world out there to make money. We want you to feel open to that.
Conclusion and Call to Action
00:27:42
Speaker
But also, if you want us to look over your shoulder and review some of these types of investments as part of your overall plan, we do that and help people make just educated decisions so they're not over their skis, so to speak, if something were to go wrong. Because we've seen plenty go wrong. It all sounds great going in, like, oh, what could go wrong? Well, COVID. So there's a lot of extraneous circumstances with these types of deals. And so it's a matter of making sure that investment size is
00:28:12
Speaker
small enough that if something does go wrong, it doesn't upset your overall plan. And so I think that's the key takeaway is we'd love to help look at that type of stuff if you want our help. Good. Well, you've been listening to the Uncommon Life Project. I'm your host, Philip Ramsey. And I am Brian Dewhurst. Until next time, go be in common. Thanks for listening. Thanks, everybody.
00:28:32
Speaker
That's all for this episode of The Uncommon Life Project, brought to you by Uncommon Wealth Partners. Be sure to visit uncommonwealth.com to learn more about our services. Don't miss an episode as we introduce you to inspiring people who are actively pursuing an uncommon life.