Summary: Today’s crowdfunding platforms offer many new opportunities that investors may not have discovered in the past. However, only accredited investors can participate.
How Do You Become Accredited?
There is no formal certification issued from an agency or institution that confirms you are accredited.
Rule 501 of Regulation D of the Securities Act of 1933 allows investors to use two different criteria for determine if they are accredited. The investor only needs to comply to one of the following methods, according to the S.E.C.
1. “A natural person with income exceeding $200,000 in each of the two most recent years, or joint income with a spouse exceeding $300,000 and a reasonable expectation of the same income level in the current year.”
2. “A natural person who has individual net worth or joint net worth with the person’s spouse that exceeds $1 million at the time of the purchase, excluding the value of the primary residence of such person.”
Using your income as proof that you are accredited is easy – you simply provide a W-2 or tax return to the issuer of the investment in order to verify how much you’ve earned for the past two years.
Proving your net worth can be a bit more complicated. It requires a balance sheet, subtracting liabilities against assets. For example, a bank statement showing one million dollars in cash is not enough evidence to prove that you have a million dollar net worth.
Instead, you need to provide a balance sheet detailing all assets (cash, bank accounts, 401Ks, IRA’s, other investments, and cars) and then deduct all liabilities (student loans, car loans, and equity lines of credit).
You cannot include your home equity as an asset, but you also don’t have to include your mortgage as a liability – unless you took out a home equity line of credit or did a cash out refinance within the past 2 months. In that case, you’d have to calculate the additional debt as a liability. Additionally, if your mortgage is higher than your home’s value. you would need to include the amount that the loan is “upside down” as a liability.
How to Boost Your Net Worth
If you own a business, talk to your CPA about using the value of that company as an asset. This could significantly increase your net worth.
If you have a lot of home equity, you may want to consider refinancing your home and taking some “cash out.” As long as you wait 2 months, you can then count the cash you took out of your home as an asset.
This can be a solid investment strategy anyway, given today’s low interest rates. For example, if you took cash out of your home with 30-year fixed rate debt at 4% and then reinvested those funds into a note earning 8%, you would then be earning 4% on funds that otherwise would have been sitting as “dead equity.” The note you invest in should be secured to property, ideally at a low LTV, offering low risk to you as the noteholder. Be sure you understand the ins and outs of private lending before doing so!
There are a few more reasons why it may be beneficial to have high debt on your primary residence:
1. Interest rates for loans on your primary residence are the lowest
2. If you are highly leveraged, the bank may help you negotiate with your insurance company in the case of a natural disaster, as they often have more at stake than you do
3. Attorneys often do title searches to determine your home’s equity, before pursuing a lawsuit. High leverage may prevent them from moving forward.
Private Placement vs Crowdfunded Investments
Private placements had been the primary way that small companies and real estate investors would raise money for their projects for many years.
A private placement allows small companies and private funds to skip the expensive and exhaustive process of registering securities if they raise capital from accredited investors “with whom they already have a pre-existing relationship.”
A small number of non-accredited investors are often allowed in these private placements if they are filed as “exempt” with the Securities Exchange Commission through a Regulation D Rule 506 (b) offering.
Private placements allow investors to “self- accredit” by answering a questionnaire and then checking the “I am an accredited investor” box on the subscription agreement. No back up documentation or proof was required.
That all changed during the Great Recession, in an attempt to jumpstart an ailing economy, the Obama Administration passed the JOBS Act of 2012. This act allowed small companies and funds to advertise their capital raise to the general public for the first time in history.
That’s when crowdfunding was born. Savvy internet marketers popped up out of nowhere, advertising various investments.
The main difference between a private placement and a crowdfunded investment (filed as a 506C) is that you must now prove you are an accredited investor in order to participate in an offering that has been advertised to the public.
And, if you are the individual or company raising the funds, be sure to understand these nuances, or have an attorney who does.