JF2452: Accredited Investors vs Qualified Purchasers | Actively Passive Show with Theo Hicks & Travis Watts

May 20, 2021 | Joe Fairless | 00:16:39

JF2452: Accredited Investors vs Qualified Purchasers | Actively Passive Show with Theo Hicks & Travis Watts

Today Theo and Travis share the differences between Accredited Investors and Qualified Purchasers. 

We also have a Syndication School series about the “How To’s” of apartment syndications and be sure to download your FREE document by visiting SyndicationSchool.com. Thank you for listening and I will talk to you tomorrow.

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TRANSCRIPTION

Theo Hicks: Hello, Best Ever listeners. Welcome back to another episode of The Actively Passive Investing show. As always, I’m Theo Hicks with Travis Watts. Travis, how are you doing today?

Travis Watts: Theo, I’m doing great, man.

Theo Hicks: So today, we are going to talk about accredited investors versus qualified purchasers. What’s the difference? What are these two things ? We’re going dive in deep. As always, disclaimer, as Travis I’m sure was going to do anyways, we are not SEC attorneys, we’re not attorneys by any means. We’re just going to go over some of the definitions of what these two types of investors are. And for more details, all legal advice, make sure you’re talking with your securities attorneys. And we’ll also direct you to the https://www.sec.gov/ website, because that’s where all the majority of this information is listed.

So Travis, before we dive into those differences, why are we talking about this today?

Travis Watts: Sure. It’s a great topic, Theo. There’s some confusion still around it. We’re going to try to simplify it here on the episode. Also, this is one of the top 10 blogs on https://joefairless.com/, accredited investors versus qualified purchasers, so I thought, “Hey, let’s make it a video segment, reach some more people with it.” Obviously, there’s a demand for wanting to know this information. And I think I’ll have you cover accredited investors just to kick it off – most people have heard that term – and then all jump into qualified purchasers, distinguish the differences and we’ll take it from there. So go ahead and take it away.

Theo Hicks: Yeah, exactly. So I’ll deal with accredited investors. And accredited investors, as most people know, these are people who the SEC deems are allowed to invest in certain types of syndications or certain types of passive investments. So there’s a criteria that’s set forth that you need to meet in order to passively invest in, say, an apartment syndication fund or in any sort of commercial real estate transaction.

So the qualifications are regulated by the SEC, it’s under Rule 501 of regulation D, which is, again, all this is on SEC’s website. So the most common way to qualify as an accredited investor is going to be an income or a net worth threshold. So a person that has an annual income that is over $200,000, or jointly, it’ll be $300,000, you qualify as an accredited investor; but it needs to exceed that threshold for the previous two years. And then you need to have the expectation of making that same income or higher in the current year. So if you have one really good year, but then in the previous year, you didn’t reach that, then technically, you don’t qualify as an accredited investor. So that’s the income.

There’s also a net worth. So an individual – or jointly is the same – has a net worth exceeding $1 million, they will qualify as an accredited investor. But net worth, the way they calculate it is that it excludes any equity you have in your personal home. So that doesn’t count toward your net worth requirement; it has to come from something else. So it’s net of any debts. So for example, let’s say you own a $2 million rental property and you have a $1.5 million mortgage, you don’t have a $2 million net worth, you get only $500,000 of that equity.

Now, if that’s not a rental property, if that’s just your personal home, then that $500,000 doesn’t count. So it’s only non-primary residents, investments, net any of the debt. So you can’t take advantage of mortgage loans to become an accredited investor. So those are the two most common ways that people usually qualify to passively invest, is that income requirement or it’s that net worth requirement. But the SEC has a lot of other ways that you can also qualify as well. So we’ll kind of quickly go over those as well.

So if you are a general partner, executive officer or director for a company that is issuing the unregistered security, then you are considered an accredited investor. So that’s just a fancy way of saying that if you are doing the syndication, if you’re a GP on a syndication deal, then you don’t need to have that annual income or net worth requirement, you are automatically considered an accredited investor because you are actually a part of that company. But you can only be a GP, executive officer or director. You can’t be an underwriting analyst or something.

Break: [00:04:54] to [00:06:55]

Theo Hicks: An entity can be considered an accredited investor if it is a private business, development company or an organization with assets exceeding $5 million. So like an entity or a company that has a net worth of $5 million in a sense, they together can passively invest in a deal as accredited investor. Also, if an entity consists of equity owners who are accredited investors, the entity itself is an accredited investor.

There were some that were actually new, that happened in mid-2020. So almost a year ago from today, they added another way that you can become an accredited investor, and it has to do with having certain types of certifications. So the technical definition is the SEC amended the definition to include individuals who have certain professional certifications, series seven, series 65, series 82. Individuals who are “knowledgeable employees of a private fund or SEC and the state registered investment advisors.”

I’m not really going to go into a bunch of detail on what that means. So just go to the https://www.sec.gov/ websites, and check out that amendment for more information on what that means. But most likely, if you’re listening to this and you qualify as an accredited investor, it’s probably because of that income or net worth, or maybe a bunch of people came together to get that net worth of $5 million to invest as an entity.

So final thoughts for accredited investors is that the SEC needs to protect less knowledgeable individual investors who might not have enough money to absorb any high losses or maybe they don’t have a high understanding of the risks associated with passive investing… So that’s really the entire point of having these requirements. Again, it’s not just because you make that much money or you have that net worth, you are just a genius at syndications. But the definition that they came up with is to protect as many people as possible. So that’s kind of why they have these requirements in the first place.

Travis Watts: Well said, Theo. That’s precisely it. If you look at the history of Wall Street and why the SEC is even in place, there’s obviously a long track record in history of fraud. They’re just trying to cut down on that. And of course, you’re going to have folks on both sides; people disagreeing, saying it’s a barrier of entry, why can’t we participate in things? And then the flip side saying, well—it’s like with all these cryptos right now, and I see all these 20-year-olds on YouTube talking about—some saying they’re making tons of money and other saying they lost everything. So I don’t know, maybe there should be regulation there. Maybe not. I don’t know, I’ll leave that up to the listeners, but I’ll dive into qualified purchasers.

Simply put, if you take nothing else out of this episode, here’s the simple down and dirty of it. A qualified purchaser has a higher financial threshold versus an accredited investor. That’s really what it comes down to. So what is that threshold? It’s $5 million in investments. So a qualified purchaser can either be family-owned company, an individual who owns $5 million or more in investments, versus that $1 million threshold for accredited investors. So this could be an entity, an individual, like I said, but also who invests a minimum of $25 million in private capital on other people’s behalf; you can also qualify that way.

So let’s define investments when I say that. So we’re talking about securities, stocks, bonds, mutual funds, real estate, cash, financial contracts, futures contracts, physical commodities, like oil, gold, silver – all of this stuff counts towards that threshold. That’s what we’re talking about. The same as the accredited investor definition there.

So if you’re part of a qualified purchaser entity, all the entity’s beneficial owners must be qualified purchasers. That’s like what you were pointing out with accredited investors – you can qualify that way; you can create an LLC, but each individual needs to be accredited or it needs to have a higher threshold of assets in that LLC to qualify the entity as being accredited.

So a qualified purchaser can be a trust that’s sponsored or managed by multiple qualified purchasers. So again, like Theo said, the best way, just go to  https://www.sec.gov/ if you really want to dig in, get all the details, figure out if your specific scenario qualifies for A, B or C.

In my experience, just being a limited partner investor in private equity and private placements, I rarely come across an offering that says, “This is exclusively for qualified purchasers.” Usually, if it’s going to be that, they’re looking for institutional capital, they’re looking for players that are going to put minimum investments of $250,000, $500,000, $1 million, stuff like that. And for the most part, that’s not your mom-and-pop accredited investors, who are more inclined to put like $50,000, let’s say, or $100,000 into a deal, something like that. So just a side note.

Break: [00:11:45] to [00:12:22]

Travis Watts: Bottom line, when it comes to being accredited or a qualified purchaser, both can have benefits, obviously, in real estate today. But even if you meet the net worth or the income requirements here, you would really be shortchanging yourself if you didn’t understand how to properly vet deals and what you’re really doing. And I’ll get into a story with that here in a minute. But make sure that you learn how to vet a deal, vet a market, vet a sponsorship team – these are the critical pieces. Theo and I recorded a three-part mini-series last year in 2020 on precisely that; how to vet a team, a sponsor and a market. That’s a very popular three-episode segment.

So if you’re watching on YouTube, I believe those episodes are 16 through 18. And if you’re listening on the podcast, it’s 2284, 2291 and 2298. So check those out. Regardless if you’re sophisticated, accredited, QP, whatever; very, very good stuff in there. Each one’s about 30-45 minutes long.

So my final thoughts – I mentioned that story… So the importance of being knowledgeable as an investor, maybe to Theo’s point, here’s the SEC trying to protect the less sophisticated folks from making a mistake or whatnot. But think about this – a lot of people, they win the lottery or become a professional athlete or a highly paid actor or actress, you might marry into money, you might have a business that you sell for millions of dollars and you never really anticipated that being the case… Does that make you a knowledgeable investor? Are you all of a sudden an investor because money’s in your bank account one day? No.

So the story I want to share is when I was in high school, and the beginning of college out in Florida, my parents owned a small aviation company, and they had a lot of high net worth clients. And I reached out to my parents and I said, “Can you connect me with some of these folks? Because I want to learn the finance game. I want to learn about investing. I want to know how I can get wealthy, this kind of stuff.” And they did, they set me up with quite a few of these individuals, male and female business owners, NASCAR drivers, retired, all these different people.

And what I learned is very few have the understanding and the mindset of being an investor. Most of them couldn’t really tell me much at all, or they would say just generic stuff, like “You buy low and sell high,” or “You hold forever and you never sell.” One guy, I remember said, “I have 100% of everything in annuities” so the financial insurance product. I have nothing against annuities, but this isn’t what I was wanting to learn. I thought just because you had wealth, that meant you’re sophisticated and that you know what you’re doing, but that’s not the case. A lot of these folks made money in other ways, and it doesn’t make you an investor mindset.

So that’s just what I want to point out, three things – educate yourself, identify your goals and investing criteria, do your due diligence, and take action. These are the most critical, important part. And thank you for tuning in to stuff like this. It makes a world of difference over time, I promise you. And that’s all I got, final thoughts.

Theo Hicks: That’s like a perfect example. As Travis mentioned, these requirements aren’t if you make $199,999, you don’t know what you’re doing it all for investing, but if you make one more dollar and boom, you’re just an expert on investing in these types of deals. So those were all great points.

And again, the overall purpose of this episode was just to define those two terms. And then, I like how you kind of wrapped it up and said that, “Look, even if you do qualify to invest in these deals, you shouldn’t just assume you know exactly what you’re doing because you have added a dollar amount in your bank account.” Make sure you’re still educating yourself, make sure that you understand your own investment criteria and your goals, and then make sure before you actually take action, you are doing your due diligence on those deals.

So as Travis mentioned, that’s really what actually passive is all about, educating you. There’s a lot of other podcast episodes and blogs that we have. We actually have a blog category called Accredited Investors. Every blog in there is directed towards educating you on how to become a better accredited investor.

So if you don’t have anything else, Travis, we’ll go ahead and wrap up. Best Ever listeners, as always, thank you for tuning in. Make sure you check out those episodes that Travis mentioned. Have a best ever day and we’ll talk to you tomorrow.

Travis Watts: Thanks, Theo. Thanks, everybody.

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