The current definition of accredited investor is based on income or net worth, but the Securities and Exchange Commission (SEC) is looking at changing that. In December, the commission proposed changes to the definition that would open the door to new investors able to put capital to work in the private lending markets. Today, I’d like to look at the proposed investor categories and how they could impact private lending.
How Many New Investor Categories The New Accredited Investor Definition Will Create
If Congress accepts the SEC’s proposal, there will be at least six new investor categories created overnight. These include:
- A new category based on professional credentials. Natural persons with Series 7, 65, or 82 licenses would qualify as accredited investors, as would other natural persons with other credentials issued by an accredited educational institution.
- A “knowledgeable employee” of a private investment fund could also be considered an accredited investor.
- Limited liability companies (LLCs), registered investment advisors (RIAs), and rural business investment companies (RBICs) could also be considered accredited investors if they meet certain conditions.
- Any entity that was not formed specifically for securities investing but that owns more than $5 million in investments could also qualify.
- Family offices with at least $5 million in assets under management and their “family clients” could be considered accredited investors.
- Finally, “spousal equivalents” may be allowed to pool their finances in order to qualify as accredited investors.
These are each significant in terms of adding new accredited investors to the pool of available capital for real estate developers and investors in every category of real estate investing currently on the market. It’s also possible that new asset classes based on these new accredited investor categories could be added as market players develop new business practices, marketing initiatives, and business models to serve these categories.
How New Accredited Investor Categories Could Impact Private Lending
In December 2018, there was $10.3 trillion in mortgage debt, 51 percent of which was provided by private lenders, according to Magnify Money. The expansion of accredited investor categories has the potential to add millions, or maybe billions, of new dollars to that mortgage debt pool as new accredited investor category participants scramble to get their piece of the investment pie. While there are platforms that cater to nonaccredited investors, the lion’s share of opportunities still target accredited investors. That makes the significance of the SEC’s proposal tremendous in several respects.
One particular way this proposal is significant is the qualified institutional buyer definition would also change. Rule 144A defines qualified institutional buyer as a company that manages at least $100 million in securities “on a discretionary basis” or is a registered broker-dealer with at least $10 million investment in non-affiliated securities. The proposed rule change would expand that definition to include LLCs and RBICs.
Let’s take a look at each of the proposed accredited investor categories and see how they could potentially impact private lending going forward.
Professional Certifications and Designations
The Series 7 exam is a general securities representative exam. Those who pass the exam may be able to solicit, purchase or sell public and private corporate securities, municipal funds, mutual funds, options, ETFs, real estate investment trusts, mortgage-backed securities, hedge funds, venture capital, and more.
A Series 63 exam is a uniform securities exam not required in every state. In those states where it is required, it must accompany another licensing exam such as the Series 6 or 7 exam.
The Series 82 exam qualifies an individual, if they pass, to sell, buy, or solicit private securities.
At the end of 2018, FINRA reported a total 629,847 registered securities representatives. That means the proposal to change the accredited investor definition by the SEC could potentially add nearly 1 million new investors to the accredited investor market. According to Glassdoor, the average annual base pay for a securities representative is $28,237. The high is $45,000. These investors likely will not individually add a lot of capital to the total investment private lending pool, but they could collectively make a big splash.
Private Investment Fund Employees
Private investment funds typically do not solicit investments from retail investors or the general public. For that reason, they may not be all that active in real estate crowdfunding (RECF), mortgage lending, commercial lending, fix-and-flips, or other private marketplace lending categories, but with an expansion of the accredited investor definition, once private investment fund employees discover they can add their own money to the private lending pool, we could see new business models and private investment fund platforms rise to meet the demand.
LLCs, RIAs, and RBICs
It is difficult to know how many LLCs currently exist. One startup lawyer who answers questions on Quora puts the number at 21.6 million. Even if he overshot his estimate by 100 percent, that’s still more than 10 million LLCs currently in existence.
It’s almost as difficult to calculate the number of RIAs in the U.S. Nevertheless, one organization attempted to do just that. RIABiz reports the number to be 11,473, and says they manage $66 trillion in assets.
SBICs represent a unique class of private investor. Due to the nature of these investments, they have the potential to infuse new capital infusion into specific types of rural businesses and real estate investments. Agricultural businesses, for instance, may rely on land acquisition and development investments. The potential for new capital entering private lending markets with the number of SBICs currently in play is huge.
The specific conditions that that would qualify LLCs, RIAs, and RBICs as accredited investor status are not spelled out by the SECs proposal announcement. However, it’s possible that the number of accredited investors in this category could grow by over 1 million. That could add billions of new capital to the private lending ecosystem in short order.
Entities That Own $5 Million in Investments
This category is likely huge. How huge is anyone’s guess. But it’s entirely likely that the number of “entities” that own more than $5 million in investments is in the millions. The vagueness of this category’s definition makes it impossible to measure the impact to private lending, but it would likely be significant.
There is no way to know for sure how many family offices exist in the U.S. The Family Office Exchange estimates there to be more than 10,000.
Family offices all have their own investment criteria. It’s safe to say that if real estate continues to be an excellent investment as it has been for the past few years, family offices should be major contributors to RECF platforms and other forms of real property-based private lending.
The spousal equivalent category has the potential to make a big impact on private lending. If spouses and spousal equivalents are allowed to pool their finances in order to qualify for accredited investor status, that could potentially add hundreds of thousands of new accredited investors to the private lending investment pool. It could even add millions or billions of dollars of new investment capital.
Accredited Investor Conclusion
It’s impossible to know for sure just how big the impact on private lending could be if new accredited investor categories are created with the SEC’s proposed changes. The potential for new capital to enter the market and establish greater liquidity is enormous. New investment classes could be created to accommodate the new categories. Current investment classes will likely grow stronger. I see the entire private lending market expanding to meet new demand.
The public comment period for the proposed changes is open until mid-February. Get more information here.