Sophisticated Investors — What Are They?

One of the more well-known concepts in registration-exempt securities offerings, also known as private placement offerings, is the accredited investor. Sales in private placement offerings can almost always be made to accredited investors, who are persons with a net worth over $1 million (excluding the value of that individual’s primary residence) and an annual income of over $200,000. However, some types of private placement offerings also allow sales of securities to non-accredited investors known as “sophisticated” investors. Sophisticated investors are defined as persons who can bear the economic risk of the investment and who, either on their own or with the assistance of independent advisors, have knowledge in business and financial matters that they can evaluate the risk of the particular investment. The investment advisor must be independent of the company (cannot be compensated by or affiliated with the company).

Issuers are responsible for making the determination as to whether a potential investor is sophisticated. Companies generally accomplish this through investor questionnaires, which ask for information such as the prospective investor’s prior investment experience, current investments, risk tolerance, education, career, and information about the investor’s advisors (if any). The company is entitled to rely on the responses, unless the company has other reason to believe that the investor’s level of sophistication requires further investigation. However, a securities regulator or a court may later determine that the purchaser lacked the requisite sophistication, and invalidate the exemption for that sale, or depending on circumstances for the entire offering.

A company should be 100% sure that a prospective investor qualifies as a sophisticated investor before selling securities to that investor. However, selling securities to sophisticated investors is always risky due to the subjective nature of the classification, as compared to accredited investors. If sales to sophisticated investors must be made, the company should have no doubt as to the sophistication of the prospective investor.