Investors, fund managers and securities attorneys often come across the terms “qualified purchasers”, “accredited investors”, and “qualified clients”.
Although seemingly similar, these terms refer to different concepts and are utilized for entirely different purposes under securities regulations.
The accredited investor analysis is generally utilized in the context of the Securities Act of 1933, for purposes of determining whether a securities offering qualifies for an exemption from registration of the offering with the Commission by virtue of complying with certain limitations as to the types of investors to whom an offering is made and how such securities are offered.
The qualified client analysis, on the other hand, is generally utilized in the context of the Investment Advisers Act of 1940, for purposes of determining whether a fund manager can charge a performance fee based upon the appreciation of the fund’s assets (often called the “carry” in private equity parlance).
Finally, the qualified purchaser analysis, reviewed below in further detail, is generally utilized for a determination of whether or not a company, such as a private fund, falls within the definition of an “investment company” under the Investment Company Act of 1940 (the “Act”), and must therefore register as such with the Commission.
In particular, the Act defines an “investment company” as an issuer that “… is or holds itself out as being engaged primarily … in the business of investing, reinvesting, or trading in securities.” The so-called “3(c)(7) exception” excludes from the definition of an “investment company” any issuer, the outstanding securities of which are owned exclusively by persons who, at the time of acquisition of such securities, are qualified purchasers – and whose securities are not publicly offered.
By way of summary, a qualified purchaser under the Act is a person who (i) owns no less than $5 million in investments; (ii) a company that owns no less than $5 million in investments, (iii) a trust that manages the assets an investor described in (i) or (ii) and that was not created for a specific purpose of purchasing offered securities; and, a (iv) person managing $25 million of its own investments or those of qualified purchasers only.
Many funds rely on the exceptions from the definition of investment company that are set forth in Section 3(c)(7), as well as others under the Act such as 3(c)(1).
Although a fund may be excepted from the definition of an investment company under the 3(c)(7) exception– and therefore, from the requirement to register under the Act—the fund manager may still be required to register as an investment adviser under the Investment Advisers Act of 1940, or to otherwise register and report pursuant to applicable state law requirements. There are exemptions from Investment Adviser registration under the Advisers Act, such as the so-called “venture capital exemption” under 203(l), the “private fund advisers exemption” under 203(m), and the registration prohibition under 203A. Even if an exemption applies from registration under the Advisers Act, the adviser may nevertheless be considered an “exempt reporting adviser” (“ERA”) and be thereby required to maintain records and submit such reports as the Commission may require. In addition, it is important to determine whether the particular fund that is being structured is subject to the “qualified client” analysis for purposes of determining and establishing its permitted fee structure.
Fund formation and structuring is a complex legal area that involves various legal and regulatory considerations. Contact our firm today for a consultation on what type of fund works best for your desired structure