Qualified Investor vs. Accredited Investor – The Differences Between the Two

Posted By : Timothy Harvard , on Apr, 2019

 

Private funds, including private equity funds, hedge funds, and venture capital funds are regulated by various federal laws governing who is permitted to invest in these funds. These laws include the Securities Act of 1933, the Securities Exchange Act of 1934, the Investment Company Act 1940, and the Investment Advisers Act of 1940. Within these laws, we find a distinction between qualified investors and accredited investors .

Although these terms sound quite similar, there are several key differences between each category of investors.

Accredited Investors
Regardless of whether an investor is buying an interest in a private fund organized as a limited liability company, or limited partnership, any investment in the fund is categorized as a security according to federal securities laws. As a result, under the Securities Act 1933, the fund is required to register the securities offering with the SEC or find and utilize an exemption from SEC registration. The exemption under Rule 506(b) of Regulation D is used in the vast majority of unregistered securities offerings. Using this popular exemption has the effect of restricting the offering to accredited investors.

Under Rule 501 of the Securities Act, an accredited investor:

  • Has income greater than $200,000 (or joint income greater than $300,000 with a spouse) in each of the two previous years with a reasonable expectation of achieving the same level of income in the current year; or
  • Possesses a net worth (with his or her spouse) greater than $1 million (ignoring the value of his or her primary residence and after discounting all liabilities including liabilities exceeding the value of the primary residence and liabilities incurred on the primary residence within the last 60 days).

An entity qualifies as an accredited investor if it is not created for the specific purpose of obtaining an interest in the fund, and:

  • Has total assets greater than $5 million; or
  • All equity owners arey accredited investors; or
  1. A director, executive officer, or general partner of the issuer of the securities being offered or sold, or a director, executive officer, or general partner of a general partner of that issuer.

Qualified Purchasers
To further examine the difference between “qualified” investors and “accredited” investors, let us look at qualified investors (also called qualified purchasers). Many private funds fall under the definition of an investment company as a result of their securities investment and trading activities, in accordance with the Investment Company Act of 1940. However, most of these funds are not required to register as an investment company under the exemptions found in sections 3(c)(1) or 3(c)(7) of the statute.

Under Section 3(c)(1) of the Act, private funds that are owned by 100 persons or less and that do not make a public offering of its securities are not bound by any requirement to register as an investment company. Funds are also exempt from registering if they are exclusively owned by qualified purchasers and do not make a public offering of securities, per Section 3(c)(7).

Generally, a qualified investor or purchaser is an investor that fills any of the following criteria:

  • A trust, not created for the specific purpose of obtaining the interest in the fund, which is managed and sponsored by qualified purchasers; or
  • An individual or family-owned business not created for the specific purpose of obtaining the interest in the fund that owns at least $5 million in investments; or
  • An individual or entity not created for the specific purpose of obtaining the interest in the fund which owns and invests $25 million or more in investments (or an individual acting as a representative of such an individual); or
  • An entity in which each beneficial owner is a qualified purchaser.

Per Section 3(c)(7), no limitation exists on the number of investors that may participate in the fund. However, the Securities Exchange Act of 1934 effectively limits funds under this Section to a maximum of 1999 investors.

Regardless of whether you are operating an established fund are launching a new fund, it is important to know who is eligible to invest in your fund. Understanding the qualified investor vs. accredited investor differences can help ensure your private fund adheres to the investor qualification standards, and helps you avoid the potential negative consequences of accepting money from unqualified investors.

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