INVESTOR CLASSIFICATIONS AND PRIVATE FUND EXEMPTIONS

When you are starting the process of launching a private investment fund, there are many considerations. One of those considerations is what type or classification of investors are you likely to pursue, and how many investors do you expect to have within the fund.

Back in 1940, the “Investment Company Act of 1940” became law as an act of congress (commonly known as “40 Act”). This 40 Act had large implications on many types of investment businesses, however it is more impactful on larger registered funds like mutual funds. Many of the private funds that exist fall under a number of exemptions from regulation such as 40 Act, however those exemptions do limit what the funds can and can’t do.

Below is a list of a few of the most common exemptions that private funds rely on and their general criteria and limitations.

3(c)(1) – This exemption is by far the most common, as the barriers to entry are lower than some of the other possible exemptions. The biggest limitation for 3(c)(1) funds is that they can only have 100 or less investors in the fund. The biggest benefit here is that the investors largely do not have to be Qualified investors, just accredited which means that the fund can accept investors that are regular wealthy, not ultra-wealthy (more on this later). The investor limit is usually called “Slots” and entities for instance are generally considered one investor, unless they are setup for the sole purpose of investing into the fund (essentially to stop people from creating multiple 3c1 funds to get around the slot issue). Another little-known fact is that knowledgeable employees of the fund manager do not count towards the 100 investor limit.

3(c)(5) – This exemption has no limits on the number of investors, or the type of investors, however it has limitations on the type of assets you invest into. At least 55% of the portfolio must be invested into “Qualified Interests”. Qualified Interests are basically mortgages or liens on real estate. In addition, at least 25% of the fund must be in real estate. This leaves about 20% that you can invest in any asset class as long as the other two hurdles are met. This exemption is most common among REITs.

3(c)(7) – Very similar exemption to the 3(c)(1) and probably the 2nd most common exemption. The main differences here is that the fund can have up to 1,999 investors (likely won’t exceed that number anyways) but it can only accept Qualified Purchasers. Qualified Purchasers generally are similar to accredited but must have at least $5 Million in investments or be an entity with at least $25 Million in assets. There are other ways to be designated a “Qualified Purchaser”, but these are the most common.

Other Exemptions – There are several other exemptions relating to specific types of investments such as small business loans, real estate, industrial banking, etc.

Generally speaking, most private fund managers must decide between the ability to take in smaller tickets but limiting the number of investors or focusing on the long term and only accepting Qualified Purchaser investors. In addition, there is sort of an investor qualification called “Qualified Client” which is in between Accredited and Qualified Purchaser. If the fund among other things is charging performance fees and falls under certain criteria, then it may be forced to only accept from Qualified Clients who are also Accredited or Qualified Purchasers.

Fundviews Capital works with Investment Managers to determine what the best exemption is for their fund. Most importantly, each Series within the structure can have their own unique exemptions.

**The above reflects the personal opinions of the author, and is not to be considered investment or legal advice or advice of any kind.