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Who Can Invest in a Hedge Fund?

The investor standard of investor suitability applied to an investment fund may depend on the state or federal investment adviser regulations the fund manager is bound by.  The two most common investor standards for private fund advisers are the “accredited investor” standard or the significantly higher “qualified client” standard.

The accredited investor Standard

Even in states where hedge fund managers at a given AUM level are not required to register as an investment adviser ("RIA"), including New York, California, Connecticut, Massachusetts, Florida, and several other states, regulations on the state or federal level generally prohibit US investors that do not meet the accredited investor standard or higher.

The accredited investor standard is the investment suitability standard under Regulation D, the safe-harbor exemption from the Securities Act registration requirements. An accredited investor is an investor that meets either the income or net worth test established by the SEC. As of 2020, the SEC broadened the definition of accredited investor to include, in some cases, a financial professional holding a FINRA Series 7, 62, or 65. 

  • The Net Worth Test

For individuals, the investor must be a natural person whose individual net worth or joint net worth with his or her spouse, exceeds $1,000,000. Net worth means the excess of total assets (excluding the investor's principal residence) at fair market value minus total liabilities. A higher standard is required for entity investors.

  • The Income Test

Alternatively, an accredited investor can also be a natural person who has an individual income in excess of $200,000 in each of the two most recent years or joint income with that person’s spouse in excess of $300,000 and has a reasonable expectation of reaching the same income level in the current year.

Note that under Regulation D Rule 506(b) there is an allowance for up to 35 unaccredited investors. For a number of liability reasons, we strongly recommend that no unaccredited investors be admitted into the fund.

 

The Qualified Client Standard

Hedge Fund managers that are subject to federal or state investment adviser regulations may only earn a performance allocation from investors that are “qualified clients”. A qualified client generally includes:

  • (i) an individual or a company that has a net worth (together, in the case of a natural person, with assets held jointly with a spouse) of more than $2,200,000 at the time the contract is entered into, exclusive of primary residence; or
  • (ii) an individual or a company with at least $1,100,000 under management of the investment adviser.
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Principals of the Fund

Executive officers, directors, and general partners of the fund, by their position and responsibilities, can likewise qualify as accredited investors and qualified clients without meeting the income or net worth requirements.

We recommend a manager speak with legal counsel to determine what investor standard the fund will require. 

 

INSTRUCTIVE RESOURCES

Capital Fund Law Group has authored numerous investment fund publications, including instructive eBooks, white papers, blog posts and sample offering document excerpts with illustrative footnotes. These complementary downloads are dedicated to helping fund managers understand the legal fundamentals of launching and operating an investment fund.

 

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