The accredited investor Standard
Even in states where hedge fund managers at a given AUM level are not required to register as an RIA, including New York, California, Connecticut, Massachusetts, Florida, and several other (principally Eastern) states, all US investors must at least be accredited investors.
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.
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 (the exemption relied upon by most hedge funds) 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 registration 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 $2,000,000 at the time the contract is entered into, exclusive of primary residence; or
- (ii) an individual or a company with at least $1,000,000 under management of the investment adviser.
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.
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.
Forming & Operating a Hedge Fund | By John S. Lore, Esq.
Written by John S. Lore, Esq., managing partner and shareholder of Capital Fund Law Group, Forming & Operating a Hedge Fund is a brief guide for emerging fund managers. Click the button below to view and download the eBook on a mobile or desktop device.
This book provides a concise guide through the process of structuring, launching and raising capital for domestic and offshore hedge funds and other private investment funds. Throughout this book, we highlight pitfalls that fund sponsors should watch for and suggest best practices to safely and effectively navigate the process of forming and operating a fund.
ABOUT CAPITAL FUND LAW GROUP
Capital Fund Law Group is a boutique investment law firm focused on advising emerging and established investment funds on all aspects of formation and operation. We provide predictable flat-fee services for most of our engagements. Our legal team has extensive experience advising hedge funds, real estate funds and private equity funds throughout the United States in various structures and strategies. We also prepare debt and equity private placement offerings for companies in all major industry sectors.
FORMING A FUND