Private funds are exempt from registering as investment companies if they are not making a public offering of securities and one of two criteria also applies. The fund must be owned by 100 individuals or less, or it must be owned exclusively by "qualified purchasers."
The SEC definition of a qualified purchaser is based on the value of an individual or entity's investments, not their net worth, which companies use to define accredited investors. Qualified purchasers can be individuals or family businesses with more than $5 million in investments, or other entities that meet certain requirements.
Criteria to be a qualified purchaser
To be considered a "qualified purchaser," at least one of the following criteria must be met:
- The purchaser is an individual or family owned business that owns $5 million or more in investments. If the purchaser is a family owned business, it cannot be formed solely for the purpose of investing in the fund.
- The purchaser is a trust sponsored and managed by qualified purchasers, which wasn't formed for the sole purpose of investing in the fund.
- The purchaser is an individual or other entity that invests at least $25 million, either for their own accounts or on others' behalf. Like the other criteria, entities cannot have been formed for the specific purpose of investing in the fund. Examples in this category would be a professional investment manager or a corporation.
- Any entity, if all owners are qualified purchasers.
For the purposes of these definitions, "investments" include but are not necessarily limited to stocks, bonds, and other securities, as well as investment real estate, futures contracts, physical commodities, financial contracts, and cash and equivalents.
A different, but related, term is a "qualified institutional buyer," which generally refers to institutions that own and invest $100 million or more worth of securities, and banks that own and invest at least $100 million of securities and have an audited net worth of at least $25 million.
Qualified purchaser versus accredited investor
The terms "qualified purchaser" and "accredited investor" are often (incorrectly) thought to be synonymous. However, there are some key differences.
Most notably, the financial thresholds for accredited investors are significantly lower than those for qualified purchasers. Accredited investors need to have a net worth (excluding primary residence) of more than $1 million, or must have earned income above $200,000 per year ($300,000 combined with a spouse) for at least three years.
Meanwhile, qualified purchasers must have at least $5 million worth of investments. For this reason, qualified purchasers are sometimes referred to as "super-accredited" investors, or some variant of that term.
Example of a qualified purchaser
Let's say that a fund that doesn't wish to register as an investment company is seeking new investors. Two investors apply:
- The first has a $7 million stock portfolio and an overall net worth of about $10 million.
- The second is a professional wealth manager who invests $20 million for his clients, not all of whom meet the definition of qualified purchasers.
In this case, the first would be a qualified purchaser, since it is an individual who personally owns more than $5 million of investments. However, the second would not meet the criteria, as they would need at least $25 million invested on others' behalf to qualify.