From sourcing and selecting investments to the way profits are distributed, private investment funds are different, and that can be daunting.
To make them a little less intimidating, we are going to start at the very beginning - with the legal structures that are commonly used to form private investment funds.1 Fund structures, whether for public or private investments vary significantly, with each subject to a different level of regulation, investor qualification, and compliance.
Matt Malone, head of investment management at Opto, breaks down the differences between drawdown and semi-liquid fundsPrivate funds pool capital from various investors to invest in a range of assets, including private equity, venture capital, real estate, and infrastructure. These funds are typically not registered with the Securities and Exchange Commission (SEC) and are limited to a specific number of “sophisticated” investors. The structure of these funds must nevertheless adhere to specific regulatory frameworks that were laid out in the 1940 Investment Company Act (the ‘40 Act).
The ‘40 Act primarily focuses on regulating public investment funds, including mutual funds and exchange-traded funds (ETFs). However, private funds often file for exemptions to the ‘40 Act found in Sections 3(c)(1) and 3(c)(7). Under these exemptions private funds are not required to register or be regulated as investment companies under federal securities laws, but - as such - they cannot offer their securities publicly.
A 3(c)(1) fund is limited to a maximum of 100 accredited investors, or “beneficial owners”. While the fund is limited in terms of the number of investors, there are no restrictions on assets under management.
To invest in a 3(c)(1) fund, all beneficial owners must meet the "accredited investor" criteria, which are:
Individuals with a net worth exceeding $1M (excluding the value of their primary residence); or
Individuals with an annual income exceeding $200,000 ($300,000 for joint income) in the last two years and the expectation of the same income level in the current year; or
Entities, such as trusts or corporations, with assets exceeding $5M
A 3(c)(7) fund is for investors that meet "qualified purchaser" criteria. Under the 3(c)(7) exemption, a fund may have up to 2,000 investors, after which it will need to be registered as an investment company under the ‘40 Act. As with 3(c)(1) funds, there are no limits on assets under management.
Qualified purchasers are:
Individuals with at least $5M in investments, or
Institutions with at least $25M in investments
Private funds are not, however, unregulated. While 3(c)(1) and 3(c)(7) funds are not registered as investment companies, they are very much subject to anti-fraud provisions and must comply with other securities laws.
Our partners benefit from across-the-board advice on the appropriate fund structure, which will depend on the target profile of your clients and the goal of the fund, among other factors.