10.4 Investor Eligibility Standards: Accredited Investors & Qualified Purchasers
Key Takeaways
- An individual qualifies as an accredited investor with income above $200,000 (or $300,000 jointly) in each of the two most recent years, or net worth above $1 million excluding primary residence.
- Since 2020, individuals may also qualify as accredited investors by holding a Series 7, Series 65, or Series 82 license, a knowledge-based rather than wealth-based test.
- A qualified purchaser is an individual owning at least $5 million in investments, a materially higher bar than accredited investor status.
- Section 3(c)(1) funds may admit up to 100 beneficial owners; Section 3(c)(7) funds admit only qualified purchasers but may have up to 1,999 investors before registration is triggered.
- Charging performance-based compensation requires the client to be a qualified client, defined by $1.1 million under management or $2.2 million net worth as adjusted in 2021.
10.4 Investor Eligibility Standards: Accredited Investors & Qualified Purchasers
1. Why Eligibility Tiers Exist
Private funds — hedge funds, private equity, private credit, venture capital, and most real asset partnerships — avoid registration under the Securities Act of 1933 and the Investment Company Act of 1940. In exchange for that exemption, they may only be offered to investors the regulatory framework treats as able to fend for themselves: capable of evaluating the offering, absorbing a total loss, and negotiating terms without the protection of mandated disclosure.
For a consultant, this is a threshold screen that precedes suitability analysis. A strategy that is appropriate for a client's objectives is irrelevant if the client is legally ineligible to invest, and recommending an unavailable product is a professional failure regardless of its merits.
2. Accredited Investor — Regulation D
The accredited investor standard, defined in Rule 501(a) of Regulation D, is the entry-level tier and governs most private placements.
Individuals qualify by any of:
| Test | Threshold |
|---|---|
| Income | More than $200,000 individually, or $300,000 jointly with a spouse or spousal equivalent, in each of the two most recent years, with a reasonable expectation of the same in the current year |
| Net worth | More than $1 million, individually or jointly, excluding the value of the primary residence |
| Professional licence | Holding a Series 7, Series 65, or Series 82 licence in good standing |
| Insider status | Director, executive officer, or general partner of the issuer |
| Knowledgeable employee | Of a private fund, with respect to that fund |
Two details are heavily tested. First, the income test requires the threshold to be met in both of the two prior years — a single high-income year does not qualify. Second, the primary residence is excluded from net worth, a change made by the Dodd-Frank Act in 2010; indebtedness secured by the residence in excess of its value is, however, counted as a liability.
The professional licence route was added by the SEC in an amendment adopted in August 2020 and effective in December 2020. It is significant conceptually: it was the first time eligibility could be established by demonstrated financial knowledge rather than wealth, addressing the long-standing criticism that wealth is a poor proxy for sophistication.
Entities generally qualify with more than $5 million in assets (if not formed specifically to acquire the securities), or where all equity owners are themselves accredited. Banks, insurers, registered investment companies, and certain plans qualify by category.
3. Qualified Purchaser — Investment Company Act Section 2(a)(51)
The qualified purchaser standard is a materially higher bar, and it exists for a different purpose: it determines whether a fund can rely on the Section 3(c)(7) exclusion from registration as an investment company.
| Category | Threshold |
|---|---|
| Individual (or joint with spouse) | At least $5 million in investments |
| Family-owned entity | At least $5 million in investments |
| Institutional / entity | At least $25 million in investments managed for its own account or others |
| Trust | Not formed for the purpose of the investment, where the trustee and each contributor is a qualified purchaser |
The critical technical point is that the test measures "investments," not net worth. Investments include securities, cash and cash equivalents held for investment, real estate held for investment purposes, and commodity interests — but exclude a primary residence, personal property, and real estate used in the conduct of a business. A client with a $5 million net worth concentrated in an operating business and a home is not a qualified purchaser.
4. Section 3(c)(1) versus Section 3(c)(7)
These two exclusions define the two dominant private-fund structures, and the exam expects candidates to distinguish them.
| Section 3(c)(1) fund | Section 3(c)(7) fund | |
|---|---|---|
| Investor standard | Accredited investors (in practice, for the Reg D offering) | Qualified purchasers only |
| Investor limit | 100 beneficial owners | Up to 1,999 before Exchange Act registration is triggered |
| Typical use | Smaller or emerging managers, early-stage funds | Large institutional hedge funds and private equity |
The trade-off is direct: a 3(c)(1) fund can accept less wealthy investors but is capped at 100 owners; a 3(c)(7) fund can accommodate far more capital but only from qualified purchasers. A separate "qualifying venture capital fund" provision permits up to 250 beneficial owners for smaller venture funds.
5. Qualified Client — Performance-Based Compensation
A third, independent standard governs fees rather than access. Under Rule 205-3 of the Investment Advisers Act, a registered investment adviser may charge performance-based compensation — a carried interest or incentive fee — only to a qualified client.
| Test | Threshold (as adjusted effective August 2021) |
|---|---|
| Assets under management with the adviser | At least $1.1 million |
| Net worth | More than $2.2 million (excluding primary residence) |
| Status alternative | A qualified purchaser, or a knowledgeable employee of the adviser |
These dollar amounts are adjusted for inflation every five years by SEC order, so a candidate should recall the mechanism as well as the current figures.
This standard is easy to overlook because it operates independently of fund access: a client may be eligible to invest in a fund and yet not be permitted to be charged an incentive fee by a registered adviser.
6. Applying the Tiers in Practice
| Client profile | Accredited? | Qualified purchaser? | Practical access |
|---|---|---|---|
| $250,000 salary two years running, $600,000 net worth | Yes (income test) | No | 3(c)(1) funds, Reg D private placements |
| $3 million investment portfolio, retired | Yes (net worth) | No | 3(c)(1) funds |
| $12 million investment portfolio | Yes | Yes | 3(c)(1) and 3(c)(7) funds |
| $6 million net worth, of which $4.5 million is an operating business and residence | Yes | No — investments below $5 million | 3(c)(1) funds only |
| Series 65 holder, $200,000 net worth | Yes (licence route) | No | 3(c)(1) funds |
The consultant's documentation obligation. Eligibility must be verified, not assumed. Rule 506(b) offerings permit reliance on investor self-certification, but Rule 506(c) offerings — those using general solicitation — require the issuer to take reasonable steps to verify accredited status, typically through tax returns, brokerage statements, or written confirmation from a licensed professional. Consultants should retain evidence of the eligibility determination in the client file, and should re-confirm status before subsequent commitments, since income and asset positions change.
A closing caution: eligibility is a floor, not a recommendation. Meeting the accredited investor threshold establishes only that a client may legally purchase an illiquid, high-fee, limited-transparency vehicle. Whether they should is a separate analysis grounded in liquidity needs, time horizon, concentration, and the client's capacity to bear a total loss.
A prospective client has a $6.0 million net worth consisting of a $3.0 million operating business, a $1.5 million primary residence, and $1.5 million in marketable securities. The client wants access to a Section 3(c)(7) hedge fund. What is the correct determination?
An individual earned $260,000 last year but $150,000 in the prior year, holds a Series 65 license in good standing, and has a net worth of $400,000 excluding a primary residence. Does this individual qualify as an accredited investor?
A registered investment adviser wishes to charge a 20% performance fee to a client who is an accredited investor with $700,000 under management and a net worth of $1.4 million excluding the primary residence. Is this permitted?